“Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your attorney, CPA, and/or other advisors regarding your specific situation.”
This year we have experienced interest rate hikes, stock market volatility, and high inflation. Many businesses and families are feeling squeezed as we wind down 2022 which makes now is a good time to be reviewing your financial plans so you can capitalize as things recover. In this article, we will discuss considerations from recent tax policy and opportunities to minimize your tax bill.
Recent Legislation: Inflation Reduction Act
The Inflation Reduction Act of 2022 contains several tax provisions including:
A new 15% minimum tax on the book income of C corporations with more than $1 billion in profits.
An additional $80 billion in funding for the IRS over the next ten years. This is expected to increase federal revenue by more than $200 billion during the same period through increased review, audit, and enforcement. Specifically “high-end noncompliance” which does not include audits of those earning less than $400,000 per year. (See the last topic for areas of IRS focus.)
A new 1% excise tax on public corporations buying back their stock from shareholders, with certain exceptions.
Cost of Living Adjustments
The standard deduction for 2022 has been raised to $25,900 for married couples filing jointly, and $12,950 for single filers. To deduct state and local taxes, medical expenses, charitable giving, and home mortgage interest you will have to have expenses over the standard deduction. Each of these categories are also subject to their own limits.
Elective deferrals to 401(k) plans have been increased to $20,500 for 2022, and $22,500 in 2023. IRA contributions remained at $6,000 for 2022 and they have been increased to $6,500 in 2023. Individuals who are age 50 and over at the end of the calendar year can make annual catch-up contributions in the amount of $6,500 in 2022 and $7,500 in 2023 for a 401(k), and $1,000 for an IRA in 2022 and 2023.
For health savings accounts (HSAs), you can contribute $3,650 for self-only coverage and $7,300 for family coverage in 2022, and those amounts are increased to $3,850 and $7,750, respectively for 2023. If you are 55 or older at the end of the year, you can put in an extra $1,000 in “catch up” contributions for both 2022 and 2023.
The annual gift tax exclusion has been increased to $16,000 for 2022 and $17,000 for 2023.
Maximize Your Business Deductions (for Independent Contract Workers Too!)
When a business owner or independent contractor has a profit motive, they are allowed deductions against their business income that are “ordinary and necessary.” This is a big advantage over employees who have limited ways of reducing their earned income. The key to properly using business deductions to lower your taxes is to record the expense and save the receipt. Here are some tips to maximize tax deductions.
You do not need a legal entity to take business deductions on your tax return. If you are operating as an independent contractor under your personal name, or as a sole proprietorship, you are allowed to take deductions to offset business income from that activity.
Business Miles
Business miles between January 1 and June 30, 2022 are deductible at 58.5 cents per mile. From July 1 - December 31, 2022 business miles are deductible at 62.5 cents per mile. Commuting miles between your home and office building are not considered business miles.
Home Office Deduction
If your primary place of business is a home office for one of your business activities, you may qualify for the home office deduction. For example, if you work a W-2 job in an office, but you have a home office for your real estate LLC, then it will count as your primary place of business for that activity.
The second requirement is that the space in your home that you use as your home office must be used exclusively for business. Lastly, you do not need to own your home to take the home office deduction.
The deduction can be calculated as the business portion of actual expenses (make sure to have documentation) or the simplified method, which is $5 per square foot up to $1,500 (300 square feet). If you choose to use actual expenses, the transactions eligible for the deduction include mortgage interest, property tax, HOA fees, homeowners insurance, utilities, phone service, internet, maintenance, repairs, home improvement costs, and security. Keep in mind, when you take a home office deduction using the actual expense method for mortgage interest and property taxes, this reduces the amount reported as itemized deductions.
S Corporations
Highly profitable LLCs may benefit from electing to be taxed as an S Corporation. An S Corporation is a corporation that elects to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes, avoiding the double taxation on corporate income. This type of entity can be beneficial for business owner’s paying high self-employment taxes. It is important to be aware of the many administrative requirements of an S Corporation and they do have large disadvantages when it comes to owning rental real estate.
A cost benefit analysis should be run before electing S Corporation status.
1099-K Reporting
A common concern in 2022 has been from a reporting rule change for tax form 1099-K, thanks to a bill tucked inside the American Rescue Plan Act of 2021. A 1099-K is a summary of transactions sent to anyone who has received at least $600 in business transactions through a third-party settlement organization or peer-to-peer payment app. Prior to 2022, a 1099-K had a much higher reporting threshold.
The new reporting requirement does not change what is taxable income, and therefore should not be a concern for taxpayers. For business owners, your 1099-K will simply match what is already recorded on your books. Most people who do not own businesses will not be affected by this change, and if you do receive a 1099-K in error you will just need to explain your reasoning to the IRS.
Hopefully the increased funding at the IRS will provide a better level of service for taxpayers and professionals who need information. We will continue to update our Common Taxpayer Resources with the latest developments.
Opportunities to Reduce Capital Gains Taxes
Taxpayers should consider whether they can minimize their tax bill on capital gain income by considering the timing of their gain. Short-term capital gains (assets held for less than 1 year) are taxed as ordinary income, while long-term capital gains are taxed at preferential rates. Ideally, gains should be received in the year with the lower marginal tax rate, or when they can be offset by losses. Actions to consider that may result in a reduction or deferral in taxes include:
Delaying the sale of an asset until you have held it for at least one year to trigger preferential tax rates on your gain.
Delaying the sale of an asset to a year where you will be subject to the 0% long-term capital gains rate (2022: income less than $41,675 for single filers, and less than $83,350 for those filing jointly).
Structuring the sale of an asset as an installment sale to defer capital gains tax (a good strategy if you will be subject to 0% capital gains tax in the future and you do not have current needs for the proceeds).
Considering whether to trigger capital losses before the end of the year to offset gains.
Taxpayers who expect to be in a higher tax bracket in 2023 may want to consider potential ways to move capital gains into 2022, such that the taxable income is taxed at a lower rate.
Avoiding Required Minimum Distributions
You are required to take a distribution from your retirement account once you reach age 72. Not all retirement savers who have reached age 72 have a need for the money in their retirement accounts. Taxpayers who will be subject to Required Minimum Distributions (RMDs) can roll over some of their savings into a Roth IRA. Unlike a traditional IRA, 401(k), and even Roth 401(k), a Roth IRA does not require distributions. This means the money in a Roth IRA can continue to grow tax-free for as long as you want, and can be left to heirs.
You do have to pay taxes when moving pre-tax money from a retirement account into a Roth IRA, which can be expensive. Careful planning with your financial and tax advisor can allow you to optimize the timing and amount of savings you move to ensure that you are paying taxes at the lowest rates.
As of the writing of this article, there is legislation being considered that could push the age of your first RMD up to 75.
Cost Segregation Studies & Real Estate Professional Status
Rental property investments are a powerful wealth building tool as they can provide monthly cash flow and debt pay down, appreciation, and tax benefits. One of the best ways to supercharge the tax benefits related to rental property investments is to mix powerful deduction strategies with real estate professional status. Real estate professionals must spend at least 750 hours in qualified real estate activities, they must spend more time in real estate than their other jobs combined, and one taxpayer on the return needs to qualify. This means that if a married couple is funding their investments with one spouse’s time consuming W-2 job, the other spouse can meet the requirements of being a real estate professional and they both can take advantage of this election.
Being a real estate professional allows you to deduct your passive rental losses against your ordinary income. This is most effective when combined with a cost segregation study. A cost segregation study is a tax strategy designed to accelerate depreciation expense. This is achieved by reclassifying some of the components of a building from an asset with a long depreciable life into assets with shorter depreciable lives. Once these components are broken out, an accelerated tax deduction is achieved because those components can be written off over a shorter time period.
2022 and 2023 are exceptional years for a cost segregation study because of the 100% bonus depreciation allowance in 2022, which is being reduced to a still meaningful 80% in 2023. Here is our depreciation guide that explains the phase-out of bonus depreciation.
It is important to note that because of the detailed reporting that the IRS requires in order to take the accelerated depreciation adjustment, it is recommended the cost segregation study be completed by a firm that specializes in the field.
While accelerating depreciation does not mean that you receive extra depreciation, if your otherwise profitable property can provide a large tax loss through depreciation deductions, the tax savings can be significant. Tax free cash flow!
Always remember, tax savings are icing on the cake. Do not make a bad investment just to save money on taxes.
20% Deduction on Rental Income
Rental property owners can take advantage of the 20% qualified business income deduction (section 199A deduction) using a safe harbor issued in Revenue Procedure 2019-38. This can be a meaningful tax saving strategy for those who have profitable rental properties if executed correctly.
The following requirements must be met by taxpayers to qualify for the safe harbor:
Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise. (If you haven’t done a good job of this in the past, it might be worth hiring a professional bookkeeper.)
For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year. For other rental real estate enterprises, 250 or more hours of rental services are performed in at least three of the past five years.
The taxpayer maintains contemporaneous records, including time logs, reports, or similar documents regarding the following: hours of all services performed; description of all services performed; dates on which such services were performed; and who performed the services.
The taxpayer attaches a statement to the return filed for the tax year(s) the safe harbor is relied upon.
This deduction can even be used for those House Hacking if the requirements are met.
Many of these requirements can be satisfied using the application “REPS Tracker.” The application is also useful for those claiming real estate professional status.
Areas of IRS Focus
Cryptocurrency: Be sure that you have a method for tracking your sale proceeds and investment basis when investing in digital assets. Many platforms are strengthening their tax reporting, but others have gone bankrupt with the recent decline in digital asset values causing tax reporting efforts to fall, leaving the burden of tracking on the taxpayer.
Independent Contractor Issues: If you are an employer, make sure that you understand the difference between employee and independent contractor classification and treat your team accordingly. If you are an independent contractor, make sure that you have a process for tracking income and deductible expenses.
S Corporation Distributions vs Salary: Be sure to work with a payroll provider who understands the officer compensation requirements for an S Corporation.
Treat your accountant as a part of your financial team by communicating transactions and questions you have with them. We believe that the best tax plans are simple and understood by the taxpayer, with some coaching from a tax accountant. Procrastinating and poor records is a recipe for overpaying on your tax bill in any year. On the contrary, most taxpayers are surprised to see how much organized records, good bookkeeping, and timely communication can save them on taxes.
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