Tax

Article Dean Dorton

A cost segregation study is an analysis performed by trained professionals to identify property that should be classified as tangible personal property or land improvements, rather than real property that is depreciated over 27.5 or 39 years. This allows the taxpayer to identify property that can be depreciated over 5, 7, or 15 years instead of the 27.5 or 39 years that typically apply to real estate. This acceleration of deductions results in substantial tax savings benefits.

Cost segregation studies apply to both newly acquired or constructed property, leasehold improvements/fit-ups, and property that was placed in service in prior years (post 1986). For property placed in service in prior years, the IRS allows a “catch up” deduction in year 1 for the additional depreciation deductions that are identified in a cost segregation study that you were entitled to but did not claim in previous years. This can generate substantial tax savings in the first year of the study.

There is no limitation on the cost of property that is eligible for a cost segregation study. The benefit of a study for a smaller building will be less than that of a larger property, but may still be beneficial. We have worked with several industries to provide cost segregation studies including auto dealerships, banks, commercial and residential property owners, medical facilities, and manufacturing facilities.

Bonus depreciation and Section 179 expense elections allow taxpayers to write off 100% of qualified tangible property with a recovery period of 20 years or less. Thus, the 5, 7, and 15 year property that is identified in a study may qualify for this additional depreciation deduction that wouldn’t normally be identified if the property was being depreciated over 27.5 or 39 years. These tax incentives for 2022 make cost segregation studies even more beneficial for the current tax year as it applies to both newly constructed and existing properties. Similar tax incentives are also available for property placed in service in tax years 2008-2021. After 2022, bonus depreciation begins to phase out, with qualifying property getting an 80% bonus deduction in 2023 and reducing by 20% each year following 2023 until it sunsets in 2027.

One of Dean Dorton’s most recent cost segregation studies was performed on a $13.5 million retail shopping center purchased in 2021. That study generated $1,168,876 of tax savings in the first year. The present value of accelerated deductions (discounted at 7%) exceeded $722,032. The return on investment for this study was 95.5 to 1.

Dean Dorton uses an Indianapolis-based engineering firm to provide cost segregation studies to our clients. This engineering firm conducts studies that conform to the Cost Segregation Audit Techniques Guide issued by the IRS. They have reviewed over $3.8B of assets and have increased cash flow of over $300M. They have successfully defended all challenges brought forth by the IRS.

We work in tandem with your CPA, whether you are served by a large international firm, a regional firm, or a local accountant, to serve your best interests and save you money.

Brandi Gillen, CPA
Tax Associate Director
bgillen@deandorton.com • 859.425.7678

Article Dean Dorton

Yesterday afternoon, President Biden signed into law the Inflation Reduction Act of 2022 (“IRA”). The IRA includes provisions intended to combat climate change, promote clean energy, and lower prescription drug and health care costs. To pay for its spending, the IRA contains several tax changes, although the tax provisions are much narrower than those proposed in the Build Back Better Act that failed to progress in Congress last fall.

Notably, the IRA extends, through 2028, the limit on excess business losses (“EBL”) that can be deducted by noncorporate taxpayers. It also appropriates $80 billion to the Internal Revenue Service for enforcement, taxpayer services, operations support, and modernization, which could lead to increased audit activity. On a positive note, the IRA contains several tax incentives for individuals and businesses related to clean energy. Other tax provisions include a new corporate alternative minimum tax, an excise tax on the repurchase of corporate stock by publicly-traded companies, an increase in the research credit against payroll taxes for small businesses, and changes to the premium tax credit.

Extension of Limit on Excess Business Losses

The Tax Cuts and Jobs Act (“TCJA”), enacted at the end of 2017, introduced a limit on business losses deductible by individuals and other noncorporate taxpayers (trusts and estates) against non-business income. Specifically, the TCJA disallowed 2018 net tax losses from active businesses in excess of $250,000 (for individual taxpayers) and $500,000 (for joint filers), adjusted annually for inflation. Disallowed losses are converted into a net operating loss (“NOL”) and carried over to the following tax year. Under the TCJA, the EBL limit was effective for tax years 2018 through 2025.

In March of 2020, the CARES Act retroactively postponed the effective date of the EBL limit until tax years beginning in 2021. The American Rescue Plan Act of 2021 (“ARP”) later extended the EBL limit for one year, through 2026.

The IRA provides for a two-year extension of the EBL limit, through 2028. To illustrate the impact of this limitation, consider the following example:

H and W are married taxpayers filing a joint return. In 2022, H generates a net tax loss from his business of $600,000 and W generates a net tax loss from her business of $240,000. Both H and W actively participate in their businesses. Their aggregated net tax loss from trades or businesses is $840,000. For tax year 2022, the EBL limit is $540,000 for joint filers. Thus, their EBL for 2022 is $300,000 ($840,000 – $540,000).

How does this limitation impact the taxable income of H and W?

Let’s assume that, in addition to the losses generated from their businesses, H and W have other investment income totaling $1,000,000. The following table illustrates how taxable income is calculated before and after the EBL limit:

<table style="border-collapse:collapse;border:none;">
    <tbody>
        <tr>
            <td style="width: 197.75pt;border: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>&nbsp;</p>
            </td>
            <td style="width: 134.85pt;border-top: 1pt solid windowtext;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-image: initial;border-left: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>Before EBL limit</strong></p>
            </td>
            <td style="width: 134.9pt;border-top: 1pt solid windowtext;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-image: initial;border-left: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>After EBL limit</strong></p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Investment income</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><span style="color:black;">$1,000,000</span></p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><span style="color:black;">$1,000,000</span></p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>H&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($600,000)</p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($600,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>W&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($240,000)</p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($240,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Excess business loss (see above)</p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$0</p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$300,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 197.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'><strong>Net taxable income</strong></p>
            </td>
            <td style="width: 134.85pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>$160,000</strong></p>
            </td>
            <td style="width: 134.9pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>$460,000</strong></p>
            </td>
        </tr>
    </tbody>
</table>

While H and W cannot reduce their 2022 taxable income by the $300,000 EBL, this loss is converted to a NOL and carried over to the following year. H and W can use the NOL in 2023 to offset up to 80% of their taxable income. To illustrate, let’s assume that H and W have the exact same facts as above for 2023. Their 2023 taxable income would be calculated as follows:

<table style="border-collapse:collapse;border:none;">
    <tbody>
        <tr>
            <td style="width: 332.75pt;border: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>&nbsp;</p>
            </td>
            <td style="width: 134.75pt;border-top: 1pt solid windowtext;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-image: initial;border-left: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>2023</strong></p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Investment income</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$1,000,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>H&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($600,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>W&rsquo;s active business loss</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($240,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Excess business loss (see above)</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$300,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>Net taxable income before NOL carryover</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>$460,000</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'>NOL carryover from 2022 (lesser of NOL of $300,000 or 80% of taxable income before NOL ($368,000))</p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'>($300,000)</p>
            </td>
        </tr>
        <tr>
            <td style="width: 332.75pt;border-right: 1pt solid windowtext;border-bottom: 1pt solid windowtext;border-left: 1pt solid windowtext;border-image: initial;border-top: none;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:  justify;font-size:15px;font-family:"Arial",sans-serif;'><strong>Net taxable income after NOL</strong></p>
            </td>
            <td style="width: 134.75pt;border-top: none;border-left: none;border-bottom: 1pt solid windowtext;border-right: 1pt solid windowtext;padding: 0in 5.4pt;vertical-align: top;">
                <p style='margin-top:0in;margin-right:0in;margin-bottom:.0001pt;margin-left:0in;text-align:center;font-size:15px;font-family:"Arial",sans-serif;'><strong>$160,000</strong></p>
            </td>
        </tr>
    </tbody>
</table>

As illustrated above, the EBL limit is merely a timing issue. Fortunately, the IRA only extends the limit for two more years and does not make further changes to current law, such as the conversion of disallowed losses into a NOL.

Increased IRS Funding

As noted above, the IRA appropriates $80 billion to the IRS for enforcement and other activities. The $80 billion is appropriated over a ten-year period and approximately broken down as follows:

  • $3.2 billion for taxpayer services;
  • $45.6 billion for enforcement;
  • $25.3 billion for operations support; and
  • $4.8 billion for business systems modernization.

An additional $15 million is appropriated to the IRS with a directive to report to Congress on the potential development of an IRS-run e-file system.

The IRA does not instruct the IRS on how to spend this additional funding with respect to enforcement activities. However, in a letter Congress on August 4, the IRS Commissioner stated that the agency’s investment of these additional resources would follow the Department of Treasury’s directive that audit rates will not rise relative to recent years for households making less than $400,000. Instead, the letter stated that the IRS would “pursue meaningful, impactful examinations of large corporate and high-net-worth taxpayers to ensure they are paying their fair share.”

Clean Energy Incentives

Investment in clean energy is a focal point of the IRA, and the law contains several tax incentives for both businesses and individuals. Notable clean energy incentives include, but are not limited to, the following:

  • Modification and extension of the credit for nonbusiness energy property – This credit, which applies to energy-efficient windows and doors, in addition to certain HVAC systems and heat pumps, is extended through 2032. The $500 lifetime limit for the credit is replaced with an annual limit of $1,200.
  • Modification and extension of the credit for residential energy-efficient property – This credit is renamed the “residential clean energy credit” and extended through 2034. It applies to residential energy-efficient property installed in a dwelling unit used as a residence by the taxpayer, such as qualified solar electric property, solar water heating property, fuel cell property, small wind energy property, and geothermal heat pump property.
  • Modification and extension of the clean vehicle credit – The credit for the purchase of clean vehicles, such as plug-in electric vehicles, is extended through 2032. The IRA eliminates the current cap on the number of credit-eligible vehicles produced by a specific manufacturer. However, it also imposes sourcing requirements on a vehicle’s critical components and battery systems. For example, electric vehicles made with any battery components manufactured by “foreign entities of concern” would be ineligible to receive the credit after 2023. The IRA also imposes a new credit limit based on the taxpayer’s income. The credit is not allowed if a taxpayer’s modified adjusted gross income exceeds $150,000 (for individual taxpayers) or $300,000 (for joint filers). The maximum credit per vehicle remains at $7,500.
  • Credit for previously-owned clean vehicles – A new credit of up to $4,000 is created for the purchase of a previously-owned clean vehicle. The credit applies only to taxpayers whose modified adjusted gross income does not exceed $75,000 (for individual taxpayers) or $150,000 (for joint filers). The credit applies to vehicles acquired after 2022 and before 2033.
  • Credit for commercial clean vehicles – The IRA creates a new business credit for qualified commercial clean vehicles acquired after 2022 and before 2033. The maximum credit per vehicle is $7,500, or $40,000 for a vehicle with a gross vehicle weight rating of at least 14,000 pounds.

The IRA also appropriates funds for the establishment of state rebate programs geared towards low- and middle-income households that purchase energy-efficient appliances.

Other Provisions

  • Corporate Alternative Minimum Tax – Effective for taxable years beginning after 2022, the IRA imposes a new, 15% corporate alternative minimum tax on the adjusted financial statement income (“AFSI”) of large corporations. The minimum tax applies to C corporations which, for a three taxable year period, have average annual AFSI greater than $1 billion. A lower threshold applies to foreign-parented corporations that are members of an international financial reporting group. S corporations are not subject to the minimum tax.
  • Excise Tax on Repurchase of Corporate Stock – The IRA also establishes a new excise tax on the repurchase of certain corporate stock. An excise tax of 1% is imposed on the fair market value of stock repurchased by a publicly-traded U.S. corporation during the taxable year. Several exceptions apply, including an exception in any case in which the total value of the stock repurchased during the taxable year does not exceed $1 million. The excise tax applies to repurchases of stock after 2022.
  • Increase in Research Credit Against Payroll Taxes for Small Businesses – Under current law, taxpayers engaged in research and development activities may be eligible for a research credit against their income tax liability. Small businesses that meet certain requirements may elect to apply the credit against their payroll tax liability. The amount of the credit that can offset a taxpayer’s payroll tax liability currently is limited to $250,000. The IRA increases this amount to $500,000 for taxable years beginning after 2022.
  • Changes to Premium Tax Credit – Taxpayers who purchase health insurance through the Health Insurance Marketplace may be eligible for a premium tax credit under current law. Eligibility for the credit depends on various factors, including a taxpayer’s household income, family size, and the federal poverty line. For 2021 and 2022, the ARP expanded eligibility for the credit to individuals with household income in excess of 400% of the poverty line and increased the credit amount for qualifying taxpayers. The IRA extends these enhancements to the credit through 2025.

Article Dean Dorton

The General Assembly did not forget property taxes when making its 2022 tax changes, but only one change has an impact on a significant number of taxpayers. In House Bill 6, the Legislature changed, as of January 1, 2022, the assessed value of used motor vehicles. The statutory change rolls back the 2022 assessed value to the 2021 value of the vehicle. As a result, motor vehicle owners who paid tax in January, February, or March of 2022, are entitled to refunds in an amount equal to the difference between the tax paid based on the January 1, 2022 assessed value and the tax due based on the January 1, 2021 value. If you recently received a check from the Kentucky State Treasurer in the range of $40-$50, it is highly likely that the check represents your refund of the tax. Property valuation administrators began using the 2021 values in April 2022, eliminating the need for additional refunds. The 2021 assessed values are to be used again in 2023.

There are two industry specific property tax changes made in House Bill 8. One change applies to “public service companies,” examples of which are gas and electric utilities. The other change is for manufacturers or retailers of prefabricated homes being held for sale. If you fit within either of these categories, contact your Dean Dorton or other tax adviser.

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It’s tax time, whether we like it or not, and the United States 2021 tax filing deadline, this year falling on April 18, 2022 is rapidly approaching! Below are some helpful tax reminders for equine industry participants as they complete their 2021 tax returns.

COVID-19 Related Economic Stimulus Programs

  •  The Paycheck Protection Program (PPP) ended on 5/31/21. If a PPP loan was forgiven before 2022, the loan forgiveness, which is non-taxable, should be reported on either a 2020 or 2021 tax return. There are also some 2021 additional reporting requirements for S corporations which previously reported the loan forgiveness on a 2020 tax return based on recent guidance issued by the IRS in 2022.

  • Employee Retention Credits concluded as of 10/1/21 for most. Credits for voluntary employer-provided paid sick and family leave for various COVID-19 related reasons expired 9/30/21.

  • For those who deferred the payment of 2020 employer payroll taxes, 50% of these were due by 12/31/21 with the remaining 50% due by 12/31/22. 

Depreciation

  • 100% bonus depreciation is available on purchases of qualifying assets that were placed in service during 2021 and 2022. Examples of qualifying assets may include yearlings, racehorses, breeding stock, equipment, fencing, land improvements and barns. Bonus depreciation is most commonly used by industry participants since it is not limited to taxable income and may be used to create or increase a tax loss. 

  • Yearlings may use the 3-year depreciation life through 2021
  • NEW farm equipment may use 5-year (versus 7-year) life

Deductions

  • Meals purchased at restaurants (including racetracks and at the sales) are 100% deductible in 2021 and 2022. These are normally only 50% deductible for tax purposes.

  • Cash donated by individuals to public operating charities during 2021 may be eligible to offset up to 100% of adjusted gross income. This limitation returns to 60% in 2022.

  • For profitable businesses owned by individuals, there may be a 20% qualified business deduction available. 

Other Items of Caution

  • Excise Business Loan Loss –

    The excess business loss limitation returns for individuals, trusts and estates in 2021 and remains through 2026 under current law. This limits the 2021 net business loss to ($262,000) or ($524,000) if filing a joint return. The excess above this limitation is treated as a net operating loss (NOL) carryforward available to offset taxable income in future years, subject to the regular NOL carryforward rules. 

  • Hobby Loss Rules –

    Attention should be paid to the hobby loss rules, which require that gross revenues be included in taxable income with no offset for any of the related expenses if an activity is treated as a hobby. The 100% bonus depreciation accelerates tax losses and tax losses sustained over a period of time may cause an IRS audit. Industry participants should employ good business practices and document the steps being taken to make a profit. 

  • Other Transactions –

    There are some additional reporting requirements for individuals who participate in virtual currency transactions (including using the virtual currency to purchase goods or services or accepting virtual currency for goods or services), for partnerships to report gross revenues and expenses for foreign tax credit purposes (even if the partnership does not have any foreign activity), and some basis reporting forms for S corporation shareholders who report losses.

This summary addresses Federal tax reminders. State tax treatment may vary and many states have not adopted the more favorable Federal tax incentives noted above.

Contact your Dean Dorton advisor with questions.

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State tax laws continue to change rapidly throughout the country. Have you wondered about potential tax liability to other states? This survey asks just a few of the  questions states ask when determining whether a business is subject to its taxes – income, franchise, or sales and use. The weight of interpretation given to specific questions may vary from state to state.

Thinking of the states other than those in which you are already paying or collecting and remitting taxes, answer the following ten questions for each of state.

  1. Are you registered with the Secretary of State?
  2. Do you hold a business license?
  3. Do you have fixed assets or leased property?
  4. Do you have payroll in the state?
  5. Do you have independent contractors working on your behalf?
  6. Do you make sales via the internet, an app, a catalogue, or by phone?
  7. Does your total revenue from the prior year exceed $25,000?
  8. Does your total payroll exceed $25,000?
  9. Do your total sales exceed $100,000?
  10. Does your total property, total payroll, or total sales exceed 25%?

If you answered “yes” to any one of these questions, it is possible that you have a reporting or filing obligation in the state. While a lot of business owners say the prefer to “roll the dice,” that strategy can be expensive. To learn more about your potential exposure in other states, contact us or your tax advisor.

Contact your Dean Dorton advisor or other professional adivsor for more information.
If you don’t have an advisor, but would like to speak with us, send an email to:
insights@deandorton.com

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Tax planning for 2021 is just as complicated as it was for 2020 for many due to the following major factors:

  • The impact on business profits, cash flow, and activity of the continued COVID-19 pandemic and the related government assistance programs, and
  • The current uncertainty about future tax law changes in proposed legislation.

Discussions of all the “what-ifs” are beyond the scope of this article, and our planning ideas will focus on the short-term – reducing 2021 taxes. We recommend you consult your tax advisor if you believe your situation is particularly impacted by unusual circumstances.

Maximize pre-tax deductions – Determine if you are on track to have 2021 maximum amounts withheld from your paycheck for your retirement plan deferrals, HSA contributions, dependent care benefits, and other pre-tax options with your employer. If you are not going to maximize these, consider having additional amounts withheld from year-end bonuses, if possible. Also, consider increasing these amounts for 2022.

Capital gains and losses – If you have realized net capital gains during 2021, consider realizing capital losses before the end of the year to offset the gains. Remember that net long-term losses can be used to offset net short-term capital gains which otherwise would be taxed as ordinary income. Also, be aware of the “wash sale” rules if you are inclined to reinvest in a security you sell at a loss.

Bonus depreciation & Section 179 – Businesses should consider these tax breaks related to fixed asset acquisitions:

  • Special “bonus depreciation” allowance. For 2021, 100% of the cost of qualifying property (includes used assets) is deductible if the property is placed in service by year end. This deduction can create or increase an existing business loss. Note: Because its requirements are much less restrictive, 100% bonus depreciation usually will make Section 179 not applicable.
  • Section 179 depreciation deduction. In 2021, individuals and business entities can elect to deduct up to $1,050,000 of qualifying business property cost in the year the property is placed in service. The deduction is reduced dollar-for-dollar for qualifying property cost greater than $2,620,000. This deduction is available only to the extent of positive business taxable income.

Self-employed retirement plans – If you have self-employment income and don’t have a retirement plan in place to shelter any of it, you may qualify to use a Self-Employed Plan (SEP). A SEP contribution deduction is allowed for 2021, even if the SEP is created and funded at any time up to the due date, including extensions, of your 2021 income tax return in 2022. Depending on the amount of self-employment income, you could fund (and deduct) up to $58,000 for 2021.

Required minimum distributions (RMDs) – Individuals with traditional IRAs and most individuals with employer-sponsored qualified retirement plan accounts are required to take minimum annual distributions from the account upon reaching a certain age, most recently changed to 72.

Charitable contributions – Depending on your situation, it may be beneficial to accelerate planned 2022 charitable contributions into 2021 or to defer 2021 contributions into 2022 to bunch them into the same year for greater tax savings.

Due to the CARES Act, the deduction limit on cash charitable donations has increased from 60% to 100% of adjusted gross income for contributions made in 2021 (note that the contributions must be to public charities or churches, not private foundations or donor-advised funds to qualify for the increased percentage). Contributions of most non-cash assets remain limited to 30% of adjusted gross income. For taxpayers who do not itemize their deductions, up to $300 of charitable contributions are allowed to be deducted this year even without itemizing.

Annual gifting – You may give your children and others up to $15,000 each in 2021 without any gift tax consequences. This annual exclusion is calculated on a per donee basis and no carryover is allowed for the unused exclusion. Consider making year-end gifts to fully utilize this year’s annual exclusion.

Roth IRAs – With individual tax rates at the lowest levels in recent memory, consider conversion of IRAs to Roth IRAs. The current tax cost from a conversion done now may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. Also, consider making a backdoor Roth IRA contribution, if your current income level is too high to make a direct Roth IRA contribution. A backdoor Roth IRA contribution consists of making a nondeductible IRA contribution followed by a conversion of the contributed funds to a Roth IRA. The rules regarding this are very particular so please consult with your tax advisor regarding this strategy.

HSAs & FSAs – Health Savings Accounts (HSAs) and Flexible Savings Accounts (FSAs) are two separate tools, each helping convert your dollars spent on medical expenses from post-tax into pre-tax, potentially saving you up to 42% of the cost. An HSA is a bank account set up to pay for medical expenses and must be paired with a high-deductible health plan. FSAs allow you to direct some of your wages into a pre-tax account, and your employer will reimburse you from the account for your documented medical expenses. Specific funding rules and limits apply to these accounts.

S Corporation and partnership losses – If your S Corporation will generate a tax loss this year, consider whether you have enough basis in the stock (or in loans you’ve made to the corporation) to take the full loss. If you don’t, additional investments should be considered. Similar considerations can arise in some situations with partnerships expecting tax losses.

Excess Business Loss – The Tax Cuts and Jobs Act (TCJA), passed in late 2017, introduced a limitation on business losses deductible by individuals and other non-corporate taxpayers (trusts and estates) against non-business income.  Specifically, the TCJA disallowed net tax losses from active businesses in excess of $250,000 ($500,000 for joint filers), adjusted annually for inflation. For pass-through entities, this is calculated at the owner level, as tax-paying persons combine all business activities when determining overall net business income or loss. Disallowed losses are treated as net operating loss carryforwards to the following year. Under the TCJA, the excess business loss (EBL) limitation was effective for 2018 through 2025. The CARES Act retroactively postponed implementation of the EBL limitation until 2021. The EBL limitation for 2021, as adjusted for inflation, is $262,000 (or $524,000 for joint returns).