Top 3 Federal Tax Law Changes that Could Affect Your Business Return
28 February 2023Every tax season, business owners must familiarize themselves with tax law changes that went into effect for that tax year. Fortunately, businesses don't have to contend with sweeping changes for 2022. But there are three major ones that could affect business taxpayers as they file federal income tax returns this year for 2022.
1. Reduced Cap on Deducting Business Interest Expense
Starting in 2018, there have been limits on how much business interest expense corporate and noncorporate taxpayers can deduct for the tax year. In general, under the Tax Cuts and Jobs Act (TCJA), a taxpayer's deduction for business interest expense for the year is limited to the sum of:
- Business interest income,
- 30% of adjusted taxable income (ATI), and
- Floor plan financing interest paid by certain vehicle dealers.
Interest expense that's disallowed under the limitation rules is carried forward to future tax years indefinitely and treated as business interest expense incurred in the carry-forward year.
To calculate ATI, businesses will need to adjust their taxable income for:
- Items of income, gain, deduction or loss that aren't allocable to a business,
- Any business interest income or business interest expense,
- Any net operating loss deduction,
- The deduction for up to 20% of qualified business income from a pass-through business entity,
- Any allowable depreciation, amortization or depletion deductions for tax years beginning before 2022, and
- Other adjustments listed in the proposed regulations.
Deductions for depreciation, amortization and depletion were added back when calculating ATI for tax years beginning before 2022. For tax years beginning in 2022 and beyond, the deductions for depreciation, amortization and depletion aren't added back. This could result in a lower interest expense limitation amount, which in turn will increase your taxable income.
Important: Small businesses with average annual gross receipts of $27 million or less for the three-tax-year period ending with the preceding tax year are exempt from the interest expense limitation rules for 2022. This threshold is indexed annually for inflation.
The interest expense deduction limitation rules get more complicated for businesses operating as partnerships, limited liability companies (LLCs) treated as partnerships for tax purposes and S corporations. Basically, the limitation is calculated at both the entity level and at the owner level. Special rules prevent double counting of income when calculating an owner's ATI for purposes of applying the limitation at the owner level. Contact your tax advisor for more information.
2. New Requirement to Capitalize Research Costs
Under the TCJA, starting in 2022, Internal Revenue Code Section 174 "research and experimental" expenditures must be capitalized and amortized over five years (15 years for research conducted outside the United States). Previously, businesses had the option of deducting these costs immediately as current expenses.
The TCJA also expands the types of activities that are considered R&D for purposes of Sec. 174. For example, software development costs are now considered R&D expenses subject to the amortization requirement.
Before capitalizing R&D expenses for 2022, businesses should analyze costs carefully to identify those that constitute R&D expenses and those that are properly characterized as other types of expenses (such as general business expenses under Sec. 162) that continue to qualify for immediate deduction. Businesses with significant R&D expenditures also should discuss eligibility for the R&D credit for 2022 with their tax advisors.
3. Reduced Limit on Deducting Corporate Cash Donations
C Corporations are subject to an annual deduction limit for monetary contributions to qualified charitable organizations. Prior to 2020, the limit was generally 10% of the corporation's taxable income for the year, subject to a five-year carryover.
Pandemic-related relief upped the ante for monetary contributions to 25% of taxable income for 2020 and 2021. In addition, the limit was increased to 100% for qualified disaster relief contributions made in cash during the period spanning January 1, 2020, through February 25, 2021. The 25% limit on qualified contributions made in cash for 2020 and 2021 was applied first without regard to any qualified disaster relief contribution. Excess contributions above the 25% limit could be carried forward for up to five years.
Under current law, the rule has reverted to 10% of taxable income for 2022 and thereafter. It's essential to keep detailed records of charitable donations. Your business should retain the records for at least three years in case the IRS challenges a write-off.
Important: Charitable contribution deductions can be claimed by pass-through entities, including S corporations, partnerships and LLCs. But write-offs for pass-through entities are claimed by the individual owners on their personal tax returns. Currently, individuals may deduct monetary contributions of up to 60% of adjusted gross income (AGI). The excess above the 60%-of-AGI limit may be carried over for up to five years.
Ready, Set, File
The countdown to Tax Day has begun. This year, corporate and individual taxpayers must file their 2022 returns by April 18, and S corporations and partnerships must file by March 15. Contact your tax professional for more information on these and other tax law changes for 2022.
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