With the 2021 tax filing season ending and the 2022 year-end approaching, it is time to take stock of new and existing tax law that will impact your 2022 tax returns. In a typical year, the goal is usually to defer income or accelerate deductions to minimize current taxes. However, this year may be a little different for some and planning beyond 2022 is critical.
The following are a couple of new items that should be considered for the 2022 tax year.
Massachusetts “Millionaires Tax”
With the passage of Question 1 on the November 2022 ballot, commonly known as the Fair Share Amendment, starting in 2023 there will be an additional tax of 4 percent on Massachusetts personal taxable income in excess of $1 million. Until now, Massachusetts historically had a flat 5 percent tax rate, aside from the short-term capital gains rate of 12 percent.
This creates a situation where the general goal of deferring tax is not as advantageous if a permanent tax savings of 4 percent could be achieved by accelerating taxable income into 2022. Managing the timing of taxable income is not always in your control but there is some flexibility when it comes to flow-through business income which is reported and taxed personally to individual owners. Some examples include closing on the sale of a business prior to year-end instead of early 2023, delaying depreciation expenses or employee bonuses or, if filing on cash method of accounting, delaying payments on invoices and certain liabilities until the new year and/or collecting accounts receivable faster.
In terms of depreciation, Section 179 is often the preferred method of depreciating eligible fixed asset additions. This allows items to be fully expensed up to $1,080,000 for both federal and Massachusetts tax purposes, compared to bonus depreciation which allows for 100 percent (80 percent starting in 2023) expensed for federal tax purposes only. If your concern for 2023 is limited to the “Millionaires Tax,” bonus depreciation could be more beneficial by allowing you to maximize the federal benefit in 2022 while deferring depreciation deductions for Massachusetts purposes to 2023 and beyond when the deduction is worth more due to the higher marginal Massachusetts tax rate.
Capitalized Research and Development (R&D) Expenses
Historically, having R&D costs has been beneficial since they can generate a tax credit, while the costs incurred to generate the credit are fully deductible if the reduced credit is claimed. Under the Tax Cuts and Jobs Acts passed in December 2017, a delayed provision was included affecting tax years starting in 2022 which requires R&D expenses to be capitalized and amortized over 5 years (15 years if the activities are performed outside of the United States). The capitalization rules translate to a half year of amortization for 2022.
For example, a business that has $100,000 of R&D expenses in 2022, which would historically have been deducted in full, will only be eligible to deduct $10,000. The law change would increase taxable income by $90,000 for tax year 2022. The R&D expenses would eventually be deducted in full by year six. However, there would be additional taxable income each year due to the timing of the deductions.
There has been bipartisan support in Washington for the elimination or deferral of this change to R&D expenses as part of several acts, including the Build Back Better Act. However, no act or change has occurred to date. Although the potential remains for Washington to reverse this provision retroactively for the 2022 tax year, it would be prudent to plan for the compliance under the existing law and for the additional taxable income.
When it comes to tax planning, flexibility is needed to make sure current tax law is considered in order to minimize surprise tax bills in March and April when tax return (or extension) payments are due. This is the best time to reach out to your tax advisor and determine the best course of action that works for you based on your personal situation.
Michael Fullam is a Director at Citrin Cooperman, one of the nation’s largest professional services firms, helping companies and high net worth individuals find smart solutions. If you have questions on your tax filing, contact him at email@example.com.