Now that tax filing season has arrived, entrepreneurs need to be mindful of changes that could impact their businesses. Many tax breaks introduced during the pandemic are set to expire this year and must be reconsidered carefully before filing tax returns.
These annual adjustments are intended to prevent bracket creep, in which inflation leads to taxpayers moving into higher tax brackets involuntarily.
1. Bonus depreciation
Tax accounting requires companies to depreciate (deduct) the costs associated with business assets over their useful lives, known as depreciation. This practice reduces net earnings and decreases overall tax liabilities for an organization.
Congress devised bonus depreciation as part of its efforts to stimulate the economy, providing more immediate and significant deductions on newly purchased equipment. For a limited-time period starting September 27th 2017 until January 1st 2023, this law offers 100% depreciation on qualifying property placed into service between those dates.
Depreciation deductions offer startups an effective way to reduce short-term tax liabilities and free up funds for expansion. But keep in mind that they will begin phasing out after 2023 – plan ahead accordingly and capitalize while you still can! If you are unfamiliar with depreciation or have not planned for its changes, speak to your tax professional before making any significant purchases.
2. R&D expense amortization
R&D expenses were once treated as immediately deductible expenses; this changed with the Tax Cuts and Jobs Act’s amendments to IRC Section 174 in 2022, when companies must now amortize R&D costs over five years domestically performed research and 15 years when conducted abroad. This shift has major ramifications for startups as their tax statements must now include amortization calculations every year.
Startup software developers with multiple employees often face higher tax bills that have devastating repercussions for them and their business. Mortgage payments become unsustainable; lines of credit become scarce and even layoffs must be considered in an industry suffering from overvalued valuations that have since declined precipitously.
State-level business tax reductions are providing some respite. A grassroots effort among small software developers to restore full R&D expense depreciation has gathered pace; these businesses hope their elected representatives listen before it is too late.
3. Alternative minimum tax
Concerns that wealthy taxpayers were dodging their fair share of taxes by taking advantage of personal deductions and preferences led to the development of the individual alternative minimum tax (AMT), which operates alongside regular federal income tax rules with its own set of rules and rates to allow deductions not otherwise allowable under regular taxes. The AMT operates alongside regular federal income taxes but offers additional deductions not permitted through regular filing requirements.
Software development companies have expressed alarm at upcoming AMT bills due to reliance on costly talent for success. While full R&D expense expensing was allowed for five years under TCJA, that benefit begins to phase out at the start of 2023.
Empowerment Zone Employer Credit will only last five years before gradually decreasing from 2024 on. Individual income tax rates in many states have also seen dramatic reductions, providing small business owners who file under personal taxes a boost – New Hampshire saw its business profits tax drop from 7.6 percent to 7.5 percent starting January 1. Furthermore, its interest and dividends tax will begin being phased out starting 2023 making New Hampshire one of nine no-income-tax states!
4. Net investment income tax
As is the case with income tax brackets, the standard deduction is receiving an annual increase to keep up with inflation. By 2023 it will reach $13,850 for single filers and $27,700 for married couples filing joint returns.
NIIT, or Net Investment Income Tax, is a 3.8% surcharge imposed upon investment income earned by high-income taxpayers who surpass certain threshold amounts. It applies to individuals, estates and trusts who receive investment income such as capital gain distributions from mutual funds, rental property income, royalty or annuity income produced by businesses trading financial instruments or commodities.
NIIT, or net investment income tax, is often considered to be a “stealth” tax since its impact may go undetected when filing federal returns. Investors should remain mindful of NIIT and consider filing IRS Form 8960 along with their returns to determine if they owe it.
