Year-end tax planning considerations

ARTICLE | November 04, 2022

Authored by RSM US LLP

What actions can business and individual taxpayers take to advance toward their goals?

Taxpayers have grown stronger over the past three years because they have learned to adapt. They can now apply that hard-earned experience, resilience and flexibility to planning and action items for 2023. Whether you are an individual attending to your wealth strategy or a business dealing with various policy and economic uncertainties, you can take action to move forward.

A rapidly evolving legislative and economic landscape heightens the urgency for individuals and business owners to prioritize a comprehensive wealth planning strategy. Strengthening the family legacy will require diligent care to prepare for increased enforcement efforts and leveraging tax-saving opportunities while they still exist. 

“Uncertainty is the only certainty we have,” said Andy Swanson, partner in RSM’s Washington National Tax practice. “If you want to make lemonade out of lemons, start planning now for the best possible outcomes.”

Given increased audit activity by the IRS, high-income taxpayers can improve outcomes by preparing solid documentation and by working with their advisors to understand risk areas, including passive activity losses and technicalities within the law. 

“We have seen situations where the IRS is following strict rules and disallowing entire deductions, particularly with charitable contributions, or the planning and documentation was a little sloppy,” said Amber Waldman, a senior director who specializes in high net worth individuals for RSM’s Washington National Tax practice. 

Considering the undeniable economic headwinds and uncertainty around tax policy changes, individual taxpayers can manage liquidity by making cash flow projections ahead of estimated tax payments. Focusing on charitable contributions, harvesting losses and taking advantage of state and local tax deductions can help mitigate tax bills that are higher than expected. Interest rate planning and pass-through entity tax elections are two strategies worth considering in the current environment.

Gift and estate planning, meanwhile, involves some time-sensitive opportunities. For example, under the Tax Cuts and Jobs Act, a couple that starts making gifts in 2023 can pass on a lifetime total of $25.84 million. But that unified exemption is scheduled to sunset at the end of 2025.

Also, some planning tools are relatively advantageous in a higher-interest-rate environment, such as a charitable remainder annuity trust (CRAT) and a qualified personal residence trust (QPRT). Meanwhile, there is still uncertainty around grantor trusts and discounting, so it’s important to be aware of potential changes to current rules.

Swanson shared three guiding principles for taxpayers to apply when planning this year: 

1. Take small wins while you can. They will add up. For example, capturing losses in your investment portfolio throughout the year.
2. Be prepared, as there is a lot of volatility in the market. Waiting for an event to occur may mean missing out on existing opportunities. 
3. Be aware of potential changes to tax policy so there are no surprises if they happen. 

Access RSM's 2022 tax planning considerations for families and individuals

Energy credit opportunities created through the Inflation Reduction Act could be a windfall for companies investing in clean energy initiatives—and these opportunities to improve cash flow apply to organizations well beyond the energy and industrial sectors.

The IRA included $369 billion in new funding related to climate and more than $250 billion for energy credits. These aspects of the legislation zero in on three main areas: job creation, reducing the dependence on foreign-sourced materials, and the reduction of greenhouse gas emissions.

“Many people think of energy credits just as wind and solar, but this legislation is much broader,” said Debbie Gordon, RSM principal and leader of the firm’s Washington National Tax excise and energy tax practice. “It affects many different industries.”

Take, for instance, a grocery store chain that wants to go green; the business might consider installing solar panels on the roof of its facilities or investing in commercial electric vehicles. That company might qualify for investment tax credits related to those specific projects, as well as potential increased credit rates if it uses domestically sourced materials for those investments, and possibly other state and local benefits on top of that.

“In terms of cash flow, one of the most important things to discuss is how to monetize these credits within the IRA,” said Dana Jackson, RSM partner and leader of the firm’s federal credits and incentives practice.

Companies that want to maximize the potential of these energy credits should be thinking about:

• Clean energy assessments: A third-party advisor can help your business understand which current projects might be eligible for credits, as well as the eligibility of projects planned.
  
• Project planning: Some of these credits don’t go into effect for a few years, and teams may need that time to ramp up and get the necessary technology in place.
• Financial impacts modeling: Businesses will need to assess which credits may be more lucrative, which ones may be taken together, and which ones may not be stackable.
  
• Transferability: Some companies may want to explore transferability or sale of these credits, whether through a state exchange or on a direct basis. “From a buyer perspective, you want to make sure that you’re buying something that is free and clear of any potential auditor clawback,” said Rob Calafell, RSM principal and the firm’s state and local credits and incentives practice leader.  

 Other important areas of consideration include contract negotiations, clauses for prevailing wage and apprenticeship, tax insurance and the timing of state incentives.

State fiscal situations over the last two years have been stronger than ever. The vast majority of states reported revenue above projections. States have paid down debt, increased pension payments and returned money to taxpayers. Through mid-fiscal year 23, almost all states are running surpluses over current projections.

And yet…

“If macroeconomic conditions deteriorate, that could change the health of state fiscal conditions very quickly, sometimes within one fiscal year,” said Mo Bell-Jacobs, senior manager who specializes in state and local taxes in RSM’s Washington National Tax.

Inflation and other economic headwinds are warning signs against complacency for state revenue departments and, by extension, state and local taxpayers. Yes, individual income tax collections have skyrocketed over the last eight months. Yes, sales tax revenue has climbed similarly. Yes, wages and compensation remain high in a competitive labor market that figures to continue.

But year-end state and local tax planning discussions should note that pace of growth is likely unsustainable. The U.S. economy contracted in each of the first two quarters of 2022, and inflation reached its highest level in four decades. Higher prices have helped sales tax collections, but taxpayers should be prepared to reach a tipping point for employment and consumption.

“There are some worries out there in talking to state legislators and policy officials in revenue departments,” said David Brunori, RSM senior director who specializes in SALT for Washington National Tax. “I think things are good, but there are definitely warning signs.”

Other SALT issues leading year-end planning discussions include an uptick in audit activity. States are pursuing more desk audits and passive audits, with revenue departments trending more aggressive as they return to operations that resemble those before the pandemic.

Also, taxpayers should consider including Public Law 86-272 and internet activities covered by Multistate Tax Commission guidance; remote and hybrid workforces; pass-through entity workarounds and digital assets in their year-end planning and preparation for 2023. 

Access RSM's 2022 state and local tax planning guide

Businesses engaged in year-end federal tax planning must contend with significant uncertainties, as well as some well-defined challenges. While inflation and other economic headwinds threaten to drag the United States into a recession, less clear are the tax policy ramifications of midterm elections and a potential shift in the balance of power in Congress.

The U.S. economy contracted in each of the first two quarters of 2022. Inflation reached the highest level in 40 years. RSM’s economists in late October put the likelihood of a full-blown recession over the next 12 months at about 65%, up from 45% in the summer.

With those storm clouds forming, a leading topic of tax planning conversations is cost containment, said Matt Talcoff, leader of RSM’s Washington National Tax practice.

“As we see prices increase, businesses will need to have cash flow and liquidity, which will come partly from managing tax cash outflow,” Talcoff said.

As interest rates climb, some businesses must plan for different scenarios involving the calculation for the limitation on the deduction of business interest expense, which could be addressed by a year-end tax extenders bill. In general, Talcoff said, planning discussions will include questions about expensing of products, moving inventory in and out quickly and debt financing.

Multinationals feeling the weight of supply chain impairments can consider tax variables to issues such as inventory and sourcing. “You have to consider inventory accounting methods and understand tax treaties, think about repatriating income, think about your permanent establishment and your nexus around the globe,” Talcoff said.

The tight labor market remains a factor for many companies also. Given that it is unlikely to abate, businesses are analyzing the tax implications of strategies to recruit and retain employees. It’s a wide array of considerations, from employee credits to incentive packages to tax obligations for remote workers.

As if that weren’t enough, tax policy presents some question marks in the final weeks of 2022 and beyond.

A tax extenders bill in a lame-duck session of Congress could address the tax treatment of research and development expenses, an extension of 100% bonus depreciation, and other issues. The timing and scope of any legislation in the near term will depend partly on which party wins a majority in the Senate and House of Representatives. The variety of scenarios gives value to modeling, as businesses build resilience for 2023.

Access RSM's 2022 business tax planning guide