The year of 2023 is shaping up to be a rough one for small and midsize businesses. Borrowing costs are at 13-year highs, demand is slowing along with the economy and now they’ll pay more in taxes.
Higher taxes come compliments of recent Congressional legislation, primarily the recently passed omnibus spending bill. To the disappointment of many business owners, this bill failed to extend certain tax reductions stemming from 2017’s Tax Cut and Jobs Act. This decision will have long-lasting impacts.
To offset the impact, businesses will have to plan more and adjust their strategies. Here are some of the biggest tax filing changes, their effective dates and a few strategies owners can use to limit their impact on tax liabilities and bottom lines.
The end of 100% bonus depreciation
Until the end of 2022, your small business could depreciate the entire cost of qualifying expenses in a single year, as long as the asset had been placed in service before the year’s end. For example, you could write off the full cost of vehicles, furniture, manufacturing equipment, heavy machines, computer software and more if your company was using those products by December 31.
Now that 100% tax deduction will be phased out over the next five years, in 20% increments, ending after 2026.
This affects any business that needs to purchase equipment or materials, like the ones I mentioned above, to help them grow.
There are two relief valves: First, businesses can make use of the previous regime of accelerated depreciation as specified in Section 179 of the tax code but there are caps on that deduction. For 2023, the maximum amount of the Section 179 deduction is $1,160,000 and the deduction is phased out entirely for assets costing more than $2,890,000.
Under the 2017 act, the 100% bonus depreciation had no limit.
Second, businesses with multiple entities can extend the limit across multiple companies but each company will have to demonstrate a business purpose for the purchased asset and have placed it into service. It gets pretty complicated.
How to proceed? Now that the 2017 changes have been rolled back, business owners who are buying certain assets must work with advisors to develop comprehensive plans that incorporate the impact of a diminishing depreciation schedule and Section 179 deduction limits.
R&D spending changes will have ripple effect
The recent omnibus bill held another disappointment for taxpayers who own businesses. The full and immediate deduction of research and development spending ended on Jan. 1, 2022.
Now you’ll have to capitalize these expenses over a period of five years, rather than deduct them all at once in the year they occurred. Examples of such expenses include the costs to design and test new products and to enhance existing ones.
Businesses can still take advantage of an R&D tax credit for other things, such as product development, new manufacturing processes, software new manufacturing processes, software development and quality enhancements to reduce their taxable income but that credit is heavily scrutinized by the IRS.
Given these developments, make sure you can afford to spread out the cost of R&D expenses if you claim a deduction. If you claim an R&D tax credit, you’ll need to satisfy the IRS's four-part qualification test, which requires that the expense be technological in nature and development costs add or improves your business.
Deductions of Business Interest Expenses Are Limited
Finally, the latest omnibus spending bill also failed to modify a change in 2017’s tax cut legislation that limits the deduction business could take for interest payments. I’m already seeing the impact on my clients.
The previous legislation limited the deduction for interest payments made by businesses to 30% of adjusted taxable income (ATI), excluding depreciation, amortization and depletion starting in 2022. Before 2022, businesses could add back those items, which allowed for a larger deduction.
The change affects firms with more than $27 million in gross receipts in 2022. It reduces the amount of interest their owners can deduct from their taxable income – at a time when interest expenses are rising.
Business owners now find themselves in a tight spot, having to borrow more at higher rates just to sustain operations during an economic slowdown, with less ability to deduct those financing costs. Firms that fund a major expansion or major capital improvement or purchase in this environment, coupled with the disappearance of 100% bonus depreciation, face a double whammy on their big capital projects.
The sunsetting of some tax cuts included in the massive 2017 tax cut legislation now means many businesses will pay higher taxes. To get ahead and manage the impact, I urge you to study these changes and factor them into your tax, spending and planning strategies.
