As we quickly approach this year’s tax deadline (April 18th) for individual 2022 tax returns and 2023 Q1 estimates, we wanted to remind construction contractors about tax planning opportunities and considerations to keep in mind for 2023.
Below we will address sunsetting provisions that could potentially have an impact on your business’ taxable income, along with key reminders regarding planning for estimated tax payments.
Many of the provisions included in the Tax Cuts and Jobs Act (TCJA) are scheduled to sunset by December 31, 2025. However, there are a handful of provisions expiring in tax years 2022 and 2023 highlighted below that will be crucial when tax planning for your business and personal estimated taxes.
1.Interest deduction limitation. In general, your construction company may be able to deduct interest expense that was paid during the taxable year. However, starting in tax year 2018, your interest may have been subject to the Section 163(j) business interest limitation for businesses with aggregated gross receipts over the small business exception (roughly $26 million in gross receipts).
For tax years 2019 and 2020, the deduction limit was temporarily raised from 30 percent to 50 percent of adjusted taxable income (ATI). However, for tax years 2021 and forward, this temporary relief Congress provided no longer applies and the ATI limitation went back to 30 percent. In addition to this change, starting in tax year 2022, depreciation, amortization, and depletion will no longer be added back in the ATI calculation, resulting in an increased potential for deferred interest expense deductions.
2.Section 174. Effective January 1, 2022, a significant change to the tax treatment of research and experimentation expenses went into effect. Taxpayers that incurred these expenditures, also known as Section 174 costs, are now required to capitalize and amortize these costs over a period of five years if attributable to domestic research, or 15 years if attributable to foreign research. Prior to the most recent law change, taxpayers had the ability to expense these costs in the year incurred, thus getting an immediate tax deduction.
While there is hope that Congress will act to repeal the law, it is currently law and could potentially have a significant impact on the business depending on the amount of Section 174 costs incurred. Taxpayers should be mindful of the impact on their 2023 estimates and evaluate the impact of this change with their tax advisors.
3.Bonus depreciation and Section 179 depreciation. January 1, 2023, marks the start of the phase-out of bonus depreciation. The TCJA increased bonus depreciation from 50 percent to 100 percent starting in 2018, which provided immediate tax deductions and savings for construction companies. Starting in 2023, bonus depreciation will begin to phase out as follows:
- December 31, 2023 – 80 percent Bonus Depreciation
- December 31, 2024 – 60 percent Bonus Depreciation
- December 31, 2025 – 40 percent Bonus Depreciation
- December 31, 2026 – 20 percent Bonus Depreciation
Knowing the above phase-out rules is essential for planning and should result in increased consideration as to timing of capital expenditures.
One other important item to note in consideration of accelerated depreciation is in regard to Section 179 expensing. While there are different rules between bonus depreciation and Section 179 on the federal level, it is important to note that effective in tax year 2023, Pennsylvania has adopted the federal treatment of Section 179 depreciation and will allow the federal deduction on the Pennsylvania return.
4.Meals and entertainment. For tax years 2021 and 2022, your construction company may have been eligible to deduct 100 percent of business-related food and beverages that were purchased from a restaurant. This was a temporary benefit designed to help the restaurant industry which was hit hard during COVID. Although a lower impact change, starting January 1, 2023, meals will revert to the original 50 percent deduction. Please refer to our previous article, Mobile Workforce for Contractors Series: Part One – Meals and Entertainment, for additional information.
Additional Items to Consider for Tax Year 2023
1.Maximize your retirement contributions. Maximizing your retirement contributions may be a useful tool in lowering your taxable income in a financially beneficial way. Subject to income limitations, this can be accomplished by increasing contributions to your 401(k) or other retirement plans. Taxpayers can defer taxes on up to $22,500 in 2023 through their 401(k) and if you are age 50 or older, a catch-up contribution of an additional $7,500 is available.
2.Be aware of increased tax brackets. Beginning with tax years 2023, the IRS imposed inflationary adjustments to tax brackets. It is important to note that the tax bracket rates themselves ranging from 10 percent to 37 percent did not change, but the threshold of income required to fall into each bracket did change. Although the change is automatic for all taxpayers, it is a topic worth noting. As 2023 year-end comes closer, taxpayers should be mindful of planning when close to entering a new tax bracket.
3.Be aware of underpayment interest rates and changes. An important item that could potentially have a larger impact on your tax cost is the IRS’ increased interest rates for the 2023 tax year. For individuals, the rate currently in place for tax overpayments and underpayments will be seven percent annual rate. Thus, the cost of underpayment of estimated tax payments will have more of a cash burden.
Taking the time to revisit the items above will provide you with the opportunity to better manage cash flows at both the business and individual level. With the many tax law changes in recent years coupled with rising interest rates, being aware of these topics will assist you in effective tax planning to avoid overspending cash in times of economic uncertainty. If you have any questions or would like to further discuss this topic, please contact any member of our Construction Industry Group.
Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect, or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.