Looking ahead and planning for year-end
As we head into the end of 2022, business owners should talk with their advisors about tax planning opportunities that may be available to them. To prepare franchisees for the year-end, Baker Tilly’s Chris Annand, Andrew Chaves and Carla Mattsson recently participated in a question-and-answer session where they discussed some of the more time-sensitive issues that could impact your tax obligation.
Q: What should people be on the lookout prior to year-end?
Chaves: They should be aware that 2022 will be the last year they can utilize 100% bonus depreciation. For 2023 to 2027, there will be a step down of 20% each year.
Mattsson: That’s right. From November 2017 until Dec. 31, 2022, for federal purposes, any qualified property placed in service that has a depreciable life of 20 years or less was automatically eligible for 100% bonus depreciation. Beginning next year, bonus depreciation will be ratcheted down to 80% and then 60% in the following year and so on. If any franchisees have build-outs they could push to complete by the end of this year, it may be worth doing so because they can take 100% bonus depreciation. The qualified property will need to be placed in service before Dec. 31, 2022; if it’s placed in service Jan. 1, 2023, they will be able to take 80% bonus depreciation, for federal purposes. Then the remainder would be depreciated for 15 years or potentially shorter lives if they decided to get a cost segregation study.
Another thing people should be considering through 2022 planning and forward: Under current law, the depreciation and amortization addback in arriving at deductible business interest expense is going away. Taxpayers in 2022 who have more than $27 million in gross receipts on an aggregated basis, among all the related taxpayers, should consider the potential cost of bonus depreciation, especially if they are heavily leveraged or have any high-interest debt.
Annand: That’s true. It’s interesting because we’re now in an inflationary and higher-rate environment. Expenses today are higher than they were in the past and earnings may be lower as a result. With these rules flipping, a higher rate that results in higher interest expense may create a new environment for business owners where interest expense isn’t fully deductible.
Mattsson: Right. And if anyone is considering a dividend recapitalization, it is going to increase their debt load and that is something they will want to model out. Are they going to put themselves into a position where they may not be able to deduct all of their interest this year?
Annand: It’s a dual-purposed planning opportunity: one from the viewpoint of deferring taxes and another from the viewpoint of wealth creation. We can help model these different scenarios out. Also, enterprises may not have focused on cost of debt capital as much because rates have been so depressed, but they now have an opportunity to focus on cost of debt capital again. They should assess their existing credit facilities and whether there’s an opportunity to hedge interest costs, recap, refinance with their existing lender or even a run a competitive process to select a new lender under optimal terms. I know we’ve helped many in this capacity already but let’s not allow our client’s lose sight of this.
Mattsson: They could also pay down some of their debt. Because debt has been so cheap, there has been a push toward debt financing versus equity financing, but maybe that will flip, especially in the larger businesses where they are over the $27 million threshold.
Q: In addition to bonus depreciation, anything else franchisees in particular should be concerned about heading into the year-end?
Mattsson: Something that’s been coming up recently in a number of discussions with clients is the utilization of the partnership entity type. LLCs may be taxed as a partnership for the ability to utilize guaranteed liabilities to enable the partners to take losses and distributions without incurring negative tax consequences. S corporations don’t allow that. Under current law, there is an ability to guarantee debt if the partners are comfortable doing so, which increases their basis to take losses and distributions. Proactive planning should be done by partners in a partnership to help ensure that repayment of previously utilized debt to take losses doesn’t cause a taxable event in a subsequent tax year.
As you are getting into the third and fourth quarters, that’s the time to assess what your tax losses or taxable income will be for the year, what distributions to take year-to-date, what distributions you are projecting through the end of the year and if you are going to need more guarantee on your debt. You need to know in advance if you aren’t going to take a December distribution, so you can avoid at-risk recapture, which is one of the negative impacts of over-distributing in a loss environment. It highlights the importance of working off a 2022 projection earlier in the year rather than waiting until the end of the year, or January or April to prevent surprises.
Q: What is ASC 842? Is that something franchises should be aware of?
Chaves: ASC 842 is the new lease accounting standard published by the Financial Accounting Standards Board. It was adopted by public companies years ago, and it’s applicable for private companies in 2022. If your company is producing financials in accordance with generally accepted accounting principles (GAAP), you are going to need to migrate to the new accounting standard.
Q: What were the changes with pass-through entity tax elections?
Mattson: In the Tax Cuts and Jobs Act of 2017 (TCJA), Congress added a cap on the SALT deduction for individuals. A lot of people who operated flow-through businesses in high-tax states lost a significant benefit as a result of the implementation of the $10,000 cap. That provision is set to sunset in 2026. Soon after the cap was put in effect, high-tax states started to work around that. It’s been four years since the TCJA was implemented, and states are continuing to pass and refine legislation for elective pass-through entity tax regimes. The pass-through entity tax election is not a no-brainer except in a few specific circumstances, but it does have the potential to provide a substantial benefit if you have a business in high-tax states like California or New York.
Chaves: To simplify, each state has a different set of regulations, and not every pass-through entity will benefit the same depending on what state they are in and where the partners reside.
Mattsson: Also, the way each state calculates the pass-through entity tax is different. Some look at post-apportioned income, some look at pre-apportioned income, and it can depend on the residency of the investors. It’s complicated, and it’s a huge planning point that should be discussed early in the year. Some states require certain things to happen in the year that the election relates to. For instance, California requires that in order to make the 2022 election, the greater of $1,000 or 50% of your 2021 liability needed to have been deposited with California by June 15. New York requires election by either March 15 or Sept. 15 in the year the election is to be in effect. If you wait until you are already preparing your tax return to start these discussions, in a lot of states, it’s already too late for that year. You’ll just have to look forward to the next year.
Q: What estate planning provisions should individuals be aware of this year?
Mattsson: The gift tax exemption is going to sunset in 2026. In 2022, the lifetime gift exemption is $12.06 million, but it will revert to 2018 levels of approximately $6.4 million per person when indexed for inflation. Anyone who hasn’t met with their estate planning advisors and has a potential taxable estate over $5 million, which is what it will be brought down to, should start having those discussions sooner rather than later so they have the time to fully evaluate their own financial needs for the rest of their life expectancy before making any decisions about transferring wealth out of their estate.
Chaves: While there is no pending legislation to make any changes, gifting exemptions are still high. Opportunities to move some of the future transactions are still available. It’s not an actual rush, but we are getting close to substantial changes.
Q: Any other year-end tax planning matters individuals should be considering?
Mattsson: Market valuations are down in the stock market. You can transfer more growth into a Roth account if you do a Roth conversion now versus whenever it rebounds.
Chaves: Recognizing losses. If somebody plans to enter a transaction, they should utilize any available losses (subject to wash sale rules) to offset their gain. Also, any excess business loss limitation should be taken into consideration.
Mattsson: Excess business loss limitation is a limit imposed on your business losses, specifically how much of your business losses can offset your nonbusiness income (capital gains and losses, interest, dividends, wages). Last year was the first year it was back.
Annand: As we come out of the pandemic, you should be thinking about relief options that are still on the table that you might not have taken advantage of but should have, including the employee retention tax credit.
A version of this article was originally published in Geared Up, the official magazine of the Planet Fitness Independent Franchisee Council, and is reprinted with permission.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
