2022 year-end tax letter
Published on Oct. 26, 2022
It has been a challenging year both economically speaking and in terms of tax planning. While we have seen some federal tax legislation, the changes have been far more limited than many expected. Additionally, the continuing tight labor market, worries over a possible recession and high inflation are dominating concerns. In this vein, the Federal Reserve increased the benchmark interest rate by 300 basis points to date in 2022. Recent comments by the Fed indicated it intends to further increase rates until the funds level hits a “terminal rate,” or end point, with a current target of 4.6% in 2023. This not only raises business borrowing costs, but also the correlating interest expense tax deduction, which is more likely to be reduced due to the limitations enacted in the 2017 Tax Cuts and Jobs Act (TCJA). A challenging economy, ever-changing tax rules and rising interest rates make tax and business planning more critical than ever.
To date, 2022 has seen limited federal tax legislation in the Inflation Reduction Act (IRA) and United States Innovation and Competition Act of 2021 (USICA aka CHIPS-plus Act). The IRA contains a multitude of energy credits, an excise tax on stock repurchases and a new corporate alternative minimum tax (AMT). While the IRA is less expansive than the initial Build Back Better proposals, it does add numerous complexities to tax law requiring new guidance from the Treasury Department. Besides the IRA, taxpayers continue to wait on further guidance pertaining to the many other tax provisions enacted over the past five years. Finally, the CHIPS-plus Act includes over $52 billion for semiconductor facilities plus a 25% tax credit for semiconductor manufacturing. For additional discussion of the IRA, see our previous tax alert.
As we head toward a post-election lame-duck congressional session, tax legislation may resurface that targets retirement plans, digital assets and the so-called tax extenders that either expired at the end of last year or will expire at the end of 2022. There are more than 40 temporary tax provisions that expired Dec. 31, 2021, including:
- Extension of research and development expensing and/or a refundable research credit
- Refundable and/or enhanced child and dependent care tax credit
- Increased child tax credit
- Credit for qualified fuel cell motor vehicles
- Credit for construction of new energy-efficient homes
- Increase in exclusion for employer-provided dependent care assistance
- Extension of favorable formula used to compute business interest expense deduction under section 163(j)
- Charitable contribution deduction by non-itemizers
Five tax extenders expiring at the end of 2022 that may be retroactively reinstated include the full deduction for business meals provided by a restaurant (otherwise limited to 50%) as well as incentives for biodiesel and renewable diesel fuel.
We expect any legislation in the lame-duck session to be centered around items with bipartisan support. While some may push for far-reaching provisions, being able to use reconciliation in the Senate and bypass the filibuster rules will still require the sign off of Sens. Joe Manchin (D-W.Va.) and Kyrsten Sinema (D-Ariz.). Sinema’s reluctance to raising tax rates or rolling back certain TCJA provisions coupled with Manchin’s concern that expanding social programming will further overheat an economy struggling with inflation derailed last year’s larger Build Back Better proposals. We do not expect the end of 2022 to be any different.
With this in mind, look for potential legislation to include a continuation of fully expensing R&D expenses with certain retirement provisions of the Setting Every Community Up for Retirement Enhancement (SECURE) Act rolled in. Both of these enjoy strong support on both sides of the aisle. Things could get more interesting if Democrats attempt to continue the expanded child tax credit. Absent the inclusion of a work requirement, it is doubtful Manchin or congressional Republicans will support expanding the credit.
Following the midterm elections, any tax legislation is largely dependent upon the composition of the next Congress. House Republicans have offered a broadly stated policy proposal if they control the House in January. For tax policy, their statement includes a promise to “increase take-home pay, create good-paying jobs, and bring stability to the economy through pro-growth and deregulatory policies.” Actual provisions are not outlined but their statement suggests the GOP would extend TCJA tax relief provisions for individuals currently expiring at the end of 2025 as well as continuing bonus depreciation. Key individual tax elements expiring in 2025 include the top tax rate for individual taxpayers reverting to 39.6% from 37%, an end to the 20% section 199A qualified business income deduction, removing the $10,000 cap on the state and local tax (SALT) deduction and reinstating the personal and dependent exemption deductions.
If Democrats maintain control of the House and increase their majority in the Senate, they may pursue remaining policies from the original Build Back Better bill. Many provisions of the TCJA would be subject to change, such as increasing the corporate tax rate, raising individual tax rates on those earning over $400,000, and subjecting S corporation income to self-employment tax. Earlier administration proposals would raise the individual tax rate to 39.6% from 37%. Finally, long-term capital gains and qualified dividends would be taxed at 25%, up from the current 20%.
In a turbulent political year, we cannot predict the midterm election results. However, unless Democrats retain control of both houses of Congress, we expect little in the way of legislation for the next two years. Should Republicans gain control of both the House and the Senate, the Biden administration indicated any tax-related legislation passed would likely be vetoed. If one party controls each house, it’s an understatement to say compromise will be difficult. In this event, we expect extremely modest tax legislation, if any, before 2025.
One notable exception to our expectation of a stalemate in a split Congress is the possibility of a bipartisan bill addressing the regulation and taxation of digital assets. The need for clarity in the federal oversight and tax treatment of digital assets is rapidly escalating. The Infrastructure Investment and Jobs Act, a bipartisan bill passed in late 2021, made changes to reporting requirements for digital assets, including cryptocurrencies. In the intervening 12 months, several digital asset bills have been introduced, most with bipartisan sponsorship. For more details, please see our article on the ever-changing world of digital asset taxation.
Potential legislation notwithstanding, we also anticipate a multitude of regulatory guidance from the Treasury Department. For several months, we have expected the IRS and Treasury to issue additional regulations on the business interest expense deduction, cryptocurrency reporting, deferred compensation and noncompensatory options. Furthermore, we are awaiting a number of regulations dealing with partnerships taxation. Specific partnership areas we are watching include disguised sale rules, related parties, a host of basis and capital account guidelines and the fractions rule. Given the competing priorities of the IRS and Treasury, particularly considering the extent of guidance needed to implement the recently passed IRA, it remains to be seen whether any of this pending guidance will be issued in the near future. Regardless as to which regulations are published first, taxpayers can expect more compliance and documentation requirements.
We remind you that tax planning should be addressed throughout the year as an integral part of overall financial health. To assist you in this endeavor, our year-end tax letter also includes articles on the evolving world of digital assets, happenings at the IRS, information reporting, new international tax issues and reporting as well as the latest in state and local taxation.
As always, we encourage you to contact your Baker Tilly advisor or visit bakertilly.com/contact to discuss how these issues impact your tax position.