Why the IRS is Warning of the Possibility of a Smaller Tax Refund in 2023

Why the IRS is Warning of the Possibility of a Smaller Tax Refund in 2023

The IRS wants American taxpayers to be prepared for a potentially smaller tax refund in 2023. There are a few contributing factors that prompted the warning from the IRS in a recent statement, and we go over those below.

Economic Impact Payments

In a recent statement, the IRS cited the lack of Economic Impact Payments in 2022 as the main factor in lower tax refunds for next year. In 2020 and 2021, many taxpayers received additional refunds due to Economic Impact Payments (also known as stimulus payments), which were issued in response the financial impact Americans experienced during the COVID-19 pandemic. The final stimulus payment was distributed in March 2021. With no stimulus payment issued in 2022, taxpayers won’t see the additional money in their refunds.

Charitable Contribution Deductions

Additionally, in 2020 and 2021, taxpayers who take the standard deduction could claim a tax deduction of up to $300 for cash donations to charity. This pandemic-era exception hasn’t been extended for 2022. In order to write off gifts to charity, taxpayers must once again itemize. Almost 90% of taxpayers use the standard deduction, which means most Americans won’t be able to deduct charitable contributions.

An Additional Hurdle for Side Hustles and Small Gigs

The American Rescue Plan enacted a new rule that will affect those who rely on side hustles using third-party payment services like PayPal or Venmo – or sell on sites like eBay, Etsy, and Facebook Marketplace. Taxpayers who used these platforms to sell more than $600 worth of goods or services will be receiving a 1099-K form from whichever platform they used. Prior to the American Rescue Plan, the threshold that would trigger the need for a 1099-K form was either 200 transactions or $20,000. With this new requirement, many Americans will be filing taxes on their side hustles for the first time in 2023, which could also contribute to a lower tax refund for some filers. Note that money received from friends or family via a third-party app as a gift or reimbursement for personal expenses is not taxable.

NOTE: On Dec. 23, 2022, the IRS announced that calendar year 2022 will be treated as a transition year for the reduced reporting threshold of $600. For calendar year 2022, third-party settlement organizations who issue Forms 1099-K are only required to report transactions where gross payments exceed $20,000 and there are more than 200 transactions.

Tax-Saving Strategies for Small Businesses

Tax-Saving Strategies for Small Businesses

As the owner of a small business, you are well aware that taxes are one of the most important topics on which to keep up to date. Making mistakes could mean a higher tax bill, and failing to properly manage your taxes could land your business in trouble. On the other hand, planning in advance, taking advantage of available deductions, and preparing your tax returns correctly can save on the amount of taxes your business is required to pay. Keep reading for tax-saving strategies to help reduce your tax bill.

Use the Qualified Business Income Deduction

The Qualified Business Income (QBI) deduction was created when the Tax Cuts and Jobs Act (TCJA) was established in 2018. With the QBI you might be eligible to deduct up to 20% from your qualifying business income if your business is a pass-through entity—a sole proprietorship, an S corporation, a partnership, or a limited liability company (LLC), where business income is passed to its shareholders, partners, or owners to report on their personal tax returns.

Limits apply to the QBI deduction based on income level and business type, so be sure to talk to your tax advisor. It’s also worth noting that the QBI deduction is set to expire in 2025.

Fund a Retirement Plan

Providing a qualified retirement plan for yourself and/or your employees can help save money on taxes. Owners of corporations can contribute up to 25% of their salary to a tax-deferred plan like a 401(k) or 403(b). Sole proprietors can contribute up to 20% of income into a tax-deferred SEP-IRA account.

Take Advantage of Tax Credits

Tax credits can be subtracted from owed business income taxes at state or federal levels. They encourage investment or provide assistance in targeted areas such as employee hiring, training, and retention; clean energy initiatives; disaster relief; and new construction, historic preservation, and disability access. The list of potential tax credits for businesses is extensive, so be sure to check with your accountant about your available options.

Take Tax Write-Offs for Qualifying Purchases

If you purchase equipment, machinery, and vehicles (and sometimes real estate) for your business, you can take tax-write-offs. The most frequently utilized types of deprecation are Section 179 deductions and bonus appreciation.

Section 179 deductions permit business owners to deduct the costs of certain assets as soon as they’re put to use, so you can deduct the entire cost of equipment in the year it is placed in service. This could allow you to pay lower taxes in the current year and still buy or lease more equipment to write off in following years.

Bonus depreciation is an added advantage for purchasing assets. The TCJA increased this tax break from 50% to 100% of the cost for assets placed in service through January 1, 2023.

Defer Income and Accelerate Expenses

Defer income by shifting some of it from this year into the next. You can do this by holding on to year-end invoices until just before the start of the new year. You likely won’t collect the payment until the first quarter of the new year, so taxes on that income won’t be paid until next year. Accelerate expenses in the fourth quarter by prepaying some expenses that aren’t due until the following year. Of course, you’ll need to determine the year in which you expect to pay the most in taxes. For instance, if you anticipate notably higher personal income next year, it may save on taxes to collect income now rather than delay it until next year.

Deduct Travel Expenses

Business travel is entirely deductible. While personal travel doesn’t hold the same advantage, you might be able to combine an acceptable business purpose with personal travel in order to maximize business travel. Keep in mind, too, that frequent flier miles earned from business travel can be applied to personal travel at a later time.

Don’t Overlook These Tax Deductions and Credits for the Self-Employed

Don’t Overlook These Tax Deductions and Credits for the Self-Employed

There are some valuable tax deductions available for self-employed people. The key is knowing what they are and how they can help reduce your tax bill. Here are some key self-employment tax deductions to remember.

Home Office Deductions

This deduction allows you to deduct any portion of your home that is used specifically and regularly for work. There are two methods used for deducting home office expenses:

  • Regular Method: To use this method, you will itemize the actual expenses incurred by completing form 8829. The list of deductible expenses includes furniture, appliances, utilities, insurance, maintenance, and repairs. If you plan to use this method, it’s important to keep accurate and detailed receipts.
  • Simplified Method: To use this method, you will simply apply the standard deduction of $5 per square foot of home used for business, up to a maximum of 300 square feet. This is an easier way to account for home office expenses than the method above, but keep in mind that the 300 square-foot limit amounts to a maximum deduction of $1,500.

Vehicle Use for Business

You may be able to deduct the use of your vehicle on your tax return if you regularly use it as part of your business. There are two methods of calculating these expenses:

  • Actual Expense Method: Employing this method authorizes you to deduct specific costs essential to operating your business vehicle, such as gas, oil changes, tires, registration fees, insurance, and depreciation. If you also use your business vehicle for personal use, you will need to calculate the portion of the operating costs that you generated due to business travel, and only that amount is deductible.
  • Standard Mileage Rate: To use this approach, you will multiply the number of business miles driven by a flat per-mile rate. This rate can vary from year to year. For tax year 2021, it decreased from 57.5 cents to 56 cents per mile.

Health Insurance

If you are self-employed, you can deduct the cost of health care premiums for you and your family. This includes any children under 27 who are on your health plan, regardless of whether you claim them on your return. However, you won’t qualify for this deduction if you or your spouse are eligible for an employer-sponsored health plan.

Social Security Taxes

Employees who work for a company have payroll taxes deducted from their paychecks, and Social Security and Medicare are typically split equally between employee and employer (i.e., employee pays 7.65% and employer pays 7.65%). However, the self-employed pay the total 15.3% tax, which consists of a 12.4% Social Security tax and a 2.9% Medicare tax. The 15.3% tax is owed if your net earnings for the year are greater than $400. The good news for the self-employed is that they can write off half of the self-employment tax without the need to itemize. For tax year 2021, the maximum amount of self-employment income that’s subject to the 12.4% Social Security tax is $142,800. In 2022, it increases to $147,000.

Retirement Tax Shelters and Credits

If you are self-employed, you are eligible to contribute pretax money to a simplified employee pension (SEP) or a solo 401(k). This is in addition to an IRA account. Both SEPs and solo 401(k)s allow higher annual limits than regular individual retirement accounts.

Covid-Related Sick and Family Leave Credits

These tax credits are applicable for the first nine months of 2021. As a self-employed person, if you were unable to work (including telework or working remotely) due to certain COVID-19 related circumstances you are eligible to claim sick and family leave credits that are comparable to credits authorized for other businesses. These circumstances include personal sickness or quarantine, awaiting the results of a COVID test, and caring for a dependent who was sick or unable to attend school or daycare because of sickness, closure, or quarantine.

The credit amounts you are ultimately eligible for will depend on a few different factors, including the reason for missed work, timeframe of missed work, and duration of missed work. You will need to fill out the IRS’s Form 7202 to calculate your credits.

Deduction for Qualified Business Income

The qualified business income deduction (QBI) allows eligible self-employed and small-business owners (including sole proprietors) to deduct up to 20% of their qualified business income on their taxes.

In order to qualify, in general, total taxable income in 2021 must be under $164,900 for single filers and $329,800 for joint filers. These limits raise in 2022 to $170,050 for single filers and $340,100 for joint filers. If your taxable income is above these limits, complex IRS rules will verify whether your business income qualifies for a full or partial deduction.

Expensing

Expensing (also known as Section 179 deduction) lets you deduct the full purchase price of certain qualifying business assets in the year you bought them. The tax break applies to physical items—equipment (new and used), machinery, office furniture, off-the-shelf software, etc. Intangible assets such as patents and copyrights do not qualify, but improvements to business buildings as well as any installation of fire alarms and security systems do qualify for the tax break. You also cannot use this deduction for purchased land and real estate.

For tax year 2021, up to $1.05 million worth of equipment is acceptable for the immediate write-off of expenses, but this amount decreases if you put more than $2.62 million of new assets into service over the course of any single year. The equipment must have been purchased (or financed) and placed into service by December 31, 2021.

Small Business Owners Should Avoid These Common Tax Audit Triggers

Small Business Owners Should Avoid These Common Tax Audit Triggers

The IRS uses a computer program called the Discriminant Function System (DIF) to analyze tax returns and red flag them if they deviate from statistical averages. When a return draws a high DIF score, an agent evaluates it and decides if an audit is necessary. Your business should always be prepared for an audit, and that includes avoid these audit triggers when filing your small business taxes.

Higher Than Average Income

If you report a high amount of income, this may draw red flags for the IRS. Approximately 50% of the returns audited belong to taxpayers earning more than one million dollars per year. For taxpayers who earn more than $5 million, their odds of being audited more than doubles those of taxpayers who earn less.

Underreporting Cash Transactions

Don’t make the mistake of thinking that the IRS has no way to trace cash transactions. Credit card processors submit 1099-K forms to the IRS, which include a report of the total credit card transactions your business processed for the year. The IRS then applies these figures to an undisclosed formula in order to calculate the amount a business should have generated in cash sales. Therefore, if your reported cash sales reflect a lower figure than their formula detects, your business could be at risk for an audit. It’s a smart idea to keep detailed records of both cash and credit card transactions so you can support your claims should your business be audited.

Taking Too Many Deductions

Deductions are important to a small business owner, but claiming too many can raise red flags. Higher than average meal expenses and claiming your car as 100% business can set off alarm bells for the IRS and trigger and audit.

The IRS states that a legitimate business expense must be both ordinary and necessary to qualify as a deduction.

  • Ordinary expenses = common and accepted in your trade or business
  • Necessary expenses = helpful and appropriate for your trade or business. Note that an expense does not need to be indispensable to qualify as necessary.

Claiming Consistent Business Losses

Given the primary purpose of a business is to generate money, reporting losses year after year can lead the IRS to question the legitimacy of your business. If your business gets audited and you claimed losses, be prepared with documentation to demonstrate your business’ earnings and expenses throughout the year.

Be Prepared for an Audit

Your business may never need to go through an audit process, but you should manage your business always knowing that it’s possible. Keep precise records, make sure the numbers on your tax return are accurate and honest, report all income, and take suitable deductions. Lastly, consult with an accountant to be sure the totality of your revenue, expenses, and documents are free of missteps or miscalculations.

Tax Breaks for Individuals Were Extended Under the Consolidated Appropriations Act, 2021

Tax Breaks for Individuals Were Extended Under the Consolidated Appropriations Act, 2021

In late December of 2020, President Trump signed into law the Consolidated Appropriations Act, 2021 (the Act), which included the long-anticipated pandemic-related Tax Relief Act of 2020. It also included the Taxpayer Certainty and Disaster Relief Act of 2020, which extends or makes permanent numerous tax provisions, including tax breaks for individuals. The following is an overview of these key tax-related provisions for individuals.

Medical Expense Deduction

The Tax Cuts and Jobs Act (TCJA) set the threshold for itemized medical expense deductions at 7.5% of Adjusted Gross Income (AGI), but this threshold was scheduled to return to 10% of AGI as set in the Affordable Care Act. However, the expense deduction had been extended perpetually by Congress, allowing a taxpayer to continue to deduct their total qualified unreimbursed medical expenses that exceed only 7.5% of their AGI. The Taxpayer Certainty and Disaster Relief Act of 2020 made this threshold permanent.

Charitable Contribution Deduction

Generally, charitable donations are tax-deductible only if you itemize your taxes, but the Coronavirus Aid, Relief, and Economic Security (CARES) Act incorporated a provision that authorized individuals who don’t itemize to deduct up to $300 ($600 for married couples filing jointly) in cash donations in 2020. The Taxpayer Certainty and Disaster Relief Act of 2020 extended this provision into 2021 and makes it more valuable for married couples filing jointly.

Taxpayers who do itemize their deductions are typically limited to a 60% cap (i.e., the amount of charitable donations you could deduct generally could not exceed 60% of your AGI). As in 2020, that limit has been suspended in 2021.

Mortgage Insurance Premium Deduction

The Taxpayer Certainty and Disaster Relief Act of 2020 includes a one-year extension of the mortgage insurance premium deduction, so premiums paid or accrued through December 31, 2021 can be deducted on tax returns by those who itemized deductions and otherwise qualify for the mortgage insurance premium deduction.

Exclusion for Canceled Mortgage Debt

Cancelled or forgiven debt by a commercial lender can be counted as income for tax purposes. However, the Mortgage Forgiveness Debt Relief Act of 2007 generally allowed for taxpayers to exclude canceled mortgage debt from their taxable income, but only for a finite number of years. The Taxpayer Certainty and Disaster Relief Act of 2020 extended the Mortgage Forgiveness Debt Relief Act of 2007 through 2025.

Residential Energy-Efficient Property Credit

Individuals who have implemented certain energy-efficient upgrades to their homes (i.e., solar electricity, solar water heaters, geothermal heat pumps, and small wind turbines) are eligible for the residential energy-efficient property credit. The credit had been set to phase out after 2021, but the Taxpayer Certainty and Disaster Relief Act of 2020 extended it as follows:

  • Continuing the rate applicable to 2020, eligible property that is put into service in 2022 will qualify for a credit worth up to 26% of the property cost
  • Eligible property that is put into service in 2023 will qualify for a credit worth up to 22% of the property cost.

 

2021 Tax Planning for Construction Firms

2021 Tax Planning for Construction Firms

Last year construction contractors saw projects suspended indefinitely (or scrapped altogether) and escalated competition in the bidding process, both of which effectively stifled profit margins. It’s safe to say that the construction industry was not spared the upheaval of 2020. After such a tumultuous year, tax planning for 2021 might seem like a daunting challenge, but it’s a critical step for construction contractors in preparation of the year ahead.

Essential Tax Provisions for 2021 Preparation

With the uncertainty of the Covid-19 pandemic and a transfer of administrations in the White House this year, new legislation affecting tax provisions is a possibility, but there are several provisions under the current tax law, including those put in place under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, that you want to be sure not to pass over.

Bonus Depreciation

Are you eligible to use the bonus depreciation this year? Changes have been made to qualifying property under both the Tax Cuts and Jobs Act (TCJA) and the CARES Act as follows:

  • TCJA: expanded the bonus depreciation deduction to 100% for specified property obtained and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
  • CARES Act: authorized the qualified improvement property (QIP)—typically interior improvements to nonresidential property—to be depreciable over 15 years and eligible for 100% bonus depreciation.

Tax Credits and Deductions

These tax credits and deductions could aid in reducing tax liability for contractors:

  • Research and development credits: contractors who test new techniques or processes on construction jobs could be eligible.
  • Deduction for energy-efficient government buildings: contractors may be eligible for a deduction of up to $1.80 per square foot for building energy-efficient commercial buildings intended for federal, state or local governments.
  • Credit for energy-efficient residential properties: Contractors can take advantage of tax credits for certain energy-efficient residential properties.

Note that the deduction and credit for energy-efficient buildings expire at the end of 2021.

Qualified Business Income Deduction

The TCJA replaced the 9% “domestic production activities deduction” under IRC Section 199 with a 20% Qualified Business Income deduction under IRC Section 199A. It also increased eligibility to encompass more businesses. Contractors might want to start the conversation with their tax advisor on how to maximize this deduction as well as receive guidance on how to maneuver through the calculation’s somewhat complicated rules and limits.

Flexibility with Accounting Methods

Smaller construction firms (meaning those with average gross receipts of less than $26 million from the prior three years) generally enjoy more flexibility with tax accounting methods. Such firms could be eligible to use cash, accrual, completed contract or “accrual less retainage” accounting methods, all of which usually aid in managing the timing of revenue recognition. This allows companies to stimulate revenue to counterbalance current losses and recognize revenue now in expectation of higher future tax rates.

Additional Tax Planning Considerations Amid the Pandemic

To help minimize the risks of ongoing economic uncertainty, contractors should consider keeping apprised of tax changes. Given the seemingly ever-changing legislation amid the pandemic, construction firms should keep in regular contact with their tax advisors in order to avoid any tax reform surprises. However, contractors should also aim to operate without presumption of further legislation. While the economic effects of the pandemic are ongoing, don’t assume further stimulus legislation like the Paycheck Protection Program will be passed by Congress.

 

In light of a turbulent 2020, the construction industry has experienced a return to the business practices that have proven successful in the past: more attention to jobsite monitoring, legal contracts, and insurance costs. Contractors can contact an MKR advisor to incorporate 2021 tax planning into this process.