Reviewing the Latest Tax Code and Deduction Rules
It’s the time of year most business owners hate – tax time. As the first quarter comes to a close, it’s important to look back at the budget set earlier in the year and determine what tax savings are available for the current year to optimize cash flow and increase business. We know that taxes are always a given, but sometimes it’s easy to miss deductions – which can completely change the trajectory of business in the tax world while simultaneously reducing a business owner’s stress for the year ahead. During the past two years, there have been several tax law changes that you might not be aware of. Here are the top five to track and take note of before this year’s tax season comes to a close, as well as some additional tips to help you conquer tax season.
Ordinary and Necessary Expenses: The Difference
Let’s first get back to basics. The IRS defines an “ordinary” expense as anything that is “common and accepted” to a specific trade or business and a “necessary” expense as “helpful and appropriate.” To be deductible, a business expense MUST be both ordinary and necessary. To confuse matters even more, the expense could be ordinary and necessary, but NOT be deductible. Clear as mud, right?
Let’s take clothing as our example. Most would argue that clothing is a business expense, but it’s actually not a slam dunk deduction. If the clothing item can be worn outside the office, which a majority can be, it won’t be deductible. If you have clothing you provide to your employees or clients with your logo on it, you can take that as a deduction. The typical expenses that fall into this category include rent, wages, utilities, office supplies, phone, internet, etc.
Five 2022 Business Purchases You Didn’t Know Were Tax-Deductible
1. Meals and Entertainment
One of the most challenging business expenses over the past years has been the tax law changes in regard to meals and entertainment. Previously, meals and entertainment were broken down based on different factors that you would need a flowchart to read. Our first assumption was that YES – these are ordinary and necessary in the course of your business.
For 2021 and 2022 – meals served in a restaurant or by a restaurant are 100% deductible, whether it involves an employee, a client, or a prospect. This is to help kickstart the economy and restaurants in the late stages of the Covid-19 pandemic. Currently, in 2023 this will go back to 50% in some cases.
2. Travel Expenses
As travel opens back up, many business owners are ready to get back on the road. Whether it’s the costs associated with airfare, rental cars, lodging, or taxi fares, they are all 100% tax-deductible. What makes this one notable for 2022 is you could use it as a way to provide experiences for clients that aren’t entertainment-based – and ultimately qualify for a tax deduction. Instead of taking a client golfing, you could fly the client to Augusta, cover their lodging, and have it tax-deductible. The cost of the ticket into an event is still not deductible, but businesses can be creative in how they treat clients to work on other scenarios.
3. Business Use of Your Vehicle (Standard Mileage Rate)
The tax law for 2022 states that the standard mileage rate for using your personal vehicle (car, van, pickup, or panel truck) for business is 58.5 cents per mile. This is up 4.5% from the 2021 tax year when it was 56 cents. Keep in mind that this amount can be used for reimbursement to employees and is not taxable to them.
The mileage rate is calculated from many different factors. Everything from auto insurance premiums, gas prices, repairs, depreciation, and more vehicle operational expenses are included in the calculation. According to Motus, the firm that calculates the standard mileage rate in tandem with the IRS, the higher rate in 2022 is a result of high fuel prices, larger insurance premiums, and low depreciation rates due to the chip shortage.
4. Pass-Through Entity Tax Deduction
Several states have enacted workarounds to the individual tax limitation of $10,000 for state and property taxes. This is a huge win to business owners as they can now elect to have their flow-through business pay the state tax. This creates tax savings on the federal level that can be very significant in high-income states such as Minnesota, New York, Illinois, and others.
According to the AICPA, 22 states have already enacted a PTE (Pass-Through Entity) tax effective for 2021/2022 and 7 states have proposed PTE tax bills in place. These PTE level taxes are intended to provide a federal income tax deduction for the state income tax without limitation. This new workaround is very state-specific, may require elections, and can be binding on all owners. Please contact us to discuss your specific situation surrounding this deduction.
5. Retirement Contributions (SECURE Act)
The SECURE Act is one of the biggest changes to the retirement system in years. With the SECURE Act, you can create a retirement savings plan AFTER the tax year has ended. In addition to creating cash flow opportunities to fund a deduction a year later, retaining key employees in a tough economy, there are also large tax credits available.
For the first three years of the plan, the credit is $250 per eligible employee with a minimum of $500 and a maximum of $5,000. There is an additional credit in place of $500 per year for setting up a plan that has automatic enrollment.
Take Advantage of Expiring Deductions
As it stands, the 2022 tax year will be the last year you can take a total deduction for Section 179 or bonus depreciation. You can purchase certain fixed assets and take the entire amount of qualified expenses in 2022. In 2023, this is reduced to 80% and continues to decrease by 20% per year until Jan 1, 2027. These assets would include items purchased that are over $2,500 if your company doesn’t have an audit. Different purchases that fall under this category include vehicles, computers, leasehold improvements, furniture, and fixtures. By the time the end of 2022 rolls around, we may have extenders on certain bill provisions and deductions. Regardless, taking advantage of the available deductions is an important thing to start doing.
Review the Tax Law and Maximize Your Returns
It’s important to review changes to the tax law yearly before you file your taxes, preferably with your CPA, so you maximize the returns you receive. This is money that is there for the taking, and only costs time and due diligence. Making first-quarter estimates, funding retirement accounts, and leveraging cash flow makes any business owner stressed, but it doesn’t need to be. If you’re looking to have a more confident and thorough 2022 tax season, reach out to our team. We’ll take the time to understand your specific situation and maximize the returns you receive while setting you up for a successful 2022 and beyond.