Dear Clients and Colleagues,
As the fourth quarter of 2022 is drawing to a close, we recommend that you review your comprehensive wealth planning and business structures to ensure that it is consistent with your long-term objectives. While the recent mid-term election results are still not final, with a Senate run-off left in Georgia, it is clear at this point that the Republicans will take a majority in the House of Representatives while the Democrats will retain control of the Senate. Unless some level of bipartisanship takes hold, this will create significant uncertainty as to the likelihood of any meaningful tax legislation to be passed in the next two years.
That said, it remains to be seen whether Congress, during this lame duck session, will look to push through more meaningful changes in tax law before Republicans take over control of the House. Given the filibuster rules in the Senate however, it is highly unlikely such measures would be successful which means that only proposals that have bipartisan support will have a chance of passing. This could include extension of already existing tax provisions that expired either at the end of 2021 or that are expiring in 2022.
There have been some limited developments in 2022 with respect to federal tax legislation as well as with the IRS and state and local taxing agencies which could impact your year-end tax planning. These include but are not limited to:
- Due to the current high inflation rates and the required increase/indexing of certain exemptions, deductions and limitations, some of you may see some net tax savings in 2022 or 2023. (See below tables). For those making estimated tax payments or claiming withholding exemptions, please consider factoring such changes into your computations with your tax preparer.
- The Biden Administration passed the Inflation Reduction Act in 2022 which included tax legislation primarily directed at large corporations and the energy sector.
- As discussed further below, more states have adopted laws allowing pass-through entities to pay state income tax at the entity level (through what is referred to as the Pass-Through Entity Election or PTE), thereby allowing a greater deduction for state income taxes than the $10,000 per year limit enacted as part of the Tax Cuts and Jobs Act (“TCJA”).
- The enactment of the Inflation Reduction Act saw a significant increase in the IRS budget going forward. Such increase includes an allocation for increased enforcement (e.g., the possible hiring of 87,000 new IRS auditors) as a means of producing more government revenues through income tax collection as well as penalties. This will likely lead to a significant increase in IRS audit activities with respect to the top 1% of taxpayers.
Accordingly, below are a few areas that may interest you:
Individual Income Tax Planning
While many individual taxpayers continue to benefit from Trump-era tax rates and deductions, enacted as part of TCJA), with a now divided Congress, there is little expectation the framework of that legislation and any benefits associated with them will change until after the 2024 elections. That said, the impact of the current inflationary environment will result in some increases in tax brackets, exemptions and deductions going forward into 2023 which should be beneficial to all levels of taxpayers.
A number of the tax changes that came out of TCJA impacting individuals will sunset in 2025 and therefore, as that time draws closer, unless the next election results in Republican control, such changes are expected to sunset after 2025. The expiration of many of these TCJA provisions were necessary to adequately score the net revenue impact of the legislation (within the 10-year budget period limitations); further legislation will be required to extend or modify such provisions following the 2024 elections.
- Impact of Inflation on 2023 Tax Rates & Deductions
On October 18, 2022, the IRS announced its annual inflation adjustments for more than 60 different tax provisions, including changes to its current tax rate schedules. These adjustments are unique in comparison to previous annual adjustments because of the significant inflation currently taking place in the United States. As a result, the announced adjustments are larger than prior years, with a roughly 7% increase to income thresholds within each federal tax bracket. An adjustment like this should result in more US taxpayers staying in lower marginal tax brackets next year, consequently reducing their overall tax obligations for 2023.
A brief highlight of the announced changes is provided below. For more information, refer to the IRS’s recently published Revenue Procedure 2022-38.
- 2023 Tax Brackets and Rates
The seven marginal tax rates in each bracket remain unchanged for 2023. However, as mentioned above, the income tax thresholds for each bracket have been adjusted to the following:
|Tax Rate||For Single Filers||For Married Individuals Filing Joint Returns||For Heads of Households|
|10%||$0 to $11,000||$0 to $22,000||$0 to $15,700|
|12%||$11,000 to $44,725||$22,000 to $89,450||$15,700 to $59,850|
|22%||$44,725 to $95,375||$89,450 to $190,750||$59,850 to $95,350|
|24%||$95,375 to $182,100||$190,750 to $364,200||$95,350 to $182,100|
|32%||$182,100 to $231,250||$364,200 to $462,500||$182,100 to $231,250|
|35%||$231,250 to $578,125||$462,500 to $693,750||$231,250 to $578,100|
|37%||$578,125 or more||$693,750 or more||$578,100 or more|
- Standard Deduction and Personal Exemption
For 2023, the standard deduction will increase by $900 for single taxpayers and married taxpayers filing separately; $1,800 for married taxpayers filing jointly; and $1,400 for heads of household. The standard deduction is also $1,500 higher for those over 65 or blind (up from $1,400 in 2022) and $1,850 higher if also unmarried and not a surviving spouse (up from $1,750 in 2022). The basic deduction limits are:
|Married Filing Jointly||$22,700|
|Married Filing Separately||$13,850|
|Head of Household||$20,800|
- Capital Gains Rates
Income earned from the sale of property is treated as capital gains, and the IRS assesses taxes on these gains based on the taxpayer’s level of income and the holding period of the property sold. Short-term gains (gains earned on property held less than a year) are taxed as ordinary income, while long-term gains (gains earned on property held more than a year) are charged at either 0%, 15% or 20%, based on the filing status of the taxpayer and their taxable income for the year. Proper planning around the receipt of taxable income and sales of capital assets can allow for taxpayers to benefit from a lower than the maximum 20% tax rate. For 2023, the IRS increased these income thresholds applicable to long-term capital gains taxes as follows:
|Tax Rate||For Single Filers||Married, filing jointly||Married, filing separately||For Heads of Households|
|0%||$0 to $41,675||$0 to $83,350||$0 to $41,675||$0 to $55,800|
|15%||$41,676 to $459,750||$83,351 to $517,200||$41,676 to $258,600||$55,801 to $488,500|
|20%||$459,751 or more||$517,201 or more||$258,601 or more||$488,501 or more|
- Alternative Minimum Tax
The Alternative Minimum Tax (AMT) system calculates and assesses AMT based on an alternate definition of taxable income, called Alternative Minimum Taxable Income (AMTI). Low-income and middle-income taxpayers are typically not subject to AMT due to large exemptions that remove their income from AMTI classification. However, this exemption phases out for high-income taxpayers. The AMT is assessed at two rates: 26% and 28%. For 2023, the AMT exemption amounts are as follows:
|Married Filing Jointly||$126,500|
AMT exemptions phase out at 25 cents per dollar earned once AMTI reaches the following thresholds:
|Married Filing Jointly||$1,156,300|
- Child Tax Credit
The maximum Child Tax Credit is $2,000 per qualifying child and is not adjusted for inflation. The refundable portion of the Child Tax Credit is adjusted for inflation and will increase from $1,500 to $1,600 for 2023.
- Qualified Business Income Deduction (Sec. 199A)
The Tax Cuts and Jobs Act of 2017 includes a 20% deduction for pass-through businesses. Limits on the deduction begin phasing in for taxpayers with income above $182,100 (or $364,200 for joint filers) in 2023. This deduction remains available through 2025 for sole proprietors and pass-through entities (partnerships and S corporations).
- 401(k) and IRA limit increases
The amounts that individuals can contribute into their 401(k) plans, 403(b) plans, and most 457 plans will increase in 2023 to $22,500, up from $20,500 for 2022. Similarly, the limit on annual contributions into an IRA will increase to $6,500, up from $6,000.
The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), and most 457 plans is increased to $7,500, up from $6,500. Therefore, participants in these plans who are 50 and older can contribute up to $30,000, starting in 2023. The IRA catch‑up contribution limit for individuals aged 50 and over is not subject to an annual cost‑of‑living adjustment and remains $1,000.
- Year-End Charitable Gifting Opportunities
For taxpayers that itemize their deductions, donations to eligible charities and nonprofit organizations can provide significant tax savings, resulting in greater giving to such organizations. Gifting can be made in various forms including gifts of cash, securities or other property, including interests in business entities. Consideration should be given to making such gifts prior to December 31st and the impact such gifts will have on a taxpayer’s overall income tax liability.
For high-net-worth individuals looking to gift to nonprofits but who may not have yet determined which charities to give to, or where the establishment of a private foundation is not feasible, the Donor Advised Fund (DAF) structure offers opportunities to earmark amounts to be gifted (and deducted) prior to the actual payment being made to such nonprofit. The funds gifted to a DAF are immediately deductible, can grow tax free while held, and allow you to support IRS-qualified charities with grant recommendations from the DAF that you endorse. For large charitable gifts, a private foundation can be established to maintain a higher level of control over the gift and its ultimately disbursement, which can include distributing private foundation assets to DAF.
- Loss Planning
The recent downturn in the stock market has some taxpayers considering triggering their unrealized losses in order to offset the recognition of other current year gains. Similarly, the mosses in the cryptocurrency market, dubbed by some as a “crypto winter,” has resulted in currently depressed value and in some case most likely unrecoverable losses through a string of bankruptcy filings. Most recently, Blockfi and FTX declared bankruptcy and before that the cryptocurrency platform Celsius filed for chapter 11 bankruptcy during this last summer.
With the recent downturn and loss of value in the stock and virtual currency markets, some taxpayers have considered triggering their unrealized losses in order to offset the recognition of other current year gains. However, these same taxpayers may not wish to permanently and economically abandon their positions if the losses may ultimately be recoverable. One potential solution to this dilemma involves selling out of positions, recognizing a loss, and immediately thereafter repurchasing the same position before the market price materially changes. From an economic perspective, the taxpayer’s position has not changed, but the taxpayer has successfully managed to trigger losses that can be used to offset other current year gains.
As a longstanding rule under the Internal Revenue Code however, losses recognized from the sale and repurchase of the same or similar positions in stock or securities are disallowed for tax reporting purposes if, within 30 days before or after the date of sale, the taxpayer has acquired substantially identical stock or securities. This limitation on the recognition of such losses is commonly referred to as the “wash sale rule.” Sellers to traditional securities should be aware of this rule to ensure the loss triggered by selling the position is ultimately allowable for tax purposes.
However, losses on cryptocurrency losses are not believed to be subject to this rule, allowing the tax benefit of selling at a loss even if there is an instantaneous reacquisition of the same position Specially, the U.S. Tax Code does not offer consistent definitions for stock or securities, which has resulted in some uncertainty with respect to the wash sale rule’s application to cryptocurrency transactions, specifically those transactions where a taxpayer buys and sells identical cryptocurrency assets within a 30-day window. Hence, the wash sale rule’s lack of applicability to certain types of cryptocurrencies can present opportunities for taxpayers holding unrealized loss positions in virtual assets to monetize their current losses while maintaining their overall economic value in the crypto assets. Because the CFTC has concluded that Bitcoin is a form of commodity, and because these virtual currencies generally do not share many of the features that characterize a security for federal income tax purposes, taxpayers currently have an opportunity to treat many cryptocurrencies as a commodity and not a security and therefore exclude such positions from the wash sale rules. In 2021, the Biden administration’s Build Back Better bill included language that would have applied the wash sale rule to the disposition of digital assets. Although the bill stalled in Congress, these developments hint at aspirations by the government to regulate this area in the future as well as a government view that the wash sales do not in fact capture cryptocurrencies transactions within their scope. But for now it would appear that the cryptocurrency falls outside of the wash rules, presenting a unique opportunity to investor holding momentarily depressed tax positions.
Finally, if taxpayers hold cryptocurrencies related positions going through bankruptcy, there may be opportunities to trigger these losses even if positions can not be sold or otherwise transferred as well as the potential to obtain ordinary instead of capital losses, depending on the underlying facts. Whether this is an option for you will require a more in-depth analysis of your specific facts.
The relationship between individual taxpayers and their businesses continue to offer opportunity for effective tax savings, including the use in certain circumstances of C corporation structures to arbitrage tax rates, allow for greater deductions and potentially offer savings on an exit. However, much tax planning continues to focus on accessing these benefits before they sunset (absent future extensions of TCJA legislation) in 2025.
For business owners who have structured their businesses as a flow-through entity (i.e., partnership, disregarded LLC, S Corp), the following should be considered in any year-end tax planning:
- Net Investment Income Tax
For passive investments in pass-through entities, consideration should be given to net investment income tax (“NIIT”) which is imposed at 3.8% on such income. While many taxpayers view this tax as primarily imposed on passive income like dividends, interest and capital gains, it can also impact income from rental properties, mutual fund distributions or royalty and annuity income. As relates to business investments, if the activity of the owner of such investment is considered to be passive (vs. active), the NIIT can also apply on income that flows through to such owner where their adjusted gross income exceeds a certain threshold ($250,000 for MFJ, $125,000 for MFS and $200,000 for all others; thresholds which are not indexed for inflation). Where investments or business interests are held by trusts, the tax is also applied at the same rates but at much lower adjusted gross income thresholds (approximately $13,450). Careful management of your adjusted gross income threshold may minimize your exposure to the NIIT.
- Excess Business Losses
The Inflation Reduction Act of 2022 (“IRA”) extended the limitation on excess business losses for noncorporate taxpayers from 2026 to 2028. Taxpayers except corporations are limited on the amount of trade or business deductions that can offset nonbusiness income. For 2022, the limitation is $540,000 for married filing jointly. The CARES Act had suspended these limitations for 2018, 2019 and 2020; however, this limit is now back in effect and planning to mitigate its effect if your business is in a loss position should be undertaken.
- Possible C Corporation Conversions
The use of a C corporation structure for business may, if qualifications are met, produce significant currently tax savings as C corporations earning are tax at a 21% U.S. income tax rate versus the maximum 37% U.S. tax. Additionally, upon a sale Section 1202 allows for up to $10 million of gain from the sale of qualified small business stock to be exempt from taxation. A detailed analysis on whether to utilize such benefits is beyond the scope of this newsletter, but DUGGAN BERTSCH attorneys are familiar with this analysis and can assist you in determining if converting your pass-through business to a C corporation is in your best interest.
The TCJA imposed a $10,000 limitation on individual’s deduction for payment of state and local taxes in itemizing their deductions. For many high taxed states, this resulted in significant limitations on state income and property tax deductibility and resulted in an effort to find a workaround from the legislation to allow for deductibility. Most states that impose income tax developed a Pass-Through Entity Election (“PTE”) whereby individual owners and their pass-through entities could elect to pay the state income tax at the entity level, thereby resulting in a reduction (and deduction) of the entire amount of state income tax that would be imposed on such income.
This has been implemented on a state-by-state basis, meaning not every pass-through entity will realize the same benefit. Some states have allowed owners or partners to claim a credit for their share of the taxes paid by the entity, while others allow the owner or partner to exclude their distributive share of the entity’s income. Special consideration is needed when owners are residents of different states. At the end of 2022, 29 states plus New York City, have enacted a PTE tax. All states permit PTE as an election, except Connecticut which is mandatory, and most are irrevocable elections.
In addition to the potential SALT savings from making a PTE election., many U.S. businesses are becoming more exposed to state income taxes following the Supreme Court’s 2018 decision in South Dakota vs. Wayfair, Inc., which gave authority to many states to tax businesses on their e-commerce activities, despite having no physical presence to the state. The old rules for state income taxation (based more on physical presence) are changing, with a focus on businesses that have a nexus to the state based on where the customer receives the benefit of the product or services being provided. As states are becoming more aggressive with their enforcement activities in this area, we recommend reviewing your business operations as well as legal structure to mitigate SALT exposure.
As indicated above, the recent changes to congressional control following the mid-term elections will likely mean a stalemate in Congress for the next 2 years with respect to any meaningful tax legislation. This means that from an estate planning perspective, the increased lifetime exemptions enacted as part of TCJA will continue to be available for transfers of assets out of your estate. Due to the current high inflation rates, the lifetime exemption will see a significant increase going into 2023, resulting in almost $2 million additional exemption for married couples filing jointly. For those that have already employed estate transfer techniques, additional gifting or transfers may be available to use up the added exemption, such as gifting or freeze planning to gift trusts with spousal lifetime access provisions (“SLAT”). Similarly, some of you may require structuring a more complicated gifting structure to maximize your wealth transfer at year-end. Gifting LLC interests, closely held business interests, or restricted assets can be more powerful based on how these assets are valued. For instance, gifting non-transferrable, non-controlling interests are significantly less valuable than gifting assets directly and therefore use up less of your lifetime exemption. As a result, a taxpayer can better leverage their lifetime exemption by gifting discounted interests in a holding company that directly owns assets rather than gifting the asset. While limiting these discounts have repeatedly been a target in D.C., it remains to be seen if or when legislation may actually get passed that limits such discounting of an estate’s assets under these methods, so these techniques remain currently available for use. Finally, as the great migration of baby boomers to warmer and lower taxing states continues to increase, all estate plans should carefully identify residence/domicile for state estate/inheritance tax purposes prior to any relocation you may be considering.
- Increase of Annual Exclusion and Estate & Gift Exclusion Amounts
The IRS released the 2023 annual exclusion gifting amount and lifetime exclusion amounts. In 2022, taxpayers may gift, free of gift or estate tax, up to $16,000 per person. The annual exclusion amount will increase to $17,000 in 2023:
Annual Gifting Exclusion
If able, a taxpayer should utilize this annual exclusion prior to year-end, which is available on a use it or lose it basis each year. Moreover, thoughtful consideration should be undertaken in deciding which assets to gift. For example, gifting appreciable assets removes the current asset as well as future appreciation and generally produces more favorable transfer tax savings benefits then gifting cash. Finally, the annual exclusion for qualified medical or educational payments is unlimited. However, it is important to note that gifts to the popular section 529 plans do not qualify for the unlimited annual exclusion. It is important to note there is a special 529 gift election available where the taxpayer may pay up to five times the annual exclusion amounts into these accounts free of gift tax and without using any of their exemption amount.
Lifetime Estate & Gift Tax Exclusions
|Type of Tax||2022 Rate||2022 Exemption||2023 Rate||2023 Exemption|
|Gift||40%||$12.06 million||40%||$12.92 million|
|Estate||40%||$12.06 million||40%||$12.92 million|
|GST||40%||$12.06 million||40%||$12.92 million|
The Basic Exclusion Amount (i.e., lifetime exemption) is a unified exclusion amount for gift tax and estate tax that a taxpayer may gift during lifetime and/or own at death without being subject to gift or estate taxation. The Generation Skipping Trust (“GST”) tax also provides for a similar amount of exclusion. The TCJA increased this exemption beginning in 2018 from $5.59 million to $11.18 million and for 2023, after indexing for inflation, this exclusion amount will be $12.92 million for each individual or $25.84 million for married couples. Such exclusion is scheduled to be reduced back to pre-TCJA levels, adjusted for inflation, at the end of 2025, when it is currently expected to be around $6.4 million per person.
Fourth quarter reviews can be very valuable for improving the structure of your tax, business, and estate planning. Now that the mid-terms are mostly over and we have a sense of what the rules will be for the next couple of years, a more certain environment exists for effective tax planning. As the year draws to a close, we recommend taking the opportunity to review your overall income and estate tax positions and consider whether any of the highlights and opportunities reflected in this newsletter warrant further discussion.
At DUGGAN BERTSCH, we have substantial experience in advising private clients on sophisticated income tax and estate tax planning for both individuals and their business interests. As only one month remains within this year, the window of opportunity to consider and take advantage of the unique estate and income tax planning opportunities is very near its end. We would be happy to further discuss this these opportunities with you and encourage you to contact your DUGGAN BERTSCH adviser at your earliest convenience.
On behalf of the DUGGAN BERTSCH Team, best wishes for the holiday season and for a happy, healthy and prosperous new year!