Tom Talks Taxes - December 8, 2022

Last-minute considerations for tax year 2022

We are rapidly approaching January 2023 and the next tax season!

Before you get into full-fledged holiday mode, consider the following for your business and your clients for December 2022 and the upcoming year.

Time to part ways? You deserve to work reasonable hours with reasonable clients who value the service you provide to them. If a client does not advance that goal, let them know in advance you cannot work with them next year. Use the sample letter from a previous edition.

Ballooning IRS interest rates. The statutory overpayment and underpayment interest rate for individuals started at 3% in 2022, is now 6% and will be 7% in the 1st quarter of 2023. When you do representation engagements — do you make proactive efforts to minimize interest accruals, and do you communicate interest savings in the value you provide? How will you value and assist your 2023 clients with extension payments since underpayments will now incur hefty interest charges?

On the other hand, delayed IRS refund claims now earn a lot of interest. Let the IRS take their sweet time on them, provided the taxpayer is not in urgent need of the cash.

It’s the season for giving. Year-end charitable donations are common, but consider these two strategies for enhanced tax consequences:

1. Donate appreciated stock held long-term to get a fair market value (FMV) tax deduction while avoiding tax on long-term capital gains.

2. Make a qualified charitable distribution directly from an IRA to a charity. You can donate up to $100,000 per person annually; the amount is excluded from income. You must be over age 70.5 at the time of the distribution, and it can count in part or whole as your required minimum distribution for the year.

Convert, convert, convert! While stock market values are down, converting traditional retirement funds to a Roth IRA may make sense if 2022 is a lower-tax year. While taxable in the year of conversion, the later distribution of the funds and any growth is tax-free. The conversion amount must be held within the Roth IRA for at least five years to avoid the 10% early withdrawal penalty.

Reasonable compensation - no choice. The significant Social Security wage base increase (from $147,000 in 2022 to $160,200 in 2023) and new IRS enforcement dollars make S corporation reasonable compensation planning compelling. Can you turn a blind eye to a client who pays insufficient compensation year after year? Does that put you at risk? (And read this if you think the answer is no.) Why do you work with clients who ignore your advice year after year when there are prospects who hunger for proactive tax advice? Consider bundling an annual reasonable compensation analysis as part of your S corporation tax preparation and value the package appropriately.

COVID payback. 2020 coronavirus-related distributions can be repaid within three years of the taxpayer receiving the distribution, and previous or future income inclusions can be reversed. Time is of the essence as the three-year window will close sometime in 2023 — possibly as soon as January 2023!

Deduct business state income taxes. Thanks to IRS Notice 2020-75 (and the forthcoming proposed regulations, if we ever get them), partnership and S corporations can elect in many states to pay a state-level income tax while passing through a tax credit to the owners for the taxes paid. The net effect is to make state income taxes fully deductible as business expenses and not subject to the $10,000 individual cap. Every state is different, so be sure to know your state's rules and the states where your clients do business. Estimated tax payments for the entity tax are generally deductible when paid, so the amount and timing of the estimated payments determine when the owners have reduced pass-through income. This is essential annual tax planning for business owners - how are you handling this next year if you are not currently advising on it? Should your client make an estimated tax payment this month to get a tax year 2022 deduction?

Get withholding just right. There is no benefit to a large tax refund since the IRS doesn’t pay interest to you for holding on to your cash. With interest rates much higher (~4% for an ultra-safe 4-week Treasury bill, which is easy to purchase on TreasuryDirect), significant interest can be lost with a large refund. Pay enough in withholding and estimated tax payments to avoid the §6656 estimated tax penalty, check the projection as needed, save the rest, earn good interest, and pay any balance due at tax time. What is the value of this advice to the client? How do you communicate it?

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