While getting your tax information in good order is always a smart move, you may want to be particularly diligent in 2023. The Inflation Reduction Act (IRA) increased the IRS budget by nearly $80 billion over the next decade, giving them more money for audits and enforcement. As a result, some issues are bigger targets than others. Here are the hot-button topics for the IRS in 2023:
Business Hot Button IRS Topics for 2023
174 Research + Experimentation Expenses
The government changed the rules for deducting Section 174 research and experimentation (R+E) expenses. Before, your business could deduct the full amount of eligible R+E expenses each year. This made it easier to track and gave you a sizable upfront tax break.
As of January 1st, 2022, your business must now amortize these expenses and the deduction over time. You spread the deduction for US-based R+E expenses over five years and foreign expenses over 15 years. For example, if you spent $1 million on US-based expenses in 2022, you can deduct $200,000 in 2022, and the balance of $800,000 is deducted $200,000 annually for the next four years to claim the full amount.
This change may impact whether you met the estimated tax payment requirements for 2022. The IRS will check to see if you are deducting the entire 174 R+E expenses all at once. They will also see whether your business is accurately tracking and calculating the deductions over the correct amortization schedules.
Research + Development Tax Credits
Since the 174 R+E deduction is less generous, your business could claim many of the same research expenses under the R+D tax credit. The credit is worth approximately 10% of your eligible research spending for the year. You can carry any unused credits forward for up to 20 years. As a dollar-per-dollar reduction of your tax bill, a credit is also more valuable than a deduction.
The catch is that not all 174 R+E expenses can be claimed under R+D credits. You can claim direct research costs for the R+D credit, such as the wages of researchers, supplies, and the cost of hiring contractors and consultants for research.
However, you cannot claim indirect costs like rent or utilities for your research facilities. You also cannot claim the costs of patents or foreign research under the R+D credit. Instead, these expenses can only be used for the 174 R+E deduction. IRS audits will check whether you properly divide research expenses between the two tax breaks.
Employee Retention Credits
The government created Employee Retention Credits (ERCs) to support businesses and their employees during the COVID-19 pandemic. Businesses that shut down for safety reasons or faced a significant decline in receipts could use this credit to offset the cost of still paying employee wages rather than laying people off.
Given the turmoil of the pandemic, the government made it easy to claim this credit without showing proof. As a result, some businesses may have claimed the credit when they weren’t eligible, perhaps after some poor tax advice. The IRS issued a warning against third parties pushing business owners to make improper claims for this credit.
The IRS is now actively auditing past claims for ERCs. If your business used this credit, review your calculation and documentation with a tax expert now. That way, you’ll be prepared to justify your position and could proactively fix any errors.
In addition, if you qualified for this credit but the refund didn’t arrive until after your business owed taxes, you could apply to have penalties waived for late tax payments. A qualified tax and business advisor can help you determine the best penalty relief options.
Individual Hot Button IRS Topics for 2023
If you invest in cryptocurrencies, an IRS audit will check whether you correctly recorded the tax basis and sales proceeds of all your trades for capital gains and losses. If you earned cryptocurrencies by supporting blockchains through mining, this could also lead to owing business income and self-employment tax. Last, digital assets stored outside the United States could face additional international tax rules and reporting requirements.
Tax laws for this evolving market remain complex. Keep accurate records of your trades and transfers between wallets as the IRS ramps up cryptocurrency tax enforcement.
SALT Cap Workarounds/Pass-Through Entity Elective Taxes
The Tax Cuts and Jobs Act of 2017 capped the deduction for state and local taxes (SALT) at just $10,000 per year. States that charged high-income tax rates, like California and Oregon, looked for a workaround. In 2020, the IRS announced it would permit taxpayers to use pass-through entities like S-Corps and LLCs to claim more than this limit.
Since then, 29 states have created programs based on a Pass-Through Entity Elective Tax (PEET). If you use this approach, the key is getting the calculation right. Unfortunately, there is quite a bit to keep track of, between properly establishing your pass-through entity, managing its tax filing along with your individual return, and following your own state’s tax laws. It’s even more challenging if you own property and/or file returns in multiple states.
To further complicate the situation, the IRS has not provided much guidance as the SALT limit expires at the end of 2025. It’s not an urgent long-term issue at the federal level. Make sure you work with a tax advisor well-versed in these rules, especially for your state(s) of residence. Together, you can maximize this deduction without running into issues with state and federal tax authorities.
Capital losses are created when you sell an asset for less than what you paid for it. You can deduct the losses against your capital gains. If your losses exceed the gains for the year, you can deduct an additional $3,000 against your other personal income.
Generally, you can avoid IRS issues by properly tracking and reporting your annual gains and losses. Taxpayers run into audit trouble when they claim ordinary loss deductions meant for professionals.
Professional day traders can deduct their investment capital losses against their total personal income; the $3,000 annual limit doesn’t apply. To qualify as a day trader, your trading activity must be so frequent and substantial that it qualifies as a business, as defined by the IRS. The IRS looks for regular investors who try to improperly present themselves as day traders for this tax break.
The same applies to rental investment properties. Once again, a larger loss deduction is accelerated for those who primarily work in real estate as landlords or brokers, spending more than 50% of their working hours and 750 hours per year on this work. The IRS looks out for those using rental properties as a passive investment who still try to claim this ordinary loss deduction before the property is disposed of.
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Meet the Author
Pat Murphy Hirata, CPA, JD
Aldrich CPAs + Advisors LLP
Patricia Murphy Hirata joined Aldrich CPAs and Advisors in 2022. Before Aldrich, Pat led several wealth and estate planning groups as a Partner at the 5th largest accounting firm in the U.S. and served as the Chief Financial Officer at a nationally recognized real estate company. Pat has significant expertise in various areas, including the... Read more Pat Murphy Hirata, CPA, JD
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