As we celebrate the New Year and move into filing season, it is a good time to review where the industry stands with specialty tax areas that are an increasingly large portion of business tax returns. These areas include cost segregation, research tax credits, energy credits and deductions, and international tax compliance. With the recent passage of the Inflation Reduction Act of 2022, and the lack of tax extenders, it is important to be aware of how these complicated areas are ever changing.
When considering these specialty areas, one of the first aspects taxpayers need to consider is the increased enforcement efforts by the IRS. Whether it be R&D tax credits, cost segregation, 179D or penalties related to international tax compliance, you do not have to look hard to find examples of where and when the IRS is enforcing the law more effectively. With heightened funding levels for the IRS under the Inflation Reduction Act, the increase in IRS enforcement looks to continue into the coming years. Taxpayers and preparers need to be diligent in ensuring their studies are completed in a quality manner or clients may be at risk.
The Tax Cuts and Jobs Act of 2017 included provisions that will affect the handling of specialty tax moving forward. As a budgetary tool, the TCJA had sunset provisions that start to come into play in 2022 and 2023. These include a change to the calculation of adjusted taxable income for the 163(j) limitation, a leveraging down of bonus depreciation starting in 2023, and the new amortization requirement for 174 expenses. While many of these were expected to be fixed through an extenders bill, as of the writing of this article Congress has not been able to bring the extenders to fruition. This will impact businesses as they decide how to handle cost segregation studies, due to the reduction of bonus and the interaction of depreciation with 163(j).
One area that people assume is affected relates to the research and development tax credit. While the new requirement to amortize Section 174 expenses does begin in 2022, this does not reduce research tax credits. The R&D tax credit is based on the amount of Section 41 expenses. While all Section 41 expenses are Section 174 expenses, not all Section 174 expenses are Section 41. In other words, claiming an R&D tax credit does not create Section 174 expenses; it simply allows you to take a credit on top of the expense you were already taking. This means taxpayers that forgo the R&D tax credit will still have the same amount of Section 174 expenses to amortize, they will now just not have the R&D tax credit to offset this deduction.
As if the changes we dealt with in 2022 were not enough, more changes are coming in 2023. Under the Inflation Reduction Act, the Energy Efficient Building Deduction (179D) and the New Energy Efficient Home Credit (45L) drastically change starting in 2023. In addition to requiring the prevailing wages for some of the increased credits, 179D can now be transferred from tax-exempt entities, and the 45L tax credit changes to be linked to Energy Star, versus the previous requirements under the International Energy Conservation Code. For some taxpayers, this may increase their credits and deductions, but for others this will make the credits and deductions much less valuable. It will be critical to review and discuss early in 2023 to ensure properties being completed through the year qualify.
The ever-changing landscape of specialty tax will make the 2022 filing season more complicated. Combining this landscape with the increased compliance risk from the IRS, it is more important than ever for taxpayers and their CPAs to ensure they receive sound technical expertise. While the opportunities are still significant, it is critical for CPAs to understand and advise clients appropriately to maximize opportunities in these specialty areas.
