In this episode of The Sound of Automation podcast, we talk with Tarah Ablett, Senior Manager at Clayton & McKervey. Tarah helps manufacturing and industrial automation clients leverage tax planning opportunities and navigate tax compliance issues. Bryan and Tarah discuss year-end tax planning tips and what to expect in 2023. Listen in to learn more.
Bryan Powrozek: 2022 taxes now are pretty much a done deal. There’s not too much you can do right now. But looking forward to what’s on the horizon for 2023, what are some of the big changes? Or are there any big changes that owners should be aware of going into 2023?
Tarah Ablett: Sure. There’s some things that we’ll get into in further detail today. But the things that come to mind to think about are surrounding some deductions.
Depreciation deductions are going to see some changes in ’23, as well as some interest expense deductions. The research credit, which is a big one that we’ll get into. And then, like I previously mentioned, some state tax considerations as well. Those are kind of the main things that we’re looking at right now.
Speaker 3: Welcome to The Sound of Automation, brought to you by Clayton & McKervey. CPAs for growth-driven businesses.
Bryan Powrozek: Welcome to The Sound of Automation. I am Bryan Powrozek with Clayton & McKervey. And joining me today is my colleague, Tarah Ablett. Tarah, how are you today?
Tarah Ablett: I’m good, thanks, Bryan. How are you?
Bryan Powrozek: Doing very well. Well, hey, tell you what? To start off here, how about before we jump into our topic, you just give everybody a little of your background on what you do with Clayton & McKervey, and for industrial automation companies?
Tarah Ablett: Sure, yeah. So I am a tax manager here at Clayton & McKervey. We focus on closely-held businesses, and tax planning, and all things compliance.
I specialize in the industrial automation space, and so I work with a lot of clients in that industry. Of course, taking the research credit, dealing with all the state taxes. And so our plates are full, especially as we come up here on year-end, and thinking about planning ideas and whatnot.
Bryan Powrozek: Excellent. Well, yeah, and that’s a great lead into what we’ll be talking about today here. We’re recording in December, and so that’s right before the busy time for us. So really the goal of today’s podcast is just to share some of what companies should be thinking about for next year.
Obviously, 2022 taxes now are pretty much a done deal. There’s not too much you can do right now. But looking forward to what’s on the horizon for 2023. So I guess at a high level, what are some of the big changes? Or are there any big changes that owners should be aware of going into 2023?
Tarah Ablett: Sure. There’s some things that we’ll get into in further detail today, but the things that come to mind to think about are surrounding some deductions. Depreciation deductions are going to see some changes in ’23, as well as some interest expense deductions. The research credit, which is a big one that we’ll get into. And then like I previously mentioned, some state tax considerations as well. Those are kind of the main things that we’re looking at right now.
Bryan Powrozek: Yeah, so I guess let’s start off on the depreciation side of things. I know there’s some things going on with section 179 and bonus depreciation. What can taxpayers expect to see next year?
Tarah Ablett: Up until this year, the last couple of years, taxpayers have had the opportunity to take full advantage of that first year depreciation deduction, whether it was through bonus depreciation or section 179, which allows you to basically capitalize an asset, but then take the full cost of the asset as a first year depreciation. Of course, there’s some exceptions and things that don’t qualify or limits. But, as we head into ’23, that bonus depreciation goes from 100% in the first year, to only 80%. So it’s still out there, it’s still available and is advantageous, but I think for the last couple of years taxpayers have been used to just basically being able to write it all off in the first year. Now we still have section 179, which is the same thing. First year, 100% depreciation. It’s just that there’s kind of cap as far as what you can purchase and then still be able to take that all in the first year. So usually with inflation, it adjusts a little bit every year. But once you hit that about two and a half million to three million dollar threshold, then you have to start reducing your 179 expense. Just things to be aware of. If anyone hasn’t made those last couple of purchases in 2022, of course you would want to take advantage of that 100% bonus. It’s still around in the new year, just in a reduced format.
Bryan Powrozek: Yeah, and I think business owners have almost kind of gotten used to this ability to fully deduct everything.
Tarah Ablett: Exactly.
Bryan Powrozek: And again, not that you would put off a purchase necessarily now, because you can only take 80% of it on bonus, or if you’re reaching the cap on 179. But just something to think of from more from a tax-planning perspective as they’re going forward next year. That if you are making some big capital purchases that you were going to get the full benefit of previously, you might want to run that by your tax advisor. Make sure you don’t miss out.
Tarah Ablett: Exactly.
Bryan Powrozek: So moving on to, you also mentioned interest. There’s some changes in the way that that interest is being managed?
Tarah Ablett: Yeah. Yup, so with the Tax Cuts and Jobs Act that was passed in ’17, implemented in ’18, there was this new rule and calculation surrounding the deductibility of interest expense. It’s this calculation that you get to an adjusted taxable income number, and then you can take 30% of that as your interest expense if you have interest up to that amount. With the pandemic, that limitation went up to 50% for a couple of years. It is backed down now, it was already backed down to 30 in ’21. But the bigger thing to look for in ’23 is that, in that calculation where you arrive at your adjusted taxable income, no longer can you add back the depreciation expense. And so, if you’re starting with a lower number, of course your limitation is going to be lower too. It’s just going to be one of those things that if you are paying a lot of interest expense, similar to depreciation, you’re used to a certain amount, there’s potential for that to be reduced in ’23.
Bryan Powrozek: And sometimes that interest issue can be a little bit problematic for companies. Particularly companies that might be at the lower end of taxable income, right?
Tarah Ablett: Right.
Bryan Powrozek: If you have lower taxable income, and maybe the cash flow isn’t necessarily there. And then you see this big adjustment back, adding interest back, you could end up having to pay tax. So definitely one of those things that business owners want to make sure that, if their provider hasn’t talked to them about making sure they’re planning accordingly for that, to ensure there’s enough cash around to make your tax payments and things like that.
Tarah Ablett: Exactly, yeah. Sort of nothing worse than expecting to have a low taxable income number, only to then have to pay tax.
Bryan Powrozek: Yeah, exactly. Exactly. All right. So let’s move on to something that’s near and dear to my heart. The R&D tax credit. I mean, that’s a huge benefit for automation companies that we’ve seen over the years. That’s now taken a little bit of a hit, at least in the near-term. Still got my fingers crossed we hear a change. But what’s the latest with the R&D tax credit?
Tarah Ablett: Yeah, and you may have touched on this in previous episodes. But in case not, we are looking at a situation where, beginning with 2022, so as we ramp up to prepare 2022 tax returns, the research and development expenses, referred to as 174 costs, are actually required to be capitalized and amortized over a period of time. As opposed expensing them all, as taxpayers always have. This is something, again, that was in the Tax Cuts and Jobs Act that we really did not anticipate it lasting this long. We certainly thought there would be a fix by now. There’s a ton of discrepancy with what the Act actually means, and how to apply that. So we have very little guidance. We are still hoping for a fix, but worst-case scenario, where taxpayers are used to expensing these, oftentimes pretty significant things related to R&D. If those are required to be added back and then capitalized, there’s going to be some pretty significant tax being paid.
Really nothing they can do about it at this time, other than just be aware that it’s out there. We’re hoping and waiting. There certainly could still be a fix before year end. There could be a fix after year end, and then it would be hopefully retroactive. But not only would it impact their taxable income, but also their ability to have that credit. Just because you would only be able to take the amount that was recorded as an expense. So a lot of uncertainty, a lot of waiting and watching, and looking for any guidance that we can get our hands on in the next few months here.
Bryan Powrozek: Yeah, and I think within the industry, a lot of the focus was on the, I think kind of the, “Well now it doesn’t make sense for me to claim the credit if I’m going to have to prepay tax, essentially because I’m taking it.” I think a lot of the content that was generated previously, was maybe focused more on the people who’ve never claimed the credit before and we’re thinking about it. So now it’s like, “Okay, we wouldn’t want to go after it because of the tax implications.” And in hopes that this would’ve been resolved, as you said. Not too many people focused on the practical implications for people who are already claiming credit. And so, as you mentioned, because you’re going to be required to capitalize these expenses, now you’ve got a consistency issue potentially that…
And again, there’s no clear-cut guidance on this from the IRS either that, if you’ve taken the credit in the past, are you now supposed to capitalize… Continue to take the credit, but now you have to capitalize those expenses and you don’t really have an option? Unless you go back and say, “Well, we never were really entitled to the credit to begin with.” And so now you’re dealing with amending returns, and repaying tax and all that other stuff. It makes the planning piece challenging. So for listeners out there, if your company is already claiming the R&D credit, and your provider hasn’t brought this issue up to you, it’s definitely worth a conversation. Because, as Tarah mentioned, we’re hopeful that this gets resolved early next year. But if it, say it gets resolved by March, and you have to have estimated tax payments in, you’ve got to come up with a solution before we know with complete certainty what’s going to happen.
Tarah Ablett: Exactly. And I anticipate there’s going to be a lot more taxpayers and business owners choosing to extend their returns as a result of this. However, they’re still going to have to make those decisions when it comes time to come up with those extension calculations. So we’re looking and hoping. And this is an industry-wide issue, where practitioners are really kind of scratching their heads of what to do, and talking to their clients about it. But we’re certainly hopeful and looking for something to happen here in the next couple of months. But just beware that you may be having to make some of those difficult decisions right at the last minute.
Bryan Powrozek: Yup, exactly. And so now you’ve kind of got almost this perfect storm, with the depreciation and interest and now the R&D stuff that your cash management’s going to become especially critical as you’re going through your ’23 tax planning. Because you could end up having to make some payments you ordinarily wouldn’t have. So factoring that into your whole strategy is vitally important.
Tarah Ablett: Absolutely.
Bryan Powrozek: Yup. So moving on from the credits. The vast majority of the industrial automation clients we work with, I’d probably say almost 99% of them, are partnerships or S-corps. A pass-through entity of some sort. What type of considerations do they need to be thinking about going into this next year?
Tarah Ablett: For those taxpayers that are a pass-through entity, like you mentioned, oftentimes they are filing in a couple, or several, states. And when it comes to state taxes, there’s 50 states with 50 different sets of rules. And so there’s a lot of different taxing regimes out there. One of the things that is becoming more prevalent with the state taxes is sometimes referred to as a pass-through entity deduction, or a flow-through entity tax regime. The basis of it is that, again, going back to the Tax Cuts and Jobs Act, the individual itemized deduction related to state and local tax was capped at $10,000. Now for most taxpayers in the United States, that’s a pretty low amount, and they’re getting hit with not being able to take those deductions on their personal return. And so for owners of these pass-through entities, some states are coming up with a regime whereby the entity would pay the tax at the entity level, that the owner would then get credit for on their state tax return. So by doing this, number one, the entity, the flow-through income is lower, because of taking that deduction. And then the business owner is still paying state tax. But because they’re getting this credit for a tax paid on their behalf, they’re not getting that limitation at the federal level of $10,000. There’s a handful of states that have implemented it with the 2021 year end. It seems like it’s becoming more and more prevalent, and a few more states are rolling this out each year. A lot of times there’s set calculations and elections to be made. And so it certainly is something that you want to look at and see if you would benefit from, and if it applies to states that you’re doing business in, and filing returns in. But if it applies, and it makes sense for you, it is a pretty big tax savings structure. You don’t want to just jump in and make all these elections, because there are some compliance requirements surrounding it. But it certainly can be advantageous to the business owner.
Bryan Powrozek: Yeah, and still something that, when this comes out, people might have a chance to talk with their providers about. Because I mean, some of the states do have requirements where it’s, the payments have to be made that year, right?
So it’s not something where you can jump in January 1st, make the payment, make it retroactive to the prior year. So if you do decide you want to take advantage of it, it does require a little planning. If you happen to miss it for the ’22 tax year, definitely look for it for ’23. Because we’ve talked about a couple things here that are going to potentially drive additional tax for taxpayers. And so this is one area where you can maybe get a little back and help the cash flow in the other direction.
Tarah Ablett: Exactly, yup. Yeah. And like you mentioned, looking to make those payments before year end, that’s sort of the key in order to get the federal taxable income down. So definitely a little bit of time left to consider that, and then look for it next year if you miss out.
Bryan Powrozek: Excellent. Obviously we’ve talked a lot, and I think that this is probably the one staple going into every tax season, is that there’s a lot of changes, a lot of uncertainty. And the importance of talking about things with your tax preparer is critical to make sure you’re doing everything right, and you’re optimizing your tax position. Are there any other big items that we’re discussing with our clients currently?
Tarah Ablett: Obviously we’ve been in a pattern of… Between the Tax Cuts and Jobs Act, which was a planned change, and then the coronavirus pandemic, all the changes surrounding that. There’s been a lot of changes for taxpayers in the last couple of years, and we’re just a couple of years away from another election. And so I think taxpayers need to be in good shape to be having those planning conversations, and have their books in order. Clean, kind of ready. Because some of these things, like the pass-through deduction that was rolled out for Michigan last year, was very last minute. If you’re having those conversations with management, and with your providers, you’re in a position to make some of those decisions, and deciding whether that makes sense for you or not. So I think just remaining ready to jump in on anything, and have those clean records so that you can, at any moment say, “Okay, yes, this makes sense,” or it doesn’t. Is really what I think would put you in a good position to make some good decisions from here on out.
Bryan Powrozek: Yeah, definitely. And something else I would encourage. If you go to Clayton McKervey’s website, and look in our Insight section, we’re constantly putting out articles. You can also sign up for our industrial automation newsletter, where we try and keep business owners up to date on these types of topics.
Just going back to the R&D credit for a minute. As the developments come out on that, we’ll be publishing on that to keep people up to speed with everything that’s happening, and how it’s going to impact their business. So definitely something, from the listener perspective, if you’re not already engaged with us, and our content, our articles, things like that, definitely worth checking in.
Because as these things change, as Tarah mentioned, we try to get content on it in a way that’s going to be helpful for the business owner. We’re not going to dive deep into the code sections and what all the verbiage means, but kind of break it down into, what does this mean for you as a business owner? How should you respond?
Tarah Ablett: Sure.
Bryan Powrozek: Another, and this is something that I think we get all the time as we’re talking with prospective clients, is that they tend to… We see a lot of clients come in who get frustrated by their current tax provider not giving them that proactive guidance and advice. They’re basically just the compliance partner that takes care of things. So if someone listening to this episode heard something you were talking about and is like, “Gosh, my provider’s not talking to me about these things.” What’s a good way for them to reach out to you and connect, and maybe get some questions answered?
Tarah Ablett: Sure. Yeah, I’d say the best way would probably be to email me, tablett@claytonmckervey. I’m sure you can find our emails on our website too.
But I would say email is the best way to get ahold of me. And then certainly I can help point you in the right direction, answer your questions, and support wherever we can. So that would be great.
Bryan Powrozek: Fantastic. Well, Tarah, I appreciate you coming on and sharing some of your insights. Enjoy the last few weeks here before things get crazy again. And we’ll speak again soon.
Tarah Ablett: Thanks Bryan.
Bryan Powrozek: Yup, thanks.
Speaker 3: Thank you for tuning in. Don’t forget to like us, subscribe, and share on social. To learn more about Clayton & McKervey, visit us at claytonmckervey.com. That’s C-L-A-Y-T-O-N-M-C-K-E-R-V-E-Y.com. We thrive on finding the solutions for you.