Tax issues you might have missed during year-end close
June/July 2023 Footnote
Editor's note: Updated May 30, 2023
The IRS officially kicked off the tax filing season Jan. 23, 2023, and issues continued to arise in the tax world. With competing deadlines and plenty of busyness, you weren’t likely able to stay on top of every piece of new information.
Here are some of the key issues you might have missed.
Recent tax legislation
The Inflation Reduction Act of 2022 was passed in August 2022 and included an assortment of climate and energy tax provisions, along with authorization to spend $80 billion more on the IRS.
The Consolidated Appropriations Act was passed in December 2022, with spending of $1.7 trillion. However, there was no extension of the five-year phaseout of the 100% bonus depreciation or other provisions originally passed in the Tax Cuts and Jobs Act of 2017, which is generally scheduled to expire after 2025.
Congressional tax committee changes
Following the 2022 elections, Rep. Jason Smith (R-MO) became chair of the House Ways and Means Committee, where federal tax legislation originates. Sen. Ron Wyden (D-OR) retained leadership of the Senate Finance Committee.
This split generally indicates a stalemate in advancing new tax legislation — sometimes viewed as a welcome reprieve for tax and finance professionals.
Debt ceiling discussions
The $31.4 trillion debt ceiling was reached earlier this year. As of this magazine’s publication time, there is a deadlock in negotiations, with the Biden Administration rejecting a House plan to raise the debt limit only with cutbacks in spending. The Treasury Department has been juggling accounts to keep paying the government’s bills. New borrowing authority may be needed as soon as early June 2023.
Social Security tax increases
Social Security taxes are a direct add-on cost to company payrolls, since employee contributions are matched by employers. Every additional dollar increase in payroll generally has up to an additional 7.65% corresponding cost.
Social Security taxes continue to increase each year and a change to the treatment of S Corporation earnings may be a real possibility on both sides of the political aisle.
At the end of March 2023, the Social Security trustees released a report finding that Social Security is 11 years from insolvency if no action is taken, one year sooner than last year’s analysis indicated. The so-called Old-Age and Survivors Insurance Trust Fund is using reserves to help pay current retirees. The report said all beneficiaries will face a 20% across-the-board benefit cut upon insolvency if there are no changes.
For 2023, retirees received an 8.7% inflation-based adjustment to benefits, but with an increase in the base from $147,000 to $160,200 of earnings subject to tax for workers. For higher income earners, an additional $818.40 of tax will be matched by employers for Social Security contributions of $9,932.40 from each the employer and employee.
In addition to Social Security taxes, the 1.45% Medicare tax continues to apply to all compensation, not just the $160,200 maximum subject to Social Security taxes. An additional 0.9% Medicare tax applies to employees, but not employers, for compensation exceeding $200,000 single or $250,000 married filing joint. Perhaps not coincidentally, this 0.9% added to the combined 2.9% employee and employer Medicare taxes equals the 3.8% net investment income tax on passive income.
An S Corporation earnings proposal in the 2021 American Families Plan that was resurrected on July 7, 2022, but was not passed, would amend the definition of net investment tax to include gross income and gain from any trades or businesses that are not otherwise subject to employment taxes for taxpayers with adjusted gross income in excess of $400,000 single or $500,000 married filing joint.
If enacted, this proposal would eliminate the potential Medicare tax savings for a dual-status S Corporation owner/employee who splits earnings between a reasonable salary that is subject to employment taxes and additional S Corporation earnings on Schedule K-1 avoiding employment taxes. The IRS explanation of reasonable salary is posted as S Corporation Compensation and Medical Insurance on www.irs.gov
Employee classification proposal
Some independent contractors could be classified as employees under a new proposed rule on employee classification issued by the U.S. Department of Labor on Oct. 11, 2022. California’s change has been challenged in court.
With such a change, companies hiring reclassified independent contractors would be subject to matching Social Security and Medicare contributions, along with other employee benefit costs.
Employee retention credit claims
On March 7, 2023, the IRS restated an earlier warning urging taxpayers to carefully review the employee retention credit guidelines before trying to claim the credit, since some third parties are pushing ineligible taxpayers to file on amended returns.
The IRS says that promoters of this scheme charge large upfront fees — or a fee that is contingent on the refund amount — and may not inform taxpayers that wage deductions claimed on the business’s tax return must be reduced by the amount of the credit.
Despite the IRS’s past efforts to alert individuals and businesses to the issue, the problem persisted during the 2023 filing season as tax professionals reported pressure from clients wanting to claim the credit improperly.
Additional guidance for tax professionals is expected from the IRS Office of Professional Responsibility. In the meantime, it advises businesses to be cautious of advertised promotions and direct solicitations promising tax savings that are too good to be true, noting that business owners could be required to repay the credit along with penalties and interest.
S Corporation qualification
Long-standing IRS Revenue Procedure 2013-30 provides automatic permission to make late elections, including qualified subchapter S trust (QSST) elections and electing small business trust (ESBT) elections.
The IRS also recently issued Revenue Procedure 2022-19, which provides taxpayer assistance procedures for S Corporations and their shareholders to resolve frequently encountered issues with certainty and without requesting a private letter ruling. Much of the guidance addresses a second class of stock issues, rather than eligible shareholder violations, which generally would be addressed in an IRS private letter ruling request.
A potential buyer of an S Corporation client typically will request a copy of the Form 2553 Election by a Small Business Corporation and related IRS acceptance letter during the tax due diligence process. A replacement letter now may be requested under Revenue Procedure 2022-19 regarding a missing IRS acceptance letter for an S election or an IRS acceptance letter for a QSub election.
LLCs may have inadvertently filed invalid S Corporation elections because they neglected to remove partnership tax provisions from their LLC operating agreement that ran afoul of the single class of stock rules for S Corporations.
The IRS clarified on Oct. 12, 2022, that the new self-help remedy for retroactively fixing invalid S Corporation elections in Revenue Procedure 2022-19 applies to limited liability companies that failed to update their operating agreements before filing an S election. A sample of each required statement is provided in the revenue procedure’s appendix.
2023 tax proposals
On March 9, 2023, the General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals — called the Green Book — was released.
While speculative as to enactment, proposals tend to recirculate year over year as potential revenue raisers. Definitions of “high-income taxpayers” and “wealthy” vary by proposal, and often change in final legislation.
Included in the Green Book are proposals to:
- Increase the corporate income tax rate from 21% to 28%.
- Apply the net investment income tax to pass-through business income of high-income taxpayers.
- Increase the net investment income tax and additional Medicare tax rate from 3.8% to 5% for high-income taxpayers.
- Increase the top marginal individual income tax rate to 39.6% for high-income earners.
- Tax capital income for high-income earners at ordinary rates.
- Treat transfers of appreciated property by gift or on death as taxable events.
- Impose a 25% minimum income tax, inclusive of unrealized capital gains, on the wealthiest taxpayers.
- Impose special distribution rules on high-income taxpayers with large retirement account balances.
- Impose an annual limit of $50,000 per donor, indexed for inflation after 2024, on the donor’s total gift tax annual exclusion.
- Repeal deferral of gain from like-kind exchanges beyond $1 million per year.
Always be aware
Even though calendar-year companies have completed another year-end close, be aware that tax law changes have a way of sneaking into law throughout the year — even during monthly and quarterly closing of the books.
Mark A. Sellner, CPA, JD, LL.M (taxation), owner of Sellner Tax Consulting, LLC, consults with other CPAs and their clients on tax matters, including S Corporation and partnership taxation and the tax consequences of buying and selling a business. Previously, he served as director of graduate studies in taxation at the University of Minnesota’s Carlson School of Management. Mark is a recipient of the MNCPA’s R. Glen Berryman Excellence in Teaching and Distinguished Service.