Various provisions of the Internal Revenue Code that are tied to specified dollar amounts provide that those dollar amounts are to be increased for inflation. In the accounting methods area, those provisions include the following:
- The increase to the threshold to be considered a small business taxpayer, which determines whether some entities can use an overall cash method of accounting and/or be exempt from Sections 263A, 460 and 471, and from the Section 163(j) business interest expense limitation
- The inflation adjustments to the amounts that can be fully expensed under a Section 179 election instead of being capitalized and depreciated; with the reduction in the percentage of bonus depreciation that may be claimed beginning in 2023, this deduction may be beneficial for qualified taxpayers.
Rev. Proc. 2022-38, 2022-45 I.R.B. 445, provides the inflation-adjusted amounts for taxable years beginning in 2023 for these, and other, Internal Revenue Code provisions.
Increase in Number of Taxpayers That May Qualify as Small Business Taxpayer
Section 448(c) states that the “gross receipts test” used to determine whether certain taxpayers are required to use an overall accrual method of accounting will be adjusted for inflation for taxable years beginning after December 31, 2018. The inflation adjustment will allow a C corporation or partnership that has a C corporation as a partner to use the overall cash method of accounting (unless prohibited by another section) for its taxable year beginning in 2023 if its average annual gross receipts for the three-taxable-year period ending before the 2023 taxable year does not exceed $29,000,000, an increase from $27,000,000 in 2022 and $26,000,000 in 2021.
In addition to being able to use the cash method, small business taxpayers are also exempt from the requirement to capitalize additional costs under Section 263A, the requirement to account for inventoriable costs under Section 471 and the requirement to use the percentage-of-completion method for long-term contracts under Section 460.
A taxpayer using an accrual method of accounting that does not exceed the gross receipts test and wishes to use the overall cash method, including a taxpayer that may have recently changed to use the overall accrual method because it exceeded the gross receipts test in a prior year, may be able to file an automatic accounting method change (Form 3115) to make such a change. Similarly, a taxpayer currently capitalizing costs under Sections 263A and 471 and/or using the percentage-of-completion method under Section 460 may be able to file an automatic method change to stop using these methods; some of these method changes may be combined with a change to the overall cash method.
The increased amount for the gross receipts test will also affect the limitation on the business interest deduction under Section 163(j). For taxable years beginning in 2023, if a taxpayer meets the $29 million gross receipts test, it will be exempt from the business interest limitation for 2023. Generally, the application of Section 163(j) is not considered a method of accounting; therefore, a taxpayer that now qualifies as a small business taxpayer is not required to file a Form 3115 to be exempt from the Section 163(j) limitation.
Section 448(c)(2) requires that the gross receipts of certain controlled corporations, partnerships and proprietorships, and of affiliated service groups be aggregated in applying the gross receipts test. Additionally, at the beginning of each tax year, a taxpayer currently using an overall cash method and/or currently exempt from Sections 163(j), 263A, 471 and 460 should confirm that it continues to qualify as a small business taxpayer based on the applicable dollar threshold for the tax year. If it no longer qualifies, then the taxpayer must evaluate whether it needs to change to a proper method by filing a Form 3115 (or to begin applying the Section 163(j) limitation in the current year).
Increase in Amount of Depreciable Business Assets Taxpayer May Elect to Expense
A taxpayer that wishes to expense certain qualified depreciable business assets under Section 179 instead of depreciating them also benefits from an inflation adjustment for taxable years beginning in 2023. The limitation and phaseout for the election to expense certain depreciable business assets under Section 179 had been increased for inflation for a number of years.
For taxable years beginning in 2023, the aggregate cost that a taxpayer may elect to deduct is $1,160,000 — an $80,000 increase from 2022. This limitation is reduced by the amount by which the cost of Section 179 property placed in service during the taxable year beginning in 2023 exceeds $2,890,000 — an increase of $190,000 from 2022. Further, for sport utility vehicles, the costs that may be taken into account for taxable years beginning in 2023 have increased by $1,900 — from $27,000 to $28,900.
In general, property that may be deducted under Section 179 is
- Property purchased for use in the active conduct of a trade or business that is tangible property to which Section 168 applies;
- Computer software defined and described in Section 197(e)(3) to which Section 167 applies;
- Personal property; or
- Qualified real property.
In addition to the limitations mentioned above, the deduction may not exceed the taxable income from the taxpayer’s trade or business during that year.
Section 179 expensing may be especially attractive for taxpayers that have previously taken advantage of 100% bonus depreciation in recent years. Absent a legislative change, the bonus depreciation percentage will begin to be phased down for property placed in service after December 31, 2022. For property placed in service in calendar year 2023, the applicable bonus depreciation amount is reduced to 80%. Thus, taxpayers that qualify may want to consider making a Section 179 election for property placed in service in 2023 to maximize the amount that may be immediately expensed and reduce the amount that will be recovered with depreciation deductions.
Written by Karen Messner. Copyright © 2023 BDO USA, LLP. All rights reserved. www.bdo.com
For a detailed discussion of the aggregation rules, see “The Not-So-Simple Aggregation Rules For Tax Reform’s Simplifying Conventions,” August 2019.
