That change? Businesses may again deduct research and development costs, or R&D costs, as incurred.

Note: The current law says firms must capitalize R&D costs and then amortize the costs over a number of years.

But this change is trickier than you might at first guess. Some complexities exist. Also you have some tax planning opportunities related to any existing, capitalized R&D costs your tax return shows.

In this post, I walk you through the newly restored R&D deduction rules. And then I’ll explain not just how to recover deductions from prior years, but also how to maximize the tax savings you enjoy when you do this.

But let’s review how we got here.

R&D Deductions Pre-2022, The Golden Era

Prior to January 1, 2022, taxpayers had two primary options for handling R&D expenses:

1. Taxpayers could deduct R&D expenses in the year incurred. This applied to in-house R&D costs and certain contract expenses, and was the most common treatment.
2. Alternatively, businesses could elect under §174(b) to amortize R&D over at least 60 months.

The ability to expense R&D immediately had two tax accounting benefits. First, it reduced a taxpayer’s income which meant it also reduced a taxpayer’s tax burden. Second, it simplified the accounting by avoiding complex capitalization and amortization tracking. Then the rule changed.

R&D Deductions 2022 – 2024, The Dark Era

From 12/31/2021 through 12/31/2024, tax law required taxpayers to capitalize R&D costs. Those costs were amortized over 60 months if domestic R&D and over 180 months if foreign R&D.

That all sounds reasonable enough. But some practical observations about the capitalization policy. The policy:

• Increased the tax burden for tax payers involved in R&D activities
• Reduced cash flow reinvested in R&D activities, thereby hindering innovation
• Burdened firms with complex accounting treatment
• Boosted tax return preparation fees
• Increased chance of tax return errors due to limited IRS guidance

The good news is R&D expenses are, potentially, immediately deductible again.

The American Innovation and Growth Act of 2025

The American Innovation and Growth Act of 2025, also known as the “One Big Beautiful Bill,” or “OBBB” for short, ends the capitalization policy of TCJA. Further, it allows taxpayers the ability to deduct still capitalized R&D costs from 2022 – 2024.

Domestic R&D

Domestic R&D costs, generally, qualify for immediate expensing if they meet the definition of R&D expenditures, which include:

• Wages paid to employees directly engaged in qualified research
• Supplies used in the conduct of research
• Contracted research
• Software development costs
• Cloud computing and data hosting costs

Activities must be performed in the United States or a US territory, including contractor work, for immediate expensing.

Foreign R&D

Foreign R&D costs are still required to be capitalized and amortized over 180 months. Some foreign R&D examples include:

• Wages paid to employees outside of the United States (frequently in Canada, India, UK, and other EU countries)
• Third party vendors or contractors located outside of the United States
• Foreign software development costs
• Materials and supplies used in foreign R&D activities

Note, too, foreign R&D costs no longer qualify for R&D credits beginning 1/1/2025.

Reversing 2022 – 2024 Capitalization

The OBBB introduced two methods to claim R&D deductions that were missed during the capitalization period.

Method 1, Small Business Amendment Option

This allows small taxpayers (average 3-year revenue under $31 million) to file an amended return for any of the open 2022 – 2024 tax years to expense previously capitalized R&D expenses.

This method results in the fastest cash recovery, however, there is some preparation cost for amending previously filed tax returns, and possibly greater IRS examination risk.

Our recommendation is to look at the taxpayer’s marginal tax rate in the year in question to see if it makes sense to amend.  You probably don’t want to do this if the taxpayer’s marginal rate is low.  If the marginal rate is high, 35 or 37%, for example, amending may make the most sense.

Method 2, Catch-Up Deduction Election

This method allows any taxpayer, big or small, to either:

1. Deduct 100% of the unamortized basis of capitalized R&D in 2025, or
2. Deduct 50% of the unamortized basis in 2025, and 50% in 2026

The taxpayer must make the election on their originally filed 2025 tax return, making this likely the least expensive option with a lower amount of examination risk.

With this method, however, the taxpayer won’t realize the tax benefit until they file their 2025 or 2026 tax returns, which will occur in 2026 or 2027.

You will want to do some forecasting to optimize this.  It probably doesn’t make sense to spread the deduction over two years if you anticipate 2025 to be a big income year and 2026 to be a small income year, for example.  And you will want to analyze the tax benefits between the catch-up deduction and small business amendment options.

An Example to Illustrate

Say a taxpayer’s tax return capitalized $500,000 of R&D wages in 2024, and then amortized $100,000 of this spending. That leaves $400,000 of yet-to-be-amortized R&D costs at the start of 2025.

This taxpayer chooses between four options:

1. Continue amortizing the capitalized R&D wages at the rate of $100,000 a year.
2. Amend the 2024 tax return and adding the $400,000 of capitalized 2024 R&D wages to the 2024 tax return.
3. Take the $400,000 of still capitalized R&D wages as a deduction all on the 2025 tax return.
4. Split the $400,000 of capitalized R&D wages evenly across the 2025 and 2026 tax returns thereby putting a $200,000 deduction onto each return.

Taxpayers, probably with the help of their tax accountants, will want to “run the numbers” to see which option delivers the best savings. But the two general rules to consider are, first, sooner is better than later. (This is the ol’ time value of money.) But the second thing to consider is, if a firm can, it wants to use its deductions on the years where the marginal tax rates are highest.

Next Steps

Here is a small checklist of things to check if you are involved with R&D activities:

• How much unamortized basis is left in capitalized R&D after 2024?
• Try to estimate 2025 and 2026 income
• Compare the income in the period of capitalization to estimated 2025 and 2026 income
• Estimate the tax savings of each period and choose the one with the largest benefit.

I should also mention that deducting R&D does not prohibit or limit your ability to claim R&D credits.

As you can see, the change to R&D expensing is hugely consequential. Tens of thousands of small and mid-size business will be affected by this change.

This is one of the most tax-payer friendly developments we’ve seen in years. If you are a tax practitioner, you want to be looking closely at your R&D clients.  If you are a taxpayer involved in R&D activities, you want to be discussing this with your tax preparer.

Want to know how R&D tax credits work?  Click on this link.

The post One Big Beautiful Bill’s New R&D Deductions appeared first on Evergreen Small Business.

The date part of that? Easy. You can read a calendar.

The tangible property part? Mostly easy, too. The main rule is anything with a class life of 20 years or less? You can bonus depreciate.

But that “purchase” requirement? Trickier that you might guess.

The Technical Purchase Requirement

So, the Section 168(k) statute says we look to Section 179(d)(2) to determine what a purchase is. And that chunk of the law says this:

For purposes of paragraph (1), the term “purchase” means any acquisition of property, but only if—

(A) the property is not acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under section 267 or 707(b) (but, in applying section 267(b) and (c) for purposes of this section, paragraph (4) of section 267(c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants),

(B) the property is not acquired by one component member of a controlled group from another component member of the same controlled group, and

(C) the basis of the property in the hands of the person acquiring it is not determined—

(i) in whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired, or

(ii) under section 1014(a) (relating to property acquired from a decedent).

Which provides most but not all the rules you need… so let’s just step through this.

No Bonus Depreciation for Related Party Acquisitions

A first observation? Someone can’t purchase property from a related party.

That simple rule makes sense just from a loophole prevention context. Without that prohibition, families and family-owned businesses could manipulate bonus depreciation deductions at will.

No Bonus Depreciation for Purchaser Contributed Property

A more subtle requirement. If you purchase some property and then contribute it to a partnership or corporation? No bonus depreciation.

This wrinkle may matter more than you think. For example, if you and your spouse buy a short-term rental thinking you should be able to get giant bonus depreciation deductions? That may work, sure.

But then if you contribute that property to an LLC which you and your spouse both own and then treat that LLC as a partnership? Okay, now we got a problem. The reason? The bonus depreciation deduction would need to go on a partnership tax return. Except the partnership didn’t purchase. You and your spouse did.

No Bonus Depreciation on Inherited Property

Bonus depreciation doesn’t apply to inherited property someone acquires from a decedent and for which tax law (specifically Section 1014) resets the basis to the fair market value usually at time of death.

You can read this rule right in the statute I quoted above. But so you understand and so this makes sense, assume you and your spouse own property—maybe it’s an income rental—and you’ve already depreciated it fully. Maybe you bought the property for $200,000 decades ago and have long since deducted all the available depreciation meaning the adjusted for depreciation “cost basis” now seats at $50,000.

In a community property state, the death of one spouse resets the basis to the fair market value. If the above property at the date of death of the first spouse is now worth $1,000,000? The surviving spouse can again begin depreciating the property. And based on that new $1,000,000 basis. But he or she can’t use bonus depreciation. Rather, the surviving spouse uses regular old MACRS depreciation.

Note: Bonus depreciation would not apply to much of an income rental. Only the parts of the property that represents tangible personal property with of 20 years or less.

No Bonus Depreciation for Section 754 Elections

A sort of related issue: If someone buys into a partnership with tangible property or inherits an interest in a partnership with tangible property? Their purchase price or the Section 1014 basis adjustment can, if a Section 754 election has been made, cause the partnership to adjust the basis and depreciation numbers for that partner’s share of, say, the machinery.

However, the regulations for Section 168(k) specifically exclude taking bonus deprecation on this amount created via the Section 754 election. (Let me cite the actual regulation in case you’re a tax practitioner and want to read this: Reg 1.168(k)(f)(9).)

Yes Bonus Depreciation on Section 1031 Like-Kind Exchanges

So, you might guess that the statute quoted earlier prevents you from deducting bonus depreciation on a least some of the basis you count after a like-kind exchange. But that’s not exactly right. In general, if you want, you can take bonus depreciation on the new property you acquire via a like kind exchange.

Example: You trade land worth $1,000,000 but with a basis equal to $100,000 for a building worth $1,000,000. You can use Section 1031 to avoid paying taxes on the $900,000 realized gain. And the probably you can bonus depreciate the part of the new building that counts as tangible personal property. If 20% of the new building is tangible personal property and your basis is only that $100,000, probably you can deduct $20,000 of bonus depreciation.

If you trade the $1,000,000 piece of land and use a $2,000,000 mortgage to acquire a $3,000,000 building and 20% of that building counts as tangible personal property, you can probably bonus depreciate 20% of the $2,000,000 and the $100,000 so roughly a $420,000 bonus depreciation deduction.

Yes Bonus Depreciation on Section 1033 Involuntary Conversions

A quick final point: If you use Section 1033 to handle an involuntary conversion? Roughly, the accounting for a Section 1033 involuntary conversion works like the accounting for a Section 1031 like-kind exchange.

In other words, if the involuntary conversion causes you to lose one property (a vehicle, a building, or whatever) and you replace that property, you can potentially use bonus depreciation on the carryover basis and the new property’s excess basis.

A fire destroys equipment with basis $400,000 and FMV $1,000,000. The taxpayer receives $1,000,000 insurance and reinvests it all in similar equipment (qualifying under §1033). Basis in replacement equipment = $400,000 (carryover). Under the §168(k) regs, that $400,000 basis qualifies for bonus depreciation (since equipment has a recovery period <20 years)

The post The Section 168(k) Bonus Depreciation Purchased Requirement appeared first on Evergreen Small Business.

Thus, if you’re a business professional selling your services?  You want to know how the new Washington state professional services sales tax works. You want to know where and when it applies. And you also want to understand how you can or should constructively respond. (You have some options here.)

One other remark before I start jabbering. This is still all a little foggy. Who knows how this ends up. Discussions appear to be underway among policy makers about whether this sales tax on professionals was what they intended and whether it should continue to be the law. And now into the details.

How the Washington State Professional Services Tax Works

Normally, states don’t levy sales tax on professional services. And for a long time, Washington state’s tax laws worked the same way.

But as a matter of fact, professional services often fall into a category, digital automated services, that states can and do subject to retail sales taxes.

What is a digital automated service? Here’s the statutory definition: A digital automated service (quoting from the revised code of Washington) “means any service transferred electronically that uses one or more software applications.”

Thus, a plain language reading: Email? Online portals? Video conferencing? Your telephone? All those use one or more software applications to transfer electronically text, files, video or audio. Thus, professionals using those tools to provide services potentially needed to calculate and collect retail sales taxes. Except for one thing: An exclusion applied to this work in past.

Historically while professional services did look like a digital automated service, state law excluded (and here again I quote) “any service that primarily involves the application of human effort by the seller, and the human effort originated after the customer requested the service.”

In April 2025, however, the legislature struck the boldfaced language above using Engrossed Substitute Senate Bill 5814, a couple of weeks later Governor Ferguson signed the bill into law, and now professional services may be subject to retail sales taxes.

Which Firms Need to Deal with New Sales Tax

Probably if you’re a Washington state professional, you need to calculate, collect and remit Washington state sales taxes starting October 1, 2025. (And if you are a Washington state resident, you need to pay Washington state sales taxes when you buy professional services.)

Just to be clear—remember the trigger here is a professional uses software to deliver the service—all of the following items probably count as digital automated services and therefore trigger retail sales taxes:

• A consultant does a bunch of research and then delivers the research results via a streaming video conference. That streaming video conferencing software results in the activity being treated as a retail sale.
• A researcher writes a whitepaper and then emails the paper to the client. The email software triggers classification of the service as a retail sale.
• A tax accountant prepares a tax return and then delivers the return using an online portal. The online portal results in the tax return being treated as a digital automated service.
• A bookkeeper provides remote general accounting services via QuickBooks Online or maybe via a remote desktop connection to the QuickBooks desktop software. Either the QuickBooks Online software or the Windows remote desktop connection software trigger classification of the service as a retail sale.

A clarification: A professional might be able to deliver any of these services in non-digital, non-automated ways. The consultant can deliver a presentation in person (though maybe shouldn’t use PowerPoint?) The researcher can courier or hand deliver the research paper. The tax accountant can print a copy of the tax return and ask clients to pick up that up in person. A bookkeeper might be able to work onsite. These alternatives allow the professional to avoid classification as a digital automated service.

But many professionals? Yeah, they’ve embraced technology. They use software to automate and speed up their work. And at this stage, reconfiguring the workflow to escape the sales tax? That seems impractical.

How Business and Occupation Taxes and Rates Change

Here’s something else to know. The change in the state’s rule about how the tax accounting works delivers some new benefits.

For one thing, the business and occupation excise tax rate probably drops. Retail sales business and occupation (B&O) tax rates run .471 percent (so slightly less than half a percent). Services B&O tax rates usually run 1.5 percent for small businesses and then 1.75 percent for larger businesses.

Furthermore, while the services B&O tax applies to often all of a firm’s revenues, the retail sales B&O tax rate applies to in-state sales.

A professional services firm with $1,000,000 in revenues in past paid a 1.5% or 1.75% services B&O tax on $1,000,000 of revenue. But if half the firm’s services go to out of state customers? The new Washington state professional services sales tax subjects $500,000 to the new lower retail sales .471% B&O tax.

The drop in B&O taxes obviously doesn’t “pay” for the maybe 10 percent-ish retail sales taxes. But it may partially compensate the firm for new compliance costs and the clients it loses due to the effective 10 percent-ish increase in prices. And that’s the next thing to talk about.

Price Elasticity Means Professional Services Firm Will Leak Clients and Revenues

One important practice management point to mention.

If your services cost 10 percent more due to the new sales tax, probably some clients will change their purchasing habits.

In the case of a tax accounting firm, for example? Some clients might move to a retail tax preparer where the preparer delivers a paper copy of the tax return after collecting the numbers. (A paper deliverable saves the sales tax.)

And a tax accountant should not be completely surprised if a client moves to an out of state tax accounting firm. Technically, that firm won’t have to follow Washington state’s sales tax accounting rules unless it provides more than $100,000 of services to Washingtonians. (The Washington client should still pay the tax as a use tax.)

How large will this attrition grow? My guess is 3 percent-ish. That percentage of lost business reflects the usual elasticity of professional services, -.3. (That’s minus 30%.) In other words, a 10 percent price increase to the clients and customers times minus 30% equals a minus 3% change.

Accounting Stuff You Want to Do For Sales Tax

Before I wrap this up, some steps I think you and I take:

1. Get good address information into the accounting system so we can correctly source sales because these sales get sourced to where a client uses the service. (You can use the state’s lookup tool here.)
2. Set up your accounting system to correctly calculate the right sales tax rates on invoices. This will be a headache. Washington segregates the state into hundreds of local sales tax jurisdictions. Hopefully you won’t have more than a few dozen. If you do, use a sales tax service. By the way, in QuickBooks you’ll set up sale tax code items.
3. Alert clients and customers to the new effective higher price if you now need to begin charging sales taxes. We can’t protect our clients from this new cost. We can warn them.
4. Clearly differentiate any remaining services from retail sales on invoices. For example, if you meet with a client on-site, that’s clearly professional service and not retail sales.
5. Explore un-bundling services. A $1,000 tax return for example might be unbundled into a $900 tax return (not subject to sales tax) and then the following delivery options: $100 for portal delivery (subject to sales tax) , $200 for mailed paper delivery (not subject to sales) or free “counter” pickup (also not subject to sales tax). This approach adds risks unless we first get clear guidance from the Department of Revenue. But unbundling might work
6. If you’re reading this blog post before October 1, 2025, complete and bill that work-in-progress before the October 1. Also try to collect for that work before October 1 since while it technically shouldn’t be subject to sales tax unless it was performed after October 1? Gosh, you never know what position the state might take.

Related Articles

Washington state enacted a bunch of changes to state tax laws in April and May of 2025. These two blog posts describe in detail two changes significant for many small business owners:

The changes in the Washington Qualified Family-owned Business Interest Deduction for 2025 and future years.

The bumps in the state’s estate tax rates, which you can explore using our updated Washington estate tax calculator 2025 version

The post Washington State Professional Services Sales Tax appeared first on Evergreen Small Business.

Note: More detailed instructions appear below the calculator but you can probably use numbers from your 2024 or 2025 tax returns to calculate the new formula’s effect on your Section 199A deduction.

Using the Big Beautiful Section 199A Calculator

To use the Section 199A calculator, follow these steps:

1. (Optional) Replace my very rough estimates of the thresholds for phasing in the Section 199A limitations–$200,000 for single filers and $400,000 for married filers–with better numbers if you have them. (The Treasury will provide better numbers for 2026 later in 2025 if the Big Beautiful Tax bill passes and thereby perpetuates the Section 199A deduction.)
2. Enter an M or an S into the Filing Status box to incidate your tax return filing status.
3. Enter or estimate your taxable income using the Taxable Income box.
4. Describe your non specified service trades or businesses qualified business income, W-2 wages and depreciable property boxes. Note that if you’ve aggregated your non-SSTB businesses, the calculator should work fine. If you have multiple, un-aggregated businesses, it may not work accurately. Sorry.
5. Provide your total specified service trade or business (SSTB) income. You should be able to aggregate all your SSTBs into a single number.
6. Click Calculate.

Tip: For more information about how the new Section 199A formula works, take a peek at this blog post: The New Big Beautiful Section 199A Deduction.

A final caution: Assuming the Big Beautiful Tax bill passes Congress, it’ll be months before the Treasury can issue updated regulations. Thus, consider the Big Beautiful Section 199A calculator’s numbers rough estimates.

The post Big Beautiful Section 199A Calculator appeared first on Evergreen Small Business.

But so you can plan how this new deduction will work in your situation? This short blog post explains the mechanics.

To give you a big picture overview here at the very start? The two main features of the new deduction formula are (1) the tax savings are a little bigger. And then (2) for business owners with limited deductions due to W-2 wages or status as a specified service trade or business, the limitations phase-out more slowly.

The actionable insight here: If the law passes, you want to verify your now larger and better Section 199A deductions are optimized.

New Formula Applies to Tax Years Starting in 2026

A first important note? The Big Beautiful Section 199A deduction applies for tax years beginning after December 31, 2025.

Also, the new Section 199A deduction is permanent. (The current version essentially expires at the end of 2025.)

Percentage Bumps Up from 20 Percent to 23 Percent

The deduction percentage rises from 20 percent to 23 percent.

Example 1: The original Section 199A deduction formula gave a taxpayer with $1,000,000 of qualified business income a $200,000 deduction (potentially.) The big beautiful Section 199A deduction gives that taxpayer a $230,000 deduction (again potentially.)

Note: A limitation exists for both the original and the new version of the Section 199A deduction. Taxpayers get that 20 percent or 23 percentage deduction on the lessor of their qualified business income or on their ordinary (so not long-term capital gains or qualified dividend) taxable income.

Limitations Phase-in Differently

Both the original and new version of the Section 199A deduction limit the deduction for taxpayers with taxable incomes above a threshold amount based on W-2 wages, the unadjusted (before depreciation) basis of depreciable property, and then based on the trade or business falling into a specified service trade or business category like healthcare, law, consulting, and so forth. (People call these SSTBs.)

But the new law changes the “speed” at which the limitations occur. This decreases the marginal tax rate these limited taxpayers pay. (Under the current formula, the marginal tax rate in worst case situations can approach 70 percent.) Mechanically, how this works is confusing. But essentially taxpayers calculate two Section 199A deduction amounts and then use the smaller amount as their tentative deduction.

Note: We’ve got a simple JavaScript calculator here, “The Big Beautiful Section 199A Calculator,” which you can use to make the calculations. But maybe finish reading this post so you understand what’s going on with the formulas.

Step 1 in New Section 199A Limitation Calculation

The first step in determining the Section 199A deduction? The formula calculates the Section 199A deduction looking just at the non-SSTB qualified business income.

It calculates this first potential Section 199A deduction as the lessor of 23 percent of either the qualified business income or as a “limited” amount based on the W-2 wages and original cost of depreciable property. (This is the same formula as in the original version of Section 199A. The formula limits the deduction to the greater of either 50 percent of the business’s W-2 wages or 25 percent of the W-2 wages plus 2.5 percent of business’s depreciable property using the unadjusted basis immediately after acquisition). But let’s work through an actual example.

Example 2: Thomas, a single taxpayer, owns two businesses which each make a $1,000,000 a year: a farm and a law firm. The farm pays $300,000 of wages and uses $400,000 of depreciable machinery. Thus, the first version of the formula ignores the law firm because it’s a specified service trade or business. It only calculates the Section 199A deduction on the farm. This non-SSTB deduction equals the lesser of either 23 percent of the $1,000,000 of qualified business income ($230,000)… or the greater of 50 percent of the wages ($150,000) or 25 percent of the wages ($75,000) plus 2.5 percent of the $400,000 of machinery ($10,000) so $85,000 in total. Thus, the non-SSTB Section 199A deduction equals $150,000.

Step 2 in New Section 199A Limitation Calculation

The second step in determining the new Section 199A deduction works like this. The formula tentatively calculates the Section 199A deduction as equal to 23 percent of all the qualified business income from both non-SSTBs and SSTBs. Then this version of the formula limits this deduction if a taxpayer’s taxable income rises above a threshold amount. Specifically, the formula subtracts an adjustment equal to 75 percent of the amount by which taxable income exceeds the Section 199A phase-out threshold.

In 2025—so the year before the Big Beautiful Section 199A deduction takes effect—the threshold amount equals $197,300 for single filers and $394,600 for married filers. Roughly then, in 2026, the threshold amounts should equal $200,000 for single filers and $400,000 for married filers. (If the Big Beautiful Tax Bill passes, Treasury will probably provide the actual 2026 threshold numbers in late 2025.) But let’s just work through an example using my guesses as to next year’s threshold amounts.

Example 3: Again, Thomas owns two businesses, a farm and a law firm. Both make $1,000,000 a year. Th second version of the Section 199A deduction therefore equals 23 percent of the $1,000,000 of farm income ($230,000) plus 23 percent of $1,000,000 of law firm income ($230,000)… so that’s $460,000… thenthe formula subtracts 75 percent of the taxable income Thomas earns in excess of the single filer’s threshold. If that threshold equals $200,000 and his taxable income equals $1,000,000 due to other deductions he claims? The excess equals $800,000, calculated as the $1,000,000 minus the $200,000. The adjustment amount then equals 75 percent of $800,000 excess, or $600,000. That $600,000 adjustment in effect zeros out the second version of Section 199A deduction which equaled $460,000.

In the end, the limited big beautiful Section 199A deduction then equals the greater of the two version’s calculation results: $150,000 or $0. And that means a Section 199A deduction equal to $150,000.

Business Development Company Dividends Now Qualified Business Income

A final tweak. The new big beautiful Section 199A deduction treats dividends from electing Section 851 qualified business development companies as qualified business income, so in the same way that REIT dividends get treated. Thus, this income produces a Section 199A deduction.

About the Inflation Adjustment

And a postscript: When I asked ChatGPT to review my draft for this post, it suggested I point out one other tweak: The new law resets the base year for inflation adjustments to 2025 so taxpayers don’t lose several years of CPI increases. Which is a good point.

The post The New Big Beautiful Section 199A Deduction appeared first on Evergreen Small Business.

But this subject requires some background. Let me provide that first.

Some Background Context

Newport’s book talks about the benefits of workers taking time away from the hustle, noise and distractions of the typical workplace. The worker—the business owner in my discussion here—then uses that time to do deep work.

What is “deep work?” Cal Newport defines the term in his book Deep Work: Rules for Focused Success in a Distracted World as,

Professional activities performed in a state of distraction-free concentration that push your cognitive capabilities to their limit. These efforts create new value, improve your skill, and are hard to replicate.

Newport contrasts deep work with shallow work, which he describes as:

Non-cognitively demanding, logistical-style tasks, often performed while distracted. These efforts tend to not create much new value in the world and are easy to replicate.

And then, just to fall a little deeper down the rabbit hole: Deep work works and looks different than shallow work. The key features of deep work include:

1. Focus and Intensity: It requires uninterrupted, focused attention.
2. Cognitive Demand: It challenges the mind and pushes intellectual limits.
3. Value Creation: It results in high-value output, such as innovative ideas, advanced problem-solving, or high-quality work products.
4. Skill Building: It strengthens expertise and fosters growth in one’s abilities.
5. Rarity: Deep work is increasingly rare in a world full of distractions and shallow tasks, which is why it’s a valuable and competitive skill.

Examples of deep work might include:

• Writing a book, report, or blog post with high analytical or creative content.
• Solving complex technical or mathematical problems.
• Learning a new, difficult skill.
• Developing long-term strategies or plans.

Where to Do Deep Work is the Next Question

Let me briefly summarize one other aspect of deep work. Newport suggests working outside of the regular office or workplace. Particularly if the office environment is prone to distractions.

Newport emphasizes, for example, the importance of minimizing interruptions and creating a dedicated space that supports focused, high-cognitive-demand tasks. Predictably, successful deep work might include or even require physically removing oneself from a noisy or distraction-filled office.

Some specific suggestions from Newport:

1. Isolation for Focus: Newport highlights that many knowledge workers benefit from setting up a “deep work location” away from their regular workplace. This could be a library, a home office, or even a rented space.
2. Workplace Retreats: He describes the idea of short-term retreats to a different location, such as a cabin or a quiet space, to focus on specific deep work projects.
3. Control Your Environment: The regular workplace often prioritizes accessibility and responsiveness (e.g., open offices, constant communication tools), which are incompatible with deep work. Working in a controlled environment with fewer distractions allows for extended periods of focus.
4. Routines and Rituals: Newport advises creating rituals to signal your brain that it’s time for deep work. If the workplace doesn’t facilitate this, an alternative location can help establish these routines.

He goes on to discuss practical considerations, too. If you or I are thinking about deep work, we want a location that allows for distraction-free time, free from social interruptions and electronic notifications. That location needs to provide the tools and resources necessary to accomplish the work (e.g., Wi-Fi, books, notes). Logically, consistency in using the space helps train your mind to associate it with deep work.

While Newport acknowledges that not everyone can leave the workplace regularly, he suggests that for those who can, it’s an effective way to reclaim focus and produce high-value work. And that’s why I think you and I need to think about deep work. More specifically, how we get more deep work into our annual work schedules. And now we’re ready to talk about deep work tax deductions.

Rules for Deep Work Tax Deductions

So, the obvious question: Can you deduct the costs of doing deep work? My answer, supported by the research Newport reviews in his book, is “yes.”

Two important requirements, however: First, you or I need to think about deep work costs as investments that deliver a profitable return on investment. For the tax nerds reading this, we might say the expenditures connected for deep work need to meet the Section 162 standard. Essentially that standard says the expense must be ordinary and necessary and connected to a profit motive. (For more detail about how to apply this general rule to travel expenses which is often what deep work tax deductions will be, you can refer to Treasury Regulation 1.162-2.)

Tip: If you or I were considering a large investment in deep work, doing the work of creating a formal business with estimated returns on investments seems essential. You want to do that to verify what you’re thinking about makes sense. You want to have that business plan or capital investment analysis documented later on if someone like an IRS examiner has questions.

The second thing to stay alert to? Travel expenses—which again will often be what deep work investments represent—also require significant additional documentation. Section 274(d) and regulation 1.274-5 give specific instructions. But essentially you or I need to document contemporaneously:

1. 1. • • The business purpose of the expense.
        • The amount of the expense.
        • The time and place of travel or the date and description of the meal or entertainment.
        • The business relationship to the individuals involved (for meals and entertainment).

Note: The IRS website provides more and detailed information here: https://www.irs.gov/taxtopics/tc511

Risks of Deep Work Tax Deductions

Three risks of deep work tax deductions need to be considered:

1. If your tax return with the deep work deductions gets audited? My guess is that auditor will find your deep work focus strange. Possibly at least a little sketchy. The base salary of an IRS examiner as I write this is about $60,000 a year. Thus, that man or woman, perhaps understandably, may struggle to understand why you have invested $20,000, $50,000 or whatever on some seemingly “harebrained scheme” to turn your $200,000 business into a $2,000,000 business. Thus, stay alert to the optics here. How you present and describe your deep work may matter a lot if a tax agency auditor asks. (I really would recommend reading Newport’s book and then honestly asking yourself if you can make deep work “work.”)
2. You need to do the deep work to get the deductions. That sounds too obvious. But deep work isn’t the same thing as a vacation. You and your family need vacations too. So maybe the actionable step here is to make sure you get vacation-y work breaks into your year too?
3. International travel to be deductible requires a higher, more rigorous level of documentation and work. (You essentially need to work full-time.) Thus, you probably want to avoid that approach. Domestic travel in comparison only requires that your travel primarily be for business and not extravagant.

The post Deep Work Tax Deductions appeared first on Evergreen Small Business.

But that blog post got me thinking about the Section 183 Schedule C problem.  Which is similar.

But before we dig into the details, let’s discuss briefly what Schedule C is. And then I’ll move on to discussing the Section 183 connection to Schedule C.

What is Schedule C?

Schedule C is a profit and loss schedule that is filed on the individual level to report business income.  When you file Schedule C, you are telling the IRS you “engaged in an activity for profit.”  An activity must be “engaged in for profit” in order to be considered a business.

Positive net income from Schedule C is ordinary income subject to self-employment and income tax.  Negative net income from Schedule C offsets, or reduces, your other ordinary income.  It also reduces the income taxes you pay.

What is the Section 183 Schedule C problem?  Many of the Schedule C losses filed every year with the IRS do not rise to the level of an activity engaged in for profit. The activities, in other words, are hobbies.  You do not want to report a loss from a hobby, receive a tax benefit, and end up under examination with the IRS.

If you are unsure whether your activity is a hobby or a business, the IRS lays out nine factors to help you decide. These factors will help clarify whether you operate an “engaged in for profit” business or a hobby. Whether you have a Section 183 Schedule C problem.

Let’s take a closer look at each factor.

1. Manner in Which a Taxpayer Carries on the Activity

This is the first factor detailed in the Section 183 Audit Technique Guide, and unsurprisingly, is very important.  You want to operate your activity in a business like manner.  Here are several business-y things you ought to consider implementing if you are not doing so already:

• Separate personal and business finances.  Use a dedicated business checking account and credit cards.
• Use a real accounting system to track your income and expenses.
• Write a business plan to show, specifically, how your business will make a profit.
• If your business is not making a profit, change your operating methods to reach profitability.
• Register your business and pay appropriate state level taxes and file all appropriate forms.

Again, running your activity like a legitimate business is very important to support the engaged in for profit intent.  An activity run like a hobby, is probably a hobby.

2.  Expertise of the Taxpayer or Their Advisors

You want to be an expert in your activity or listen to or hire experts that are.  This doesn’t mean you need a Ph.D. or master’s degree, but you need to have knowledge of your activity and industry.

This makes intuitive sense.  It would be impossible (or nearly) to make a profit operating an activity, or operating in an industry, you know nothing about.

Substantiate the steps you took to acquire knowledge.  It might be reading books written by experts.  Or taking seminars or classes.  Maybe you really went to school and earned a Ph.D..

Relying on (and probably paying for) advice from experts like CPAs, attorneys, and consultants also help support your activity qualifying as an engaged in for profit business.

3. Time and Effort Expended in the Activity

The time expended in the activity should be consistent with an intent to make a profit.  This is vague because there is no bright-line “time” test.   And time doesn’t need to be exclusive or significant if competent management or employees are hired.

An examiner will look at the total time spent in the activity, plus time the taxpayer spends in other business activities and employment when weighing this factor.

The point is you want good documentation of time spent on the activity, whether it is you or someone else doing the work.  The more time spent, the greater chance of your activity qualifying as an engaged in for profit business.

4. Expectation Assets Used in Activity May Appreciate in Value

The title sounds self explanatory but there is a bit of nuance.  Appreciating assets, like property used in rental real estate, help to qualify an activity as an engaged in for profit business.

The nuance?  The IRS is okay with your activity realizing losses year after year, as long as there is the expectation that, eventually, the activity pays off and generates positive income.  The regulations even indicate a “reasonable expectation of profit is not required.”

I mentioned real estate earlier; this is also common in intellectual property.  The goal is to hold the asset long enough to realize substantial appreciation.

In an examination, you want to point to supporting documents like appraisals or comparables.  Something that helps substantiate the appreciation in value.

Note: Different rules apply for farming, as discussed a bit later

5. Success of Taxpayer in Carrying on Other Similar or Dissimilar Activities

A history of successful entrepreneurship helps to qualify your activity as an engaged for profit business.  I think a history of unsuccessful entrepreneurship helps support this too.  Not every business venture ends up being profitable.

If your activity isn’t doing well?  Course correct and change things up to try and make it successful.  And document the changes you make.

6. Taxpayer’s History of Income or Losses with Respect to the Activity

I’m going to paraphrase the regulations here.  They say, basically,  that losses during the start-up stage of an activity may not necessarily indicate the activity is not engaged in for profit.  But, continued losses beyond the start-up stage, if not explainable, may indicate the activity is not being engaged in for profit.

If your activity is losing money year after year, you want to explain why.  Market conditions, disease, theft, natural disaster, fire, etc. are all good explanations of why a business might not be profitable.

7.  Amount of any Occasional Profits that are Earned

Section 183 gives a taxpayer a presumption of profit intent if gross income from an activity exceeds the deductions from the activity for at least three out of five taxable years.  Most new activities will struggle to meet this.

As I said above, the expectation of profit is not required for your activity to be considered an engaged in for profit business.  And occasional profits, especially in highly speculative ventures, indicate the activity is engaged in for profit.

You absolutely should not manipulate income or expense numbers to artificially show a profit to meet the safe harbor (more on the safe harbor below).  An IRS examiner will almost surely catch this.

An IRS examiner will compare income and expenses between periods to find deviations.  They will also substantiate the income and expenses reported on the tax return.  Phantom income, or reduced or non-reported expenses, will be easy for an examiner to find.

8. Financial Status of the Taxpayer

A lack of income or capital from other sources indicates an activity is an engaged in for profit business.  If your Schedule C activity is your only source of income, most likely you have an engaged in for profit business and not a hobby.

If you have other major sources of ordinary income, you want to carefully go through each of these factors to determine how to accurately report your activity on your tax return.

9. Elements of Personal Pleasure

We have reached the final factor, and this one is quite subjective.  What is pleasurable to one person might be a chore for someone else.

You want to minimize the amount of personal pleasure in your activity as much as possible.  Let me explain.

An activity will not be treated as not engaged in for profit merely because the taxpayer has motivations other than solely making profits.  There will always be other activities which yield higher returns.  And those activities might make you miserable.  There should be a balance of enjoyment and financial success, not a narrow focus on one or the other.

There are a handful of other points I want to discuss before we wrap up.

Farming Activities

This blog post is tailored for Schedule C activities, but Section 183 is particularly consequential for farming activities that are reported on Schedule F.  Section 183’s intent is to prevent taxpayer’s engaged in farming activities from offsetting farming losses with land appreciation.

Remember factor 4?  It doesn’t apply here, at least with land.  The regulations say the farming and holding the land for appreciation constitute one activity, but only if the farming activity reduces the net cost of carrying the land.  In other words, the farming itself needs to be profitable.  Land appreciation has no weight in the determination of a farming activity being an engaged in for profit business.

Safe Harbor

Most of Section 183 is subjective, requiring taxpayers and examiners to look at the facts and circumstances of each activity.  But, fortunately, there is one quantitative way of determining if your activity rises to the level of an engaged in for profit business.

There is a presumption an activity is engaged in for profit if:

• The activity has net profits for three out of five consecutive tax years, or
• In the case of breeding, training, showing or racing horses, the activity has net profits for two out of seven consecutive tax years.

The IRS can still dispute your activity is really a hobby and not a business, but the burden rests on the IRS to prove it.

This safe harbor is difficult to meet for business that are still in their “start up” phase.  Fortunately, there is a an election to postpone the determination, which I cover next.

Election to Postpone Determination

Form 5213, Election to Postpone Determination, can be filed to delay an IRS determination as to whether an activity is engaged in for profit.  You can find the form here.

You want to file this form in the first year or two after beginning your activity if you expect to realize losses.  When filed, the IRS will postpone their determination until after the end of the 4th consecutive tax year, or 6th year if your activity is farming.

The form must be filed within three years of the due date of the first tax return.  If you receive a Statutory Notice of Deficiency from the IRS (the notice disallows hobby loss deductions) you must file within 60 days.

Final Thoughts on the Section 183 Schedule C Problem

The IRS estimates roughly 70-80% of Schedule C filers with losses are really hobbies.  This means Schedule C’s with losses are exceptionally vulnerable to IRS examinations.

You want to be confident your activity rises to the level of “engaged in for profit” before you claim a Schedule C loss.  And  be ready to defend your position with the IRS.  If you are unsure after reading this, you may consider reaching out to a tax professional for help.

The post The Section 183 Schedule C Problem appeared first on Evergreen Small Business.

This new bit of red tape stems from Congress’s concern about money laundering and other financial crimes. And it’ll cause some small business entrepreneurs and investors to go nuts.

Essentially a BOI report identifies the individuals who own 25 percent or larger chunks of the corporation or LLC and then also individuals who have substantial control (like corporate officers and directors, LLC members, LLC managers, and so on) over a corporation or LLC.

This information gets stored in a federal database so it’s available to law enforcement agencies. And also to financial institutions who need or want to check on their customers.

Why It’s Important to Handle this BOI Report Stuff

Yes, this is all a bit of a headache. I feel pretty sure both the politicians who cooked this up and the bureaucrats who designed the system haven’t thought through the compliance costs for you and your small business. But all of that? Pretty irrelevant. You (and I) want to get ahead of this BOI report stuff for a couple of reasons.

First reason? You may need to file the report yourself. We understand that many accountants and attorneys simply do not want to do this risky, random, hard-to-schedule work.

A second reason to learn and handle this new reporting requirement quickly and correctly? The penalties for failing to file? Pretty brutal. The daily penalty equals $500 (with a $10,000 maximum). And in a worst-case scenario? Willfully failing to file a report can lead to imprisonment.

Note: Presumably, the worst case scenarios should only occur when people willfully break the law. But innocent folks can find themselves targets of aggressive regulators and prosecutors too, as our office has personally observed.

Beneficial Ownership Information (BOI) Report Disclosures

FinCEN requires pretty basic information about corporations, LLCs and similar entities entrepreneurs and investors set up. Which is maybe the only good news here.

Reporting companies (so corporations, LLCs and similar entities) must provide their:

• Full legal name
• Trade names and “doing business as” (DBA) names
• Complete current U.S. address
• State, tribal or foreign jurisdiction where formed
• Internal Revenue Service taxpayer ID number (so probably your EIN)

Tip: If you now need to get an EIN, such as for a family LLC, refer to this blog post: Step-by-step Instructions for Applying for an EIN

Then for each beneficial owner owning 25 percent or more of the company or exercising substantial control, reporting entities must provide an individual’s:

• Full legal name
• Date of birth
• Complete current address
• Unique identification number and jurisdiction from an unexpired U.S. passport, unexpired state driver’s license, or unexpired identification card issued by a state, local or tribal government (Note that if none of these identification documents exist, an individual must use a foreign passport.)
• Image of identification document for the person

By the way, for corporations, limited liability companies and similar entities formed on or after January 1, 2024, the company must also name the applicant or applicants who filed the formation documents with the state, local or tribal government. (This might be the name of the attorney or paralegal who prepared and filed the articles of incorporation or formation.)

Some Organizations Exempt from BOI Reporting

Most small businesses need to file BOI reports, as noted earlier. The Corporate Transparency Act hits small businesses hard. Plan to file the report.

However, a list of about two dozen exempt entities exist. As a generalization, if some federal or state agency already regulates and monitors a firm (so like the Securities & Exchange Commission, the Federal Deposit Insurance Corporation, a state’s insurance commissioner, a public utilities regulator, and so on), the entity doesn’t need to file a BOI report.

Entities employing more than 20 full-time employees in the U.S., generating more than $5 million of revenue in the U.S., and maintaining a physical office don’t need to file. (So big small businesses dodge the bullet.)

Finally, inactive entities with less than a $1,000 of transactions and which own no assets don’t need to file.

Every other corporation, limited liability company or similar entity? Their ownership or management needs to file and provide the information listed in those earlier two sets of bulleted points.

Timing of BOI Reports

So the timing thing is sort of confusing.

You’ll file your BOI report online at www.fincen.gov sometime on or after January 1, 2024.

If your entity existed before January 1, 2024, you have until January 1, 2025.

If your entity formed on or after January 1, 2024 but during 2024, you need to file within ninety days of the date you receive confirmation of the filing or the date the information is publicly available. (Whichever date occurs first triggers the ninety-day countdown.) Thus, if you setup a new corporation, limited liability company, or some other entity from this point forward, be sure you plan to file the BOI report at the very start. (If you’re an attorney or accountant or incorporation service who files articles of incorporation or formation? Please do this. Please.)

If your entity formed after 2024, you need to file with thirty-days of the date you receive confirmation of the filing or the date the information is publicly available. (Again, use whichever trigger occurs first.)

Also note this: If any of the information that goes on a report changes? (See those bulleted lists provided earlier.) You need to file an updated report within thirty days. Almost any change in the information reported on the BOI report triggers a requirement to update the BOI report within thirty days. For example, a new driver’s license triggers a new countdown. The two exceptions we’ve spotted: If a beneficial owner dies, you have until thirty days after the estate is settled. And then if a company dissolves, you don’t have to report that.

Next BOI Report Steps

First, if you want to yourself file the report, get and carefully read the Small Entity Compliance Guide the U.S. Treasury and Financial Crimes Enforcement Network have provided. It’s available here.  And, fortunately, the guide is well-written and thorough. Figure a two to three hour read.

Second, both individuals and reporting companies may apply for and, according to FinCEN, immediately get a FinCEN identifier, or identification number. An individual applies for a FinCEN identifier by supplying the same information as goes onto the BOI report. A reporting company applies by checking a box on the BOI report form. And the advantage of using a FinCEN identifier? Rather than enter all individual bits of information, the individual or company just provides the FinCEN identifier. Note too that using a FinCEN identifier should mean an individual needs to only make one update if some bit of information (like an address) changes. (The instructions don’t say this. But surely the FinCEN system will do this.)

Third, finally, if you get into this subject matter, and realize you just don’t feel comfortable and have too many questions about details? Go ahead and reach out to your accounting firm or attorney. Hopefully one of them will be able to help you. (We are, for example, providing this service to our corporation and partnership tax return clients. We plan to do this work in the spring after tax season ends)

The post BOI reports and Your Small Business appeared first on Evergreen Small Business.

You wondered at the time whether it was a scam, right? And now you regularly see news reports about ERC scams. Employee retention credit scams, that is.

And so two questions. Did you get scammed? And if so, what should you do at this point? Fortunately, you can probably answer these two questions pretty easily.

Note: This blog post has been updated for the additional guidance the IRS provided on October 19, 2023.

Did You Get Conned or Scammed?

You or your business qualifies for an employee retention credit in one of three ways:

First way: You’re a small business and you started another, new business sometime after February 15, 2020 and before the end of 2021. (That’s easy, right? You know if you did this.)

Second way: Quarterly revenues, as compared to 2019, collapsed. To qualify for 2020, the collapse needs to exceed 50 percent. To qualify for 2021, the collapse needs to exceed 20 percent. (Your accounting system lets you make these determinations with roughly three or four clicks of a mouse.)

And then the third way you qualify: If a government order triggered either a full or partial suspension in your business. And this method? Where the nonsense seems to occur. The place where ERC scams show up.

Fortunately, you can easily determine your eligibility for an ERC based on a government order. You just need to pull out the actual government order that either fully closed your business for some period of time. Or you need to pull out the actual government order that partially closed your business for a period of time—and then show that the partial closure reduced the hours of service or revenues by at least 10 percent.

And now here’s the cold reality. Too often? We see situations where no government order actually exists. I kid you not. And when that’s case? Yeah, sorry. No easy way to say this. But I think you’ve very possibly gotten caught in an ERC scam.

Note: Here’s an example of an actual government order from Washington state: Proclamation by the governor: Stay Health Stay Home.

Real-life Example of ERC Scams

You see all sorts of sloppy thinking regarding government orders.

For example, in one case, a business owner prominent in his industry circulated an email that talked about a government order hitting a major supplier of his firm and similar firms. We understand numerous employers filed millions of dollars of ERC refund claims based on this email.

But when we checked? No government order existed. In fact the supplier, helpfully, said so on their website. Explicitly.

Note: A clarification: A government order “counts” for purposes of employee retention credits if it affects your business… or vendors you get supplies from… or vendors of vendors you get supplies from. A government order that affects your customers does not matter for purposes of your ERC eligibility however. (It might negatively impact your revenues of course–which is another way to qualify.)

Double-check You Got Caught in ERC Scam

So your first step is obvious, right? Find or see if the ERC consultant worked from a real government order. Get a copy. Read the copy and make sure it either closed your operation down. Or it closed down the operation of a vendor in your supply chain and the impact was more than nominal.

And if you can find this document? Count yourself lucky. Because many of your small-business-owning brothers and sisters appear to have claimed employee retention credits when no government order existed. You however should be fine. Not so for people who don’t have a government order.

Take These Steps If You Actually Were Scammed

If you did claim ERC refunds you were not entitled to? You need to take several steps to dial down the damage.

First, if the federal quarterly payroll tax returns—which is where an employer claims employee retention credits—have not yet been filed? I think you stop that process. This may mean instructing the “consultant” preparing the amended returns to stop. You probably want to tell them explicitly that you now believe no government order exists if that is case.

Second, if the federal quarterly payroll tax returns have been filed? But you haven’t received a refund? I think you withdraw your refund request using the procedure desrcibed here:  Withdraw an Employee Retention Credit Claim. Note that the process works very simply in most cases: You make a copy of the 941-X form used to file the ERC refund claim, write “Withdrawn” into the left margin and then have an authorized person sign, give a title, and date the withdrawal using the right margin. You then, quoting from the IRS instructions, “Fax the signed copy of your return using your computer or mobile device to  the IRS’s ERC claim withdrawal fax line at 855-738-7609.”

Third, if the IRS has already processed ERC refunds and you now know your firm was not eligible? You want to amend any tax returns that reflect the erroneous ERC refunds. For example, you want to amend the 941 quarterly payroll tax returns again and then repay the tax refund. That will get you square with the Internal Revenue Service and stop the compounding of penalties and interest.

Another example: If you amended your 2020 and 2021 income tax returns to report the refunds as income (which is required), you want to amend your income tax returns and remove that income. This will reduce your income tax liability for 2020 and 2021 and get you a refund while you still can.

Other Resources

We’ve got a bunch of blog posts about how employee retention credits work here. If you’re concerned you didn’t know enough or still don’t know enough about employee retention credits, check these out to provide yourself with the information you’ll need to get out of this mess.

If you’re a tax practitioner who now needs to do a deep dive into the law, pick up a copy of Maximizing Employee Retention Credits from Amazon.com. (You will have a number of clients who need help with this if your firm is anything like ours. Sorry.)

If you’re an employer who got into trouble on this area? Check first with your CPA to see if he or she can help you get out of the mess. If that doesn’t work, we do have an ability to help a limited number of taxpayers. You can make contact with our firm here:  Nelson CPA PLLC.

The post If You Got Conned in ERC Scam appeared first on Evergreen Small Business.

Really, the correct term is “Qualified Plug-In Electric Drive Motor Vehicle Credits,” which is quite a mouthful.  For purposes of this blog post, I’m going to call them EV credits.

Admittedly, I have not personally owned an EV or seriously shopped for one. However, electric motor and battery technology is improving rapidly, the charging network is growing, and the incentives are great, if you can make them work.

I’m going to discuss how EV credits work and how they can benefit, and possibly influence, your next vehicle purchase.

What is an EV Credit?

Put simply, the US government gives you money, in the form of a tax credit, for purchasing a qualified electric vehicle.  The credit has been around for a while.  Maybe you’ve already gotten one.

But, the rules changed in the summer of 2022 with the passing of the Inflation Reduction Act (IRA).  And the changes make the credit less accessible to many taxpayers.

So let’s briefly discuss how EV credits worked before the IRA (pre 2023), and how EV credits work starting in 2023.

EV Credits 2022 and earlier:

If you purchased a qualified electric vehicle, you could claim a non-refundable credit of $2,917 for a vehicle with a battery capacity of at least 5 kilowatt hours, plus $417 for each kilowatt over 5 kilowatts, up to a maximum of $7,500. (Note that “non-refundable” means you can’t get a credit for more than the income taxes you otherwise owe.)

Criteria for EV to qualify:

• purchased brand new
• have an external charging source
• used in the United States primarily
• have a gross weight rating of less than 14,000 lbs
• not purchased to resell
• manufacturer can’t sell more than 200,000 EV’s in the U.S.

BTW, GM sold 200,000 EV’s by Q4 2018, with Tesla reaching 200,000 by Q1 2020 and Toyota reaching 200,000 by Q2 2022.  These brands were ineligible for any more credits under the old rules.

EV Credits 2023 and later:

The maximum credit is still a non-refundable $7,500, but the EV credits work differently with the passing of the IRA.  The IRA broadened the range of vehicles that qualify, but restricted the amount of taxpayers able to take them (more on this later).

First, lets break down the new rules for brand new EV’s.

Criteria for new EV to qualify:

• purchased brand new
• have an external charging source
• used in the United States primarily
• have a gross weight rating of less than 14,000 lbs
• not purchased to resell
• two components; $3,750 credit for critical mineral requirements (critical minerals extracted or processed in the US) and $3,750 for battery component requirements (battery produced or assembled in US)
• produced by qualified manufacturer
• final assembly in North America

Number of units sold is no longer a limitation, and, in an effort to stimulate US manufacturing, the final assembly of a qualified EV must be completed in North America.

The website fueleconomy.gov has a neat search engine to look up qualified EV’s.  You just input year/make/model to check eligibility. You can also find a list of manufacturers and qualified models on the IRS website here. The selling dealer is also required to provide you with a written statement detailing, under penalties of perjury, the maximum allowable EV credit for the vehicle you are buying.

The IRA also opened up the EV credit to used vehicles, and is limited to $4,000.

Criteria for a used EV to qualify:

• must be the first sale other than to the original owner
• vehicle must be at least two years old
• had to be a qualified EV when sold new
• must be sold by a dealer
• have a gross weight rating of less than 14,000 lbs
• purchased in the United States
• credit is limited to 30% of purchase price
• purchase price must be less than $25,000
• can be claimed once every three years

Limitations

Earlier I mentioned EV credits will be more restrictive for a lot of taxpayers.  Gone are the days of trading in your top of the line, six figure Tesla Model S every year for the newest latest and greatest, and subsidizing the initial cash outlay with a nice big $7,500 credit at tax time.

There are now MSRP restrictions and adjusted gross income (AGI) restrictions we need to cover.  Let’s begin with the MSRP restrictions.

MSRP Limits:

You cannot claim an EV credit if MSRP exceeds the following amounts:

• Vans – $80,000
• Sport Utility Vehicles – $80,000
• Pickup Trucks – $80,000
• Other – $55,000

These prices might seem high, but it is easy to cross the threshold when you start adding options to the base price.

For fun, I went to Ford’s website to build a new Lightning truck.  The base price of the Lariat model starts at $69,995.  Add in the extended range battery option and a tonneau cover, and the MSRP jumps to $81,040, making this EV ineligible for any credits.  I guess you’d want to wait on the tonneau cover and buy one with your $7,500 tax credit the following year.

Please note, MSRP does not include tax, title, license, or dealer mark-up fees.  So good news there.

Now let’s cover the new AGI limitations:

AGI Limits:

You cannot claim an EV credit if your AGI exceeds the following amounts:

• Married Filing Jointly – $300,000
• Head of Household – $225,000
• All other taxpayers – $150,000

These are respectable income levels, yes. But I don’t think it is a stretch to assume most (or at least many) people purchasing brand new EV’s likely have an AGI above the threshold.  And there is no phase out, you either qualify or you don’t.

Final Thoughts:

Hopefully no one purchases a new EV and gets surprised they don’t qualify for EV Credits when they file their tax return the following year. This is especially true for the early EV adopters that have already taken EV credits and are not aware the rules have changed, substantially, for 2023.

If the EV credit is a major deciding factor in your car purchasing process, you want to to know how EV credits work. If you follow the rules and don’t make too much money, you should get a nice big tax credit.

Make sure to read our post “Inflation Reduction Act: Tax Credits for Homeowners” for information on additional clean energy property credits.

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