Also see: 2022 Year-End Tax Planning for Businesses.

2022 Year-End Tax Planning for INDIVIDUALS. Client Letter Included.

(Parker Tax Publishing November 2022)

The first installment of Parker's annual two-part series on year-end tax planning recaps 2022's major changes affecting individual taxpayers and provides strategies clients can use to minimize their 2022 tax bill.

Practice Aid: Use Parker's Sample Client Letter as a template or just sign your name at the bottom. See Our Sample Client Letter (Individuals).

Introduction

On August 16, President Biden signed the 2022 Inflation Reduction Act (2022 IRA) (Pub. L. 117-169), a significantly scaled-back version of the Build Back Better Act. Two of the most favorable changes contained in the 2022 IRA that are beneficial for individuals are (1) a three-year extension of expanded Affordable Care Act health insurance subsidies, which were set to expire at the end of 2022, and (2) a myriad of clean energy incentives, including expanded and modified residential clean energy tax credits and clean vehicle tax credits. There is however, one tax benefit that self-employed individuals received for 2020 and 2021 that will be expiring at the end of 2021 and that is the 100 percent expense deduction for food and beverages. The deduction limitation will go back to 50 percent beginning January 1, 2023.

The following are some year-end considerations to review with clients, as well as some actions that may help reduce a client's 2022 tax bill.

Individual Tax Brackets Increased for 2022

For 2022, the top tax rate of 37 percent applies to incomes over $539,900 (single and head of household), $647,850 (married filing jointly and surviving spouse), and $323,925 (married filing separately). For 2023, inflation has pushed those brackets to $578,125 (unmarried other than surviving spouses and heads of households), $693,750 (married individuals filing jointly and surviving spouses), $578,100 (heads of households), and $346,875 (married filing separately). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax on the lesser of net investment income or the excess of modified adjusted gross income over the following threshold amounts: $250,000 for married filing jointly or qualifying widow(er), $125,000 for married filing separately, and $200,000 in all other cases. These amounts are not adjusted for inflation. High-income taxpayers are also subject to the .9 percent additional Medicare tax on certain income that is more than a threshold amount. The types of income subject to this tax include Medicare wages, self-employment income, and railroad retirement compensation. For taxpayers subject to one or both of these additional taxes, there are certain actions (discussed below) that can be taken to mitigate the damage of these additional taxes. It's worth noting that these taxes are not deductible.

For married couples, employers do not take a spouse's self-employment income or wages into account when calculating the .9 percent additional Medicare tax withholding for an employee. If a married couple's income will exceed the $250,000 threshold in 2022, and they have not made enough tax payments to cover the additional .9 percent tax, a Form W-4 should be filed with the taxpayer's employer before year end to have an additional amount deducted from the client's wages. Otherwise, the couple may get hit with underpayment of tax penalties.

The due date for filing 2022 tax returns is Tuesday, April 18, 2023, because April 15 is a Saturday, and Monday April 17 is Emancipation Day in Washington, D.C. Thus, the tax deadline is extended to the next business day.

Standard Deduction versus Itemized Deductions

It's important to determine whether it makes sense for a client to itemize deductions as there are steps that can be taken which will give a taxpayer enough deductions to itemize. For 2022, the standard deduction amounts are: $12,950 (single); $19,400 (head of household); $25,900 (married filing jointly and surviving spouse); and $12,950 (married filing separately). The additional standard deduction amount for taxpayers who are 65 or older or blind is $1,400. This additional amount is increased to $1,750 if the individual is also unmarried and not a surviving spouse.

If a client's itemized deductions in 2022 will be close to his or her standard deduction amount, consideration should be given to paying certain deductible amounts (such as medical and charitable expenses) in 2022 rather than 2023 to the extent possible, or vice versa. In essence, determine whether bunching deductions in one year and taking the standard deduction in alternate years can provide a net-tax benefit over the two-year period.

Filing Status

Generally, a return filed as married filing separately is not beneficial for tax purposes. However, in some unique cases, such as when one spouse earns substantially less or when one spouse may be subject to IRS penalties for issues relating to tax reporting, it may be advantageous to use the married filing separately tax status. Additionally, if one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not be available. Depending on each individual's taxable income, this could help the couple reduce their joint tax liability.

Income, Deductions, and Exclusions from Income Relating to a Taxpayer's Residence

Home Office Expenses: More individuals are working from home these days, and that means that more clients will be asking whether they qualify for the home office deduction. For employees, expenses relating to working from home are not deductible. The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was previously available. However, for self-employed individuals, home office tax deductions are still available. In addition, because individuals are limited to a maximum $10,000 deduction for state income and property taxes, allocating a portion of the homeowner's tax expenses to the portion of a taxpayer's home used for business, can increase deductions for these amounts that would otherwise be lost.

Mortgage Interest Deduction: For clients who sold their principal residence during the year and acquired a new principal residence, the mortgage interest deduction may be limited. For mortgages of more than $750,000 obtained after December 14, 2017, the deduction is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). For a mortgage on a principal residence acquired before December 15, 2017, the limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, for clients operating a business from home, an allocable portion of the mortgage interest is not subject to these limitations.

Deductions for Interest on Home Equity Debt: Interest on home equity debt may be deductible where a client used that debt to buy, build, or substantially improve his or her home. For example, interest on a home equity loan used to build an addition is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not. Thus, it's important to document the portion of the debt for which an interest deduction is taken.

Gain or Loss on the Sale of a Home: If a client sold his or her home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of the home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if a portion of the home was rented or was otherwise used for business, the loss attributable to that portion of the home is deductible.

Exclusion from Gross Income of Discharge of Qualified Principal Residence Indebtedness: Under Code Sec. 108(a)(1)(E), gross income does not include the discharge of indebtedness of a taxpayer if the debt discharged is qualified principal residence indebtedness and is discharged before January 1, 2026.

No Deduction for Mortgage Insurance Premiums as Qualified Residence Interest: Under Code Sec. 163(h)(3)(E), taxpayers could treat amounts paid before 2022 for qualified mortgage insurance as qualified residence interest. However, this provision expired at the end of 2021 and is not available for 2022.

Exclusion from Gross Income of Cancelled Qualified Real Property Business Indebtedness

Under Code Sec. 108(a)(1)(D), taxpayers can exclude from gross income a discharge of qualified real property business indebtedness which applies to real property used in a trade or business, such as a home office, and is secured by such real property and meets certain other qualifications.

Retirement Plan Contributions

Clients can save a lot on taxes by making the maximum contributions to a qualified retirement plan. Individuals under 50 years old who work for an employer that has a 401(k) plan can defer up to $20,500 of income into that plan for 2022. Catch-up contributions of $6,500 are allowed for individuals who are 50 or over. For a SIMPLE 401(k), the maximum pre-tax contribution for 2022 is $14,000. That amount increases to $17,000 for individuals 50 or older. The maximum IRA deductible contribution for 2022 is $6,000 and that amount increases to $7,000 for individuals 50 or over.

Charitable Contributions

With respect to charitable donations, clients may reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles the taxpayer to a charitable contribution deduction but also avoids the capital gains tax that would otherwise be due if the taxpayer sold the stock.

For example, if a client owns stock with a fair market value of $1,000 that was purchased for $250 and the client's capital gains tax rate is 15 percent, the capital gains tax on the sale would be $113 ($750 gain x 15%). By donating that stock instead of selling it, a client in the 24 percent tax bracket has an ordinary income deduction worth $240 ($1,000 FMV x 24% tax rate). So the client saves the $113 in capital gains tax that would otherwise be generated on the sale of the stock and that amount goes to the charity instead. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 - $240 - $113) compared to the after-tax cost of a $1,000 cash donation which would be $760 ($1,000 - $240). However, it's important to also keep in mind that tax deductions for contributions of appreciated long-term capital gain property may be limited to a certain percentage of adjusted gross income depending on the amount of the contribution and the type of property contributed.

Additionally, because taxpayers 70 1/2 years old and older who own an individual retirement account (IRA) must take minimum distributions from that account each year and include those amounts in taxable income, a special provision allows such taxpayers to make a charitable contribution directly from their IRAs to a charity. This has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, a taxpayer who takes the standard deduction can benefit from this rule. Second, by making a contribution directly to a charity, the donation counts towards the taxpayer's required minimum distribution but that amount is not included in income and thus reduces taxable income and adjusted gross income (AGI). A lower AGI is advantageous because it increases the taxpayer's ability to take medical expense deductions that might not otherwise be available. In addition, the reduction in AGI decreases the amount of the taxpayer's social security income subject to income tax and possibly the 3.8 percent net investment income tax if the taxpayer has a lot of investment income.

Observation: Temporary changes to the charitable deduction rules that applied for 2021, such the $300/$600 above-the-line deduction for certain cash contributions and the election to deduct up to 100 percent of AGI for qualified contributions, were not renewed and thus are not available for 2022.

Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts

For 2022, medical expenses are deductible as an itemized deduction to the extent they exceed 7.5 percent of adjusted gross income. The threshold was permanently reduced from 10 percent to 7.5 percent by the Consolidated Appropriations Act, 2021.

To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. Thus, the cost of vitamins or a vacation taken to relieve stress and anxiety don't count, but hospitalization and long-term care expenses do qualify.

Deductible medical expenses include amounts paid for health insurance premiums, out-of-pocket costs for medicine, and amounts paid for transportation to get medical care. Deductible medical expenses also include amounts paid for personal protective equipment (e.g., masks, hand sanitizer and sanitizing wipes), amounts paid for qualified long-term care services, and premiums paid for a qualified long-term care insurance contract. Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services that are required by a chronically ill individual, and must be provided pursuant to a plan of care prescribed by a licensed health care practitioner. To be deductible as a medical expense, qualified long-term care insurance premiums must meet certain criteria (e.g., the contract must be guaranteed renewable) and the deduction for such premiums is limited to an amount that is based on the taxpayer's age before the close of the tax year.

Practitioners should consider whether it might be advantageous for a client, who has not already done so, to contribute to a health saving account (HSA) if he or she does not already have one. These tax-advantaged accounts can help an individual who has a high-deductible health plan (HDHPs) pay for medical expenses. Amounts contributed to an HSA are deductible in computing adjusted gross income. These contributions are deductible whether the client is itemizing deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2022, the annual contribution limits are $3,650 for an individual with self-only coverage and $7,300 for an individual with family coverage.

If a client works for an employer who offers a Flexible Spending Account (FSA), and the client has not already signed up for an FSA account, it's worth encouraging the client to do so. This will allow him or her to pay medical and dental bills with pre-tax money. And the FSA can be used to pay qualified expenses even if the employer or employee haven't yet placed the funds in the account. While FSA funds can be used to pay deductibles and copayments, they cannot be used for insurance premiums. The maximum amount that can be set aside in 2022 is $2,850. If the cafeteria plan permits the carryover of unused amounts, the maximum carryover amount is $570.

Premium Tax Credit

Code Sec. 36B provides a health insurance subsidy through a premium assistance credit for eligible individuals and families who purchase health insurance through the Health Insurance Marketplace, also known as the "Exchange." The provision is the result of the Patient Protection and Affordable Care Act (PPACA). The premium assistance credit is refundable and payable in advance directly to the insurer on the Exchange. In the past, individuals with incomes exceeding 400 percent of the poverty level were not eligible for these subsidies. However, as a result of the American Rescue Plan (ARP) Act, the cap was eliminated for tax years beginning in 2021 or 2022 and therefore, anyone can qualify for the subsidy. In addition, the percentage of a person's income paid for a health insurance under a PPACA plan is limited to 8.5 percent of income. Thus, individuals who buy their own health insurance directly through the Exchange are eligible to receive increased tax credits to reduce their premiums.

These increased subsidies were set to expire at the end of this year, but were extended through 2025 by the Inflation Reduction Act of 2022.

Tax-Free Disaster Relief Payments under Section 139

In February of 2022, President Biden announced the continuation of the national emergency declaration concerning the COVID-19 pandemic. Thus, practitioners should be aware that under Code Sec. 139, a little-known or used provision, employers may be able to compensate employees tax-free for extra expenses incurred in 2022 due to COVID-19. This could include expenses incurred to set up a home office or to rent a place in which to quarantine or even for medical care. Under Code Sec. 139(a), gross income does not include any amount received by an individual as a qualified disaster relief payment. The term "qualified disaster relief payment" means any amount paid to or for the benefit of an individual:

(1) to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster;

(2) to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement, is attributable to a qualified disaster; or

(3) by a federal, state, or local government, or agency or instrumentality thereof, in connection with a qualified disaster in order to promote the general welfare.

In Rev. Rul. 2003-12, the IRS notes that Code Sec. 139 codifies (but does not supplant) the administrative general welfare exclusion with respect to certain disaster relief payments to individuals. According to the IRS, this exclusion from income applies only to the extent any expense compensated by such payment is not otherwise compensated for by insurance or otherwise. Additionally, qualified disaster relief payments do not include qualified wages paid by an employer, even those that are paid when an employee is not providing services.

The term "qualified disaster" includes a disaster determined by the President to warrant assistance by the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Since the COVID-19 pandemic was declared a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, the provisions of Code Sec. 139 could apply to payments received by individuals from their employers to compensate the employee for additional expenses incurred as a result of the pandemic.

Education-Related Tax Items

There are several education-related tax deductions, credits, and exclusions from income that practitioners need to consider for clients who either attend, or have children who attend, eligible educational institutions.

Tax-Free Distributions from Qualified Tuition Programs: A Code Sec. 529 qualified tuition plan is a tax-advantaged investment vehicle designed to encourage saving for the future education expenses of the plan beneficiary. Tax-free distributions from a Code Sec. 529 qualified tuition program (QTP) of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary's enrollment or attendance at an elementary or secondary public, private, or religious school, i.e. kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts. A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account. However, if the total QTP distributions to a designated beneficiary exceed the adjusted qualified higher education expenses of that beneficiary for the year, a portion of those distributions is taxable to the beneficiary. Code Sec. 529(c)(6) also provides that an additional 10 percent penalty tax generally applies to a taxable distribution from a QTP.

Deduction for Eligible Teacher Expenses: A deduction from gross income is available for eligible teacher expenses of up to $300 paid during 2022. If spouses are filing jointly and both were eligible educators, the maximum deduction on the joint return is $600. However, neither spouse can deduct more than $300 of his or her qualified expenses. Qualified expenses include unreimbursed expenses paid for personal protective equipment, disinfectant, and other supplies used for the prevention of the spread of COVID-19 in the classroom..

Exclusion from Income for Savings Bond Interest: If a client paid qualified higher education expenses during the tax year and also redeemed a qualified U.S. savings bond, the interest on the bond is excludible from income if the taxpayer's modified adjusted gross income level is below certain thresholds. The phaseout range for taxpayers filing as single or head-of-household is $85,800 to $100,800 and the phaseout range for taxpayers filing jointly or as a qualifying widow(er) is $128,650 to $158,650.

Education Credits: A client who pays qualified education expenses, and has modified adjusted gross income below $80,000 or $160,000 (for joint filers) may be eligible for an American Opportunity Tax Credit of up to $2,500 per year for each eligible student. Above those income thresholds, a partial credit may be available. The amount of the credit for each student is computed as 100 percent of the first $2,000 of qualified education expenses paid for the student and 25 percent of the next $2,000 of such expenses paid. Additionally, a Lifetime Learning credit may be available in an amount equal to 20 percent of so much of the qualified tuition and related expenses paid during the tax year (for education furnished during any academic period beginning in such tax year) as does not exceed $10,000. However, the expenses taken into account for this credit cannot be the same as expenses taken into account for the American Opportunity Tax Credit. The credit is phased out for taxpayers with modified adjusted gross income between $80,000 and $90,000 ($160,000 and $180,000 for joint filers).

Exclusion from Income for Repayment of Student Loan Debt: On August 24, President Biden announced a student loan relief plan that includes loan forgiveness for certain qualifying borrowers. Under the plan, borrowers with adjusted gross income under $125,000 (for individuals filing as single or married filing separately) or under $250,000 (for individuals filing as married filing jointly, head of household, or qualifying widower) for either 2020 or 2021 will generally receive up to $10,000 of federal student loan forgiveness, while Pell grant recipients receive up to $20,000 of loan forgiveness. Under Code Sec. 108(f)(5), enacted by the American Rescue Plan Act of 2021, gross income does not include any amount which would otherwise be includible in gross income by reason of the discharge of a student loan occurring after December 31, 2020, and before January 1, 2026. However, such loan forgiveness could be subject to state and local income taxes.

Child-Related Credits and Exclusions from Income

Child Tax Credit: For 2022, a child tax credit of as much as a $2,000 credit is available for each child under age 17. In addition, a $500 nonrefundable credit is available for qualifying dependents other than qualifying children. Where the credit exceeds the maximum amount of tax due, it may be refundable. The maximum amount refundable for 2022 is $1,500 per qualifying child. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed, and (2) qualifying relatives. The amount of the credit is reduced for taxpayers with modified adjusted income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly).

Observation: There have been ongoing discussions between Republicans and Democrats about a potential last minute end-of-year tax deal regarding a reinstatement of the research and development credit, which expired at the end of 2021 and which businesses are anxious to see reinstated, in exchange for an enhanced child tax credit that is similar to, but not as expensive as, the 2021 enhanced child tax credit enacted as part of the American Rescue Plan Act of 2021.

Dependent Care Credit: Payments to care for a child or another dependent so a taxpayer can work may be eligible for the child and dependent care credit. The credit is available to individuals who, in order to work or to look for work, have to pay for child care services for dependents under age 13. The credit is also available for amounts paid for the care of a spouse or a dependent of any age who is physically or mentally incapable of self-care. The credit is not available for amounts paid to a dependent or a taxpayer under age 19. The amount of the credit is a specified percentage of the taxpayer's total employment-related expenses. The specified percentage is 35 percent reduced (but not below 20 percent) by one percentage point for each $2,000 (or fraction thereof) by which the taxpayer's adjusted gross income for the tax year exceeds $15,000. Employment-related expenses incurred during any tax year which may be taken into account cannot exceed $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals.

Adoption Credit and Exclusion from Income of Adoption Reimbursements: An adoption credit of $14,890 is available for the adoption of a special needs child as well as other children. The credit is available for each child adopted and is generally based on expenses expended in the adoption. However, the credit for the adoption of a special needs child is $14,890, regardless of the amount expended on the adoption. The available adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $223,410 and is completely phased out for taxpayers with modified adjusted gross income of $263,410 or more. In addition, reimbursements of qualified adoption expenses or amounts paid by an employer for an adoption, up to $14,890, are excludible from income.

Alternative Minimum Tax

The odds of a taxpayer being hit with the alternative minimum tax (AMT) were greatly reduced with the enactment of the 2017 TCJA, which increased the AMT exemption and the AMT phase-out thresholds. However, it can still be an issue for higher-income clients. For 2022, the AMT exemption is $75,900 for a single filer, $118,100 for married filing jointly or surviving spouse, and $59,050 for married filing separately. The exemption begins to phase out by an amount equal to 25 percent of the amount by which alternative minimum taxable income exceeds $1,079,800 in the case of married individuals filing a joint return and surviving spouses and $539,900 in the case of unmarried individuals and married individuals filing separate returns. As a result, high-income taxpayers with household incomes above those thresholds, with large amounts of itemized deductions or significant AMT income from exercising stock options, could be at risk for the AMT.

If a taxpayer has a Schedule C business, allocating mortgage interest or property taxes to the taxpayer's Schedule C business can help prevent those amounts from being added back and increasing the taxpayer's AMTI.

Qualified Business Income Deduction

Under the qualified business income tax break in Code Sec. 199A, a 20 percent deduction is allowed against qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. The deduction is available to both itemizers and non-itemizers. The rules that apply to individuals with taxable income at or below $170,050 ($340,100 for joint filers; $170,050 for married individuals filing separately) are simpler and more permissive than the ones that apply above those thresholds. The deduction phases out entirely when taxable income exceeds $220,050 (single, head of household, and married filing separately) and $440,100 (joint filers). However, this deduction does not apply to a "specified service trade or business," which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.

Deductions for Excess Business Losses

Under Code Sec. 461(l), excess business losses of a noncorporate taxpayer are disallowed for tax years beginning after December 31, 2020, and before January 1, 2029. An excess business loss for the tax year is the excess of aggregate deductions attributable to a client's trades or businesses over the sum of aggregate gross income or gain plus a threshold amount. The threshold amount for 2022 is $270,000 or $540,000 for joint returns. Excess business losses that are disallowed are treated as a net operating loss carryover to the following tax year.

Observation: This provision was set to expire at the end of 2026, but was extended for two years by the Inflation Reduction Act of 2022.

Life Events

For clients with divorces pending at the end of the year, practitioners may want to project the differences in a final tax bill based on filing a joint return or filing as married filing separately. For clients that divorced during the year, head of household filing status, with its increased standard deduction, is appropriate if the client has dependents living at home for more than half of the year and the client paid more than half of the upkeep of the home. For clients who will be changing their name as a result of a change in marital status, the Social Security Administration (SSA) must be notified. Similarly, the SSA should be notified for a dependent whose name has been changed. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds.

On the other hand, if a spouse died during 2022, the client can still use married filing jointly as the filing status. While the year of death is the last year for which a joint return can be filed with a deceased spouse, the client may be eligible to use the head-of-household filing status for the following year or the year after that if he or she is considered a "surviving spouse." A surviving spouse is one (1) whose spouse died during either of the two tax years immediately preceding the tax year; and (2) who maintains as a home a household which constitutes for the tax year the principal place of abode (as a member of such household) of a dependent who is a son, stepson, daughter, or stepdaughter of the taxpayer, and with respect to whom the clients is entitled to a dependency exemption deduction for the years in which such exemption deductions are available. Even if the client does not qualify as a surviving spouse, he or she may nevertheless qualify as a head of household if the applicable requirements are met.

Clean Energy Credits

For individuals, clean energy tax credits are available for 2022. These credits include residential energy property credits (the nonbusiness energy property credit and the residential clean energy property credit) and vehicle-related credits (the qualified plug-in electric drive motor vehicle credit and the alternative fuel refueling property credit).

Observation: The 2022 IRA significantly expanded and modified these tax credits, generally beginning after December 31, 2022. Thus, the pre-2022 IRA provisions generally remain in effect for 2022. However, a change to the credit for purchasing an electric vehicle, requiring the final assembly of the vehicle in the United States, takes effect after August 16, 2022 (see below).

Nonbusiness energy property credit. For years before 2023, the nonbusiness energy property credit under Code Sec. 25C (renamed the energy efficient home improvement credit by the 2022 IRA) is a credit for: (1) 10 percent of the cost of qualified energy efficiency improvements installed during the year; and (2) the amount of the residential energy property expenditures paid or incurred by the taxpayer during the year.

Qualified energy efficiency improvements include the following qualifying products: (1) energy-efficient exterior windows, doors and skylights; (2) roofs (metal and asphalt) and roof products; and (3) insulation. Residential energy property expenditures generally include: (1) energy-efficient heating and air conditioning systems, and (2) water heaters (natural gas, propane, or oil). There is a lifetime limit of $500 on the total amount of nonbusiness energy property credits that may be claimed. In addition, the amount of the credit taken with respect to windows cannot exceed $200. The following additional limitations also apply to the nonbusiness energy property credit: (1) $300 for any item of energy-efficient building property; (2) $150 for any furnace or hot water boiler; and (3) $50 for any advanced main air circulating fan.

This credit expired at the end of 2021 but was extended through 2032 by the 2022 IRA. The 2022 IRA also modified and expanded the nonbusiness energy property credit for property placed in service after December 31, 2022. Beginning in 2023, the credit is increased to 30 percent of the costs of all qualified energy efficiency improvements and residential energy property expenditures made during the year. In addition, the lifetime credit limitation is replaced with an annual limit of $1,200. The annual limits for specific types of qualifying improvements will be (1) $250 for any exterior door ($500 total for all exterior doors), (2) $600 for exterior windows and skylights, (3) $600 for other qualified energy property (including central air conditioners; electric panels and certain related equipment; natural gas, propane, or oil water heaters; oil furnaces; water boilers), and (4) a higher $2,000 annual limit for heat pumps and heat pump water heaters, biomass stoves, and boilers. The 2022 IRA also added a credit of up to $150 per year for home energy audits. Roofs no longer qualify for the Code Sec. 25C credit beginning in 2023.

Residential energy efficient property credit. The residential energy efficient property credit under Code Sec. 25D (renamed the residential clean energy credit by the 2022 IRA) equals 30 percent of the cost of certain qualified property installed on or used in connection with the taxpayer's home. Before January 1, 2023, qualifying properties are: (1) solar electric property, (2) solar water heaters, (3) fuel cell property, (4) small wind turbines, (5) geothermal heat pumps, and (6) biomass fuel property. Under the 2022 IRA, biomass fuel property expenditures no long qualify after December 31, 2022. However, battery storage technology expenditures qualify beginning in 2023.

Compliance Tip: The residential energy efficient property credit and the nonbusiness energy property credit are computed and reported on Form 5695, Residential Energy Credits.

Qualified plug-in electric drive motor vehicle credit. Under Code Sec. 30D, a taxpayer who acquires a qualified plug-in electric drive motor vehicle is generally allowed a credit for the tax year the vehicle is placed in service. For 2022, the amount of the credit is $2,500, plus an amount based on the battery capacity of the vehicle if the vehicle draws propulsion energy from a battery with at least 5 kilowatt hours of capacity. The amount based on battery capacity is equal to $417 plus $417 for each kilowatt hour of capacity in excess of five kilowatt hours. However, the total amount based on battery capacity cannot exceed $5,000. The credit begins to phase out for a manufacturer's vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States. For instance, Tesla and GM vehicles purchased in 2022 are not eligible for tax credits since those manufacturers have exceeded the 200,000 vehicle threshold.

The 2022 IRA significantly modified the Code Sec. 30D credit. After August 16, 2022, the credit is generally available only for qualifying electric vehicles for which final assembly occurred in North America. However, under a transition rule, taxpayers who entered a written binding contract to purchase an electric vehicle on or before August 16, 2022, but take possession of the vehicle after that date, are not subject to the final assembly requirement.

The 2022 IRA also increased the amount of the Code Sec. 30D credit, effective after December 31, 2022. Beginning in 2023, the total clean vehicles credit amount is $7,500, consisting of $3,750 for vehicles meeting a critical minerals requirement and $3,750 for vehicles a battery component requirement. In addition, price limits apply depending on the vehicle type ($80,000 for vans, SUVs, and pickup trucks; $55,000 for other vehicles). The credit is also not available to taxpayers with adjusted gross income over $300,000 (married filing jointly), $225,000 (head of household), and $150,000 (single). Other requirements apply beginning after 2023.

Compliance Tip: The qualified plug-in electric drive motor vehicle credit is computed and reported on Form 8936, Qualified Plug-in Electric Drive Motor Vehicle Credit.

Alternative fuel vehicle refueling property credit. The alternative fuel vehicle refueling property credit under Code Sec. 30C is a credit for 30 percent of the cost of purchasing qualified alternative fuel vehicle refueling property. This credit expired at the end of 2021 but was extended through 2032 by the 2022 IRA. This credit was also expanded for years beginning after 2022.

For years before 2023, qualified alternative fuel vehicle refueling property means any property (other than a building or its structural components) used for either of the following: (1) to store or dispense an alternative fuel into the fuel tank of a motor vehicle propelled by the fuel, but only if the storage or dispensing is at the point where the fuel is delivered into that tank; or (2) to recharge an electric vehicle, but only if the recharging property is located at the point where the vehicle is recharged. The amount of the credit is limited to a certain dollar amount, which depends on whether the property is used for business or personal purposes. The amount of the credit for business-use property (i.e., depreciable property) is limited to $30,000. The amount of the credit for personal-use property (i.e., non-depreciable property) is limited to $1,000.

After 2022, the credit allowed with respect to any single item of qualified alternative fuel vehicle refueling property placed in service by the taxpayer during the tax year cannot exceed (1) $100,000 in the case of depreciable property, and (2) $1,000 in any other case. In addition, the definition of qualifying property is expanded for years after 2022 to include bidirectional charging equipment and the credit can also be claimed for electric charging stations for two- and three-wheeled vehicles that are intended for use on public roads.

Compliance Tip: The alternative fuel vehicle refueling property credit is computed and reported on Form 8911, Alternative Fuel Vehicle Refueling Property Credit.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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