7 Year-End Tax Planning Strategies 2022 For Small Business Owners
It has been a challenging year both economically speaking and in terms of tax planning. While we have seen some federal tax legislation, the changes have been far more limited than many expected. Additionally, the continuing tight labor market, worries over a possible recession and high inflation are dominating concerns.
In this vein, the Federal Reserve increased the benchmark interest rate by 300 basis points to date in 2022. Recent comments by the Fed indicated it intends to further increase rates until the funds level hits a “terminal rate,” or end point, with a current target of 4.6% in 2023. This not only raises business borrowing costs, but also the correlating interest expense tax deduction, which is more likely to be reduced due to the limitations enacted in the 2017 Tax Cuts and Jobs Act (TCJA). A challenging economy, ever-changing tax rules and rising interest rates make tax and business planning more critical than ever.
The 2023 tax season (filing your 2022 taxes) is just a few months away. New Year’s Eve will be here before you know it, and with the stroke of midnight, many tax-saving strategy deadlines will have passed. Although we entered 2022 with a lot of uncertainty about potential tax law changes, very few of the proposals that would have impacted wealthy taxpayers were enacted.
In August, President Biden signed into law the Inflation Reduction Act. The Inflation Reduction Act focused on ramping up climate- and healthcare-related spending and left out virtually all measures that would have directly raised tax rates on individual taxpayers. JP Morgan private bank put together a year end tax guide. As we head toward a post-election lame-duck congressional session, tax legislation may resurface that targets retirement plans, digital assets and the so-called tax extenders that either expired at the end of last year or will expire at the end of 2022. The accounting firm Bakertilly discussed in an article that there are more than 40 temporary tax provisions that expired Dec. 31, 2021 Are you doing everything you can to enhance your financial well-being—and minimize your 2022 taxes?
Now is the time for you to take steps that might minimize your tax bill
The 4th quarter of each year is the time for some proactive tax planning to lower the tax liabilities of your small business (hopefully with a high income). For successful business owners, tax planning shouldn’t be a once-per-year exercise when filing your taxes. With extensions, you may be able to delay filing your 2022 taxes until late 2023. However, many tax planning moves that can help lower your total taxes owed may need to be made before the end of the current year. We recommend you act now to determine what actions you might take before 2022 ends so that you will be best positioned financially when you file your return next year.
1 Review Your Estimated Net Income
Has your income jumped substantially? Has soaring inflation sapped the profitability of your business? Changes in your income, either up or down, can significantly change your tax planning for the year. With a higher income, you may want to be more aggressive in looking for tax deductions. On the flip side, when your income drops, you may become eligible for other tax breaks that you haven’t considered in the past.
2 Are You Using the Best Business Entity?
What corporate entity structure are you using for your business if any? Are you a sole proprietor, S-Corp, LLC, Partnership or C-Corp? As your business and income grow, the best structure for your business may change.
If you are making $50,000, the time and effort (and cost) of setting up an S-Corp likely isn’t worth it. However, the tax planning math often changes as you earn six figures or more. You should review this with your tax professional every few years (more often if your business is growing rapidly or if there have been changes to the ownership).
3 Maximize and confirm your business owner’s pass-through deduction
Owners of qualifying pass-through entities2 may earn a 20% deduction on domestic qualified business income—if all conditions are met (consult a tax advisor). The rules governing this deduction are complicated but worth exploring.
Currently, taking this deduction does not require owners to itemize deductions on their returns. However, the amount that can be deducted depends (in part) on the pass-through owner’s adjusted gross income (AGI). At higher AGI levels, certain limitations phase in. Also, owners of certain types of businesses are eligible for the deduction only if their AGIs are below a certain level.
If you are the owner of a pass-through entity and a cash-basis taxpayer, clustering the anticipated business expenses of the entity into one year may reduce your AGI. This way, you may be better positioned to get the full benefit of the pass-through deduction. Also, if your income is above the threshold, you may be able to reduce your taxable income so that you qualify for the deduction.
4 Optimize Your Business Retirement Plan
One of the best ways for small business owners to slash their taxes is to establish and fully fund a retirement plan. This could be anything from a SEP IRA to a Solo 401(k) or a combination of a 401(k) with a Cash Balance Pension Plan. Would you rather write a big check to the IRS or your retirement account? I know which choice I prefer. High-income small businesses can potentially defer income taxes on hundreds of thousands of dollars annually.
Here are a few of the most common retirement plans for high-income-earning small business owners. If you can contribute to a retirement account, we recommend doing so—up to the full amount permissible. The maximum annual amounts you can contribute to retirement accounts in 2022 before year-end are:
- IRAs—$6,000. If you are 50 or older, it’s $7,000
- 401(k)s/403(b)s—$20,500. If you are 50 or older, it’s $27,000
SEP IRA – If you are self-employed, you can contribute 20% of your self-employment earnings into a SEP IRA per year. The maximum contribution to a SEP-IRA is $61,000 for 2022. There are no catch-up contributions for SEP IRAs. With no year-end deadline, a SEP IRA can be set up and funded just before filing your taxes for the previous year.
Solo 401(k) – Typically, a Solo 401(k) will allow for the largest pre-tax contributions, which should translate into the largest tax savings. Business employees can contribute up to $20,500 for 2022 plus a $6,500 catch-up contribution if they are at least 50 years old. Additionally, the business can make a profit-sharing contribution, up to 25% of payroll. That means $61,000 (or $67,500 for those over 50) in allowable 401(k) contributions in 2022.
You can also benefit from a Roth Solo 401(k) for the employee portion of your contributions, $20,500 plus a $6,500 catch-up contribution for business owners over 50. If your spouse also works with you in the business, they can be included in the plan, doubling the amount you can contribute and the tax savings.
Defined-Benefit Pension Plan – For business owners looking to save even more on taxes, the Cash Balance Plan (combined with a 401(k)) could allow your business to shelter several hundred thousand dollars in income each year. Defined benefit pension plans are the most complicated of the small business retirement plans because the plan design is complex and time-consuming. If you are nearing 50 (or older), are already maxing your 401(k) and want to save even more, talk with your tax planning financial planner ASAP. If they aren’t able to help you determine if a Cash Balance plan is right for you, talk with someone who can.
Cash Balance Plan contribution limits will depend on the age and income of you and your employees. But they can often run north of $150,000 per business owner annually. (Double this if your spouse also works in the business with you). The tax savings can be huge, especially for those in high-tax states like California.
Convert a traditional IRA to a Roth – If you believe your tax rates may be higher in the future, speak with your tax advisor about whether it makes sense for you to convert your traditional IRA to a Roth IRA before this year-end. Several bills introduced in Congress in recent years would have limited taxpayers’ ability to make the conversion, but those proposals did not pass, leaving the opportunity to convert as viable as ever. Converting assets from a traditional IRA to a Roth IRA may be a smart move if you:
- Think your future income tax rates may be higher
- Can afford to pay the taxes with cash from other sources
- Do not plan to leave IRA assets to charity
- Expect the IRA to last for a while
5 Are You Eligible for The Home Office Deduction?
These days, small business owners are more likely to work from home full-time. Business owners reading this who work from home may be eligible to take the home office deduction. Here is what you need to know to determine if you qualify and better understand how this often-scary home office deduction works.
This valuable tax break can save hundreds, or even thousands, of dollars in taxes each year. The best part is that you are already incurring these expenses for housing regardless of your business use. Take the time and discuss the home office deduction with your tax preparer to make sure you qualify.
6 Take advantage of temporary 100% expensing for certain business assets
One of the positive changes from the Tax Cuts and Jobs Act (TCJA) is that you can now immediately expense 100% of the cost of qualified used and new property acquired and “placed in service” during your 2022 business year. To put this more plainly, you may be able to get a tax break for the entire cost of assets purchased in 2022. If you have a big income year, you may consider moving up some planned purchases into 2022.
Planning ahead, these tax benefits begin to phase out after 2022. Starting January 1, 2023, taxpayers can expense only 80% of the cost. Consider whether it makes sense for you, before year-end, to acquire (perhaps through borrowing) such qualified property (e.g., jet aircraft used in a trade or business).
7 Stay Proactive with Your Tax Planning
With proper timing (from proactive tax planning), your income and deductions could become even more valuable. For those who use pass-through entities (Sole Proprietor, S Corp, LLC, or Partnership), your portion of the business profit and deductions are passed through to you and eventually taxed on your own personal tax returns. Taxes are based on your overall household income and filing status.
We are expecting some changes to tax brackets in 2023 and some increases to retirement plan contribution limits.
For the self-employed, minimizing taxation is one of the best ways to increase the net profitability of all your hard work in your business. Be proactive and work with your tax planning CPA to develop a strategy to make proactive tax planning choices that will help you keep more of your hard-earned money. In the case of retirement accounts, would you rather write a check to yourself or the IRS? The choice is yours.
Are you getting the help you need? These are just a few examples of the many opportunities you may have right now to strengthen your financial health before year-end. Speak with your tax advisor about which actions may be right for you. If you have any questions feel free to reach out to Huckabee CPA for a free consultation.