Even after the end of the year there is still time for tax planning.
The 2022 tax year has ended and tax professionals around the world are encouraging their small business clients to close their books and rethink their tax returns. In a perfect world, these clients have worked year-round with their tax and accounting professionals to optimize their small business taxes. Of course, we don’t live in a perfect world, and clients are often surprised at how much their small business made (and how much tax they owe) at tax time. The good news is that there are some tax optimization strategies available to small business owners after the tax year ends.
David Levi, CPA and Managing Director at CBIZ MHM, says that funding your (or your company’s) retirement plan is one of the best ways to “use Uncle Sam’s help to move money from your left pocket to your right pocket.” For example, sole proprietors (and others) have until the non-extended due date of their tax returns (April 17 this year) to fund their traditional IRA accounts. Of course, there are income thresholds that limit the deductibility of IRA contributions, so it’s best to check with a tax professional before simply making the contribution and counting on it being deductible. Simplified Employee Retirement (SEP) IRAs offer higher contribution limits and can be set up and funded at the non-extended due date of your tax return.
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The second recommendation Levi has is to work with your tax advisor to optimize your business’s depreciation and fixed assets, both for the tax year just ended and for the future. He notes that this is an area where a qualified professional can “provide real return on investment” (i.e, earn the money you pay them) because they know all the rules and can use them to adjust the deductibility or capitalization of your specific purchases to your current and projected profit/loss situation. Obviously, your company must have purchased fixed assets (equipment, furniture, etc.) to use this strategy.
Levi reminds taxpayers (and tax professionals) that “this is one of those times when constructive reception isn’t a thing.” When it comes to depreciating equipment, it’s the date the equipment was put into service (think plugged in) and not the date it was received or delivered. Small businesses can actually move a deduction into the future by waiting to start using a device. This strategy can be useful depending on the company’s current and projected earnings.
Your tax advisor can help you determine if it’s best to “write it off” (to take the full deduction in the current year using bonus depreciation, the section 179 expense election, or the $2,500 per item de minimis safe-harbour- election) or to capitalize the expense (take the deduction over the class time of the property). Many tax professionals use a combination of both capitalization and immediate depreciation (of one or more types) to create a balance between current and future deductions. The choices can affect other items on the tax return, such as your qualified business income deduction (QBID), so it’s important to use someone who is fully versed in all the moving parts of the depreciation puzzle.
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Levi’s third recommendation is for those with LLCs filing a Schedule C with their annual Form 1040 to consider making a late election to be taxed as a Subchapter S Corporation instead of a sole proprietorship. This option won’t work for everyone, but depending on how profitable the business is and the owner’s threshold for administrative compliance (proper payroll is required), it gives owner-operators the ability to separate profit from compensation. This strategy means that while all earnings are subject to income tax, only the a fee component is subject to FICA (Social Security and Medicare) taxes.
Making a late entity selection can also have state-level benefits. Specifically, 30 states offer special pass-through entity tax (PTET) that allow taxpayers with S corporations (and partnerships) to deduct certain state income taxes as business expenses. States have implemented these new laws to provide taxpayers with a solution to the federal $10,000 state and local tax (SALT) cap introduced in 2017 as part of the Tax Cuts and Jobs Act. Levi notes that there may be benefits even for taxpayers who take the standard deduction (the SALT limit only affects those who itemize deductions on Schedule A). Taxpayers considering this strategy should definitely consult a tax professional to run the numbers to determine if the additional costs associated with the strategy (payroll and payroll taxes, filing an additional entity-level tax return, etc.) are justified by the tax savings. Don’t let the tax tail wag the dog. In addition, the rules for making the late S corporation election are complex, and failure to follow them could result in the election being rejected by the IRS. The rules surrounding PTET/SALT benefits are also different for almost every state that offers them. In other words, there are many ways to make costly mistakes with this strategy and the money spent to hire a qualified professional to help will be money well spent.
Levi recommends that business owners put some time and energy into organizing their financial information, whether they do it themselves or use a professional helper. “The faster you get on top of it [your income and expenses] the more impactful your ability to use the information will be. In other words, if you want to use any of these strategies, you must collect the necessary accounting information yesterday! If you have an accountant who also prepares your tax returns, let them know you’re interested in exploring these options – yesterday! In the heat of tax season, it’s hard for accountants and tax professionals to focus on anything other than closing client books, providing year-end reports, and filing tax and information returns (W2S, 1099s). If you want your tax advisor to help you with post-tax planning, it’s best to let them know and give them the information they need to prepare your returns and evaluate these tax planning options as early as possible.
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