End-of-year tax planning is a great way to increase your small business’s net profit without having to… … [+]
While some of you may still need to file your 2021 taxes, the 2023 tax season (filing your taxes for 2022) is just a few months away. New Year’s Eve will be here before you know it, and by the stroke of midnight, many tax-saving strategy deadlines will have passed.
The fourth quarter of every year is the time for some proactive tax planning to reduce your small business (hopefully high income) tax liabilities. For successful business owners, tax planning shouldn’t be once a year when filing your taxes. Extensions may allow you to delay filing your 2022 taxes until the end of 2023. Many tax planning steps that can help reduce your total tax owed may need to be done before the end of the current year.
Contents
View your estimated net income
Has your income increased significantly? Has rising inflation undermined your company’s profitability? Changes in your income, both up and down, can significantly alter your tax planning for the year. With a higher income, you may want to be more aggressive in seeking tax deductions. On the other hand, when your income falls, you may qualify for other tax benefits that you have not considered in the past.
Are you using the best business entity?
What business structure, if any, do you use for your business? 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’re making $50,000, the time and effort (and expense) of setting up an S-Corp probably isn’t worth it. However, the math for tax planning often changes when you earn six figures or more. You should review this with your tax professional and tax planning Certified Financial Plannerâ„¢ every few years (more often if your business is growing rapidly or if ownership has changed).
A cash balance pension plan can make it possible to both save tax and retire early.
Optimize your corporate retirement plan
One of the best ways for small business owners to lower their taxes is to create and fully fund a retirement plan. This can be anything from a SEP IRAI to a Solo 401(k) or a combination of a 401(k) with a Cash Balance Pension Plan. Prefer to write a large check to the IRS or your retirement account? I know which choice I prefer. High-income small businesses can potentially defer hundreds of thousands of dollars in income tax each year.
Here are some of the most common retirement plans for high-income small business owners.
SEP IRA – If you are self-employed, you can contribute 20% of your self-employment income to 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 you file your taxes for the previous year.
Solo 401(k) – Typically, a Solo 401(k) delivers the largest pre-tax contributions, which should translate into the biggest tax savings. Corporate employees can contribute up to $20,500 before 2022 plus a catch-up fee of $6,500 if they are at least 50 years old. In addition, the company can make a profit-sharing contribution, up to 25% of the wage bill. That means $61,000 (or $67,500 for those over 50) in allowable 401(k) contributions in 2022.
You can also take advantage of a Roth Solo 401(k) for the employee portion of your contributions, $20,500 plus a $6,500 catch-up fee for business owners over 50. If your spouse also works in the business with you, they can be included in the plan, doubling the amount you can contribute and the tax savings.
Defined benefit plan – For business owners looking to save even more on taxes, the Cash Balance Plan (when combined with a 401(k)) can allow your business to protect several hundred thousand dollars in revenue each year. You may also hear this referred to as a defined benefit plan; more likely, your basic financial advisor or CPA won’t list it all (unfortunately).
Defined benefit plans are the most complicated pension plans for small businesses because the plan design is complex and time consuming. If you’re approaching 50 (or older), already hit your 401(k), and want to save even more, contact your tax planning financial planner ASAP. If they can’t help you determine if a Cash Balance plan is right for you, talk to someone who can. Many financial advisors cannot or do not want to do the work of setting up a Cash Balance Plan.
The Cash Balance Plan contribution limits depend on the age and income of you and your employees. But they can often run as high as $150,000 per business owner annually. (Double this if your spouse also works in the company with you). The tax savings can be huge, especially for people in high-tax states like California and New York.
Are you eligible for the home office deduction?
Today, small business owners are more likely to work full-time from home. Business owners reading this and working from home may be eligible for the work from home deduction. Here’s what you need to know to determine your eligibility and better understand how often this is scary home office deduction works.
This valuable tax benefit can save hundreds or even thousands of dollars in taxes each year. The best part is that you already incur these costs for housing, regardless of your business use. Take your time and discuss the home office deduction with your tax advisor to make sure you qualify.
Don’t Ignore Your Accounting
I hope the days of filing your taxes out of a shoebox of receipts are long behind you. Even when organized, filing your business taxes can be time consuming and stressful. Schedule some time throughout the year to keep up with your accounting (or hire someone to do it for you).
Claim First Year Bonus Depreciation
One of the positive changes from the Tax Cuts and Jobs Act (TCJA) is that you can now get a 100% first-year bonus amortization on qualified used and new real estate acquired and put into use during your fiscal year 2022. To make this clearer you may be able to get a tax break for the full cost of assets purchased in 2022. If you have a high income year, consider moving some planned purchases to 2022.
By planning ahead, these tax breaks will begin to phase out after 2022.
Stay proactive with your tax planning
With the right timing (of proactive tax planning), your earnings and deductions can become even more valuable. For those using pass-through entities (sole proprietorship, S Corp, LLC, or partnership), your portion of corporate profits and deductions is passed on to you and ultimately taxed on your own personal tax returns. Taxes are based on your total household income and filing status.
We expect some changes in the tax brackets in 2023 and some increases in the contribution limits for pension plans.
For the self-employed, minimizing taxes 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 Certified Financial Plannerâ„¢ and 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.
Janice has been with businesskinda for 5 years, writing copy for client websites, blog posts, EDMs and other mediums to engage readers and encourage action. By collaborating with clients, our SEO manager and the wider businesskinda team, Janice seeks to understand an audience before creating memorable, persuasive copy.