While some of you may still need to file your 2021 taxes,
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.
The fourth quarter 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.
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.
Are You Using the Best Business Entity?
What corporate 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 and tax-planning Certified Financial Planner™ every few years
(more often if your business is growing rapidly or if there have been changes
to the ownership).
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.
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. You may also hear this called a Defined Benefit Pension
plan; more likely, your basic financial advisor or CPA won't mention it all
(sadly).
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. Many financial advisors are unable
or unwilling to do the work to set up a Cash Balance Plan.
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 and New York.
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.
Don't Ignore Your Bookkeeping
I hope the days of filing your taxes from a shoebox of receipts
are long behind you. Even when organized, filing your business taxes can be
time-consuming and stressful. Please plan to spend a little time throughout the
year to stay up to date on your bookkeeping (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 depreciation for
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.
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 Certified Financial
Planner™ and 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.
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