It’s time for year-end tax planning. Every fall, small business owners should review their tax situations to determine steps they should consider to reduce their federal income taxes for the current year — and beyond. Fortunately, no significant unfavorable federal tax law changes are expected this year. So, there’s more certainty regarding the tax rules today than this time last year. Here are five ideas to help reduce business taxes for 2022.
Small Business Tax Law Changes under the IRA
In August, President Biden signed the Inflation Reduction Act of 2022 (IRA). The new law contains several tax-related provisions that generally go into effect after 2022. Here are some key changes that may affect small businesses:
In addition, the IRA gives the IRS about $80 billion of additional funding over the next 10 years. As things now stand, the funds will go toward additional staff and technology to help with customer service and “tax enforcement activities.” This underscores the importance of substantiating any business deductions and credits claimed on your return, because the odds of being audited may be going up.
1. 100% First-Year Bonus Depreciation for Last-Minute Asset Additions
Thanks to the Tax Cuts and Jobs Act (TCJA), 100% first-year bonus depreciation is available for qualified new and used property that’s acquired and placed in service in calendar year 2022. So, your business might be able to write off the entire cost of some or all of your 2022 asset additions on this year’s federal income tax return and maybe on the state return, too.
Consider making additional acquisitions between now and year end. Contact your tax advisor for details on the 100% bonus depreciation break and exactly what types of assets qualify.
Important: Under the TCJA, the first-year bonus depreciation percentages for most eligible assets are scheduled to be reduced as follows:
- 80% for assets placed in service in calendar year 2023,
- 60% for 2024,
- 40% for 2025, and
- 20% for 2026.
For certain property with longer production periods, these reductions are delayed by one year. If you’re on the fence about making a purchase now or later, you might want to buy the asset and place it in service before year end to take advantage of the 100% bonus depreciation deduction for assets placed in service in 2022.
However, if significant tax-rate increases are expected in future years, you could be better off forgoing 100% first-year bonus depreciation and instead depreciating newly acquired assets over a number of years. If tax rates go up, those future depreciation write-offs could be worth more than a current-year 100% write-off.
Fortunately, you have until the deadline for filing your current-year federal income tax return, including any extension, to decide whether to write off purchases immediately or depreciate them over time. If your business uses the calendar year for tax purposes, the extended filing deadline is October 16, 2023, for sole proprietorships and C corporations. The extended deadline is September 15, 2023, for partnerships, limited liability companies (LLCs) taxed as a partnerships and S corporations. Extending your return may give you more flexibility to react to future tax developments or expectations about them.
2. Heavy SUV, Pickup or Van Write-Offs
The 100% bonus depreciation deal can have a hugely beneficial impact on first-year depreciation deductions for new or used heavy vehicles used over 50% for business. That’s because heavy SUVs, pickups and vans are treated for federal income tax purposes as transportation equipment. That means the business-use percentage of the cost qualifies for 100% bonus depreciation if placed in service in calendar year 2022.
Specifically, 100% bonus depreciation is available when the SUV, pickup or van has a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. You can verify this by looking at the manufacturer’s label that’s usually found on the inside edge of the driver’s side door where the door hinges meet the frame. If you’re considering buying an eligible vehicle, placing it in service before year end could deliver a sizable write-off on this year’s return.
3. Timing of Business Income and Deductions
If you conduct your business using a pass-through entity — meaning a sole proprietorship, S corporation, partnership or LLC taxed as a partnership — your share(s) of the tax items from the business are passed through to you and reported on your personal return.
As year end approaches, evaluate whether you’ll be in the same or lower federal income tax bracket in 2023. If you think that will be the case, the traditional year end strategy of deferring taxable income into next year while accelerating deductible expenditures into this year makes sense. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2022 until 2023.
On the other hand, if you expect to be in a higher tax bracket in 2023, take the opposite approach. If possible, accelerate income into this year and postpone deductible expenditures until 2023. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.
4. QBI Deductions
The deduction based on an individual’s qualified business income (QBI) from pass-through entities was a key element of the TCJA. The deduction can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income.
For QBI deduction purposes, pass-through entities include:
- Sole proprietorships,
- Single-member LLCs that are treated as sole proprietorships for tax purposes,
- LLCs that are treated as partnerships for tax purposes, and
- S corporations.
You can also claim the QBI deduction for up to 20% of qualified REIT dividends and up to 20% of qualified income from publicly traded partnerships.
Because of the income limitations on the QBI deduction, year-end tax planning moves can increase or decrease your allowable QBI deduction. For instance, year-end moves that reduce this year’s taxable income — such as claiming 100% bonus depreciation deductions or making deductible retirement plan contributions — can reduce this year’s allowable QBI deduction. Work with your tax advisor to optimize your overall tax results.
5. Tax-Favored Retirement Plans
If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions.
For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $61,000 for the 2022 tax year. If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $61,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2022 by a whopping $19,520 (32% times $61,000).
Other small business retirement plan options include:
- 401(k) plans, which can even be set up for just one person (called solo 401(k)s),
- Defined benefit pension plans, and
Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.
Important: The SECURE Act doesn’t change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, the SECURE Act change doesn’t override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.
For example, the deadline for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes and making the initial deductible contribution for the 2022 tax year is October 16, 2023, if you extend your 2022 personal tax return. However, to make a SIMPLE-IRA contribution for the 2022 tax year, you must have set up the plan by October 1. So, you might have to wait until next year if the SIMPLE-IRA option is appealing.
While you have until next year to establish a tax-favored retirement plan (except for a SIMPLE-IRA), why wait? Get it done this year as part of your year-end tax planning. Contact your tax advisor for more information on alternatives and be aware that if your business has employees, you may have to make contributions for them, too.
We Can Help
The year-end tax planning picture is much clearer this year than last year. Unless something unexpected happens, these five ideas will work for many small businesses. But there could be additional tax-smart year-end moves that apply to your situation. So, contact your tax advisor to ensure you’re covering all the bases.