It’s been a tumultuous year for many businesses, and the current economic and political climate promises more uncertainty for the short term, if not longer. Regardless of how your company has fared so far in 2022, there’s still time to engage in efforts that may reduce your federal tax liability. Here are some strategies worth your consideration.
Time your income and expenses
When it comes to year-end tax reduction strategies, many businesses that use cash-basis accounting, start with the practice of accelerating deductions into the current tax year and deferring income into the next year. You can accelerate deductions by, for example, paying bills or employee bonuses due in 2023 before year-end and stocking up on supplies. Meanwhile, you can defer income by holding off on invoicing until late December or early January.
You should consider this strategy if you do not expect to see significantly higher profits next year. If you think you will, it may be more efficient to flip the approach, accelerating income and pushing deductions into the future when they may be more valuable.
Maximize your QBI deduction
Certain self-employed individuals and owners of pass-through entities (that is, sole proprietors, partnerships, limited liability companies and S corporations) can deduct up to 20% of their qualified business income (QBI), subject to certain limitations based on W-2 wages paid, the unadjusted basis of qualified property and taxable income. The deduction, created by the Tax Cuts and Jobs Act (TCJA), is set to expire after 2025, absent congressional action, so make the most of it while you can.
If the W-2 wage or property limits are capping your deduction, you could increase your deduction by increasing wages (for example, by accelerating payment the payment of bonuses) or accelerating the purchase of capital assets. Of course, these moves usually have other consequences, such as higher payroll taxes, that you should weigh with all other business considerations before proceeding. You can avoid the income limit by timing your income and deductions, as discussed above.
Accelerate depreciation — while you can
The TCJA also increased the Section 168(k) first-year bonus depreciation to 100% of the purchase price, through 2022. Beginning next year, the allowable deduction will drop to 80% of the purchase price, then by an additional 20% each subsequent year until it evaporates altogether in 2027 (again, absent congressional action). Combining bonus depreciation with the Section 179 deduction can produce substantial tax savings for 2022.
Under Sec. 179, you can deduct 100% of the purchase price of new and used eligible assets in the year you place them in service — even if they’re only in service for a day or two. Eligible assets include machinery, office and computer equipment, software, and certain business vehicles. The deduction also is available for some improvements to nonresidential property.
The maximum Sec. 179 deduction for 2022 is $1.08 million and it begins phasing out on a dollar-for-dollar basis when your qualifying property purchases exceed $2.7 million. The maximum deduction also is limited to the amount of your income from the business, although unused amounts can be carried forward indefinitely.
Alternatively, you can claim excess amounts as bonus depreciation, which is subject to no limits or phaseouts in 2022. Bonus depreciation is available for many types of assets, including computer systems, software, vehicles, machinery, equipment, office furniture and qualified improvement property (generally, interior improvements to nonresidential property).
For all their immediate appeal, bonus depreciation and Sec. 179 expensing aren’t always advisable. For example, potential immediate tax savings may be lessened if the limitations on business interest expense deductions are triggered by a reduction in adjusted taxable income.
Additionally, in some situations it might be wise to have some depreciation available to offset your future income. You might think twice, too, if you have expiring net operating losses, charitable contributions or credit carryforwards that are affected by taxable income.
The good news is that you don’t have to decide now. As long as you place qualified property in service by December 31, 2022, you have the option of choosing the most advantageous approach when you file your tax return in 2023.
Get real about your bad debts
Business owners are sometimes slow to accept that they’re going to go unpaid for services rendered or goods delivered. If you use accrual-basis accounting, though, facing the facts can land you a bad debt deduction.
The IRS allows businesses to deduct “worthless” debts, in full or in part, that they’ve previously included in their income. To show that a debt is worthless, you need to show that you’ve taken reasonable steps to collect but without success. You aren’t required to go to court if you can show that a judgment from a court would be uncollectible.
You still have time to take reasonable steps to collect outstanding debts. It’s important to keep detailed records of these efforts. If you determine you can’t collect, you may be able to deduct some or all of those debts for 2022.
Start or replace your retirement plan
If you’ve put off establishing a retirement plan, or simply outgrown the plan you started years ago, you have time to possibly trim your taxes this year — and likely improve your employee recruitment and retention at the same time — by starting a new plan. Eligible employers can claim a tax credit of up to $5,000, for the first three years, for the costs of starting a SEP IRA, SIMPLE IRA or a qualified plan such as a 401(k) plan.
The credit is 50% of your costs to set up and administer the plan and educate your employees about it. You can claim up to the greater of $500 or the lesser of:
- $250 multiplied by the number of non-highly compensated employees who are eligible to participate in the plan, or
- $5,000.
You can begin to claim the credit in the tax year before the year the plan becomes effective. And, if you add an auto-enrollment feature, you can claim a tax credit of $500 per year for a three-year period beginning in the first taxable year the feature is included.
Leverage your startup expenses
If you launched a new business this year, you might qualify for a limited deduction for certain costs. The IRS allows you to deduct up to $5,000 of startup costs and $5,000 of organizational costs (such as the costs of creating a partnership). The deduction is reduced by the amount by which your total startup or organizational costs exceed $50,000. You must amortize any remaining costs.
An eligible cost is one that you could deduct if it were paid or incurred to operate an existing business in the same field. Eligible costs also must be paid or incurred before the active business begins. Examples include business analysis costs, advertisements for the business’s opening, travel and other costs related to lining up prospective distributors, suppliers or customers, and certain salaries, wages and fees.
Turn to us for planning advice
The strategies detailed here are a sampling of ideas and involve tradeoffs that require thoughtful evaluation and analysis, and a balancing of business considerations with a desire for tax savings. Additionally, tax planning is not merely a year-end activity, but an ongoing evolving conversation that should be happening throughout the year as facts, laws and opportunities change. Our CSH tax experts can help you make the right choices to ensure your company is not paying more tax than it should.
