As the tax filing season looms, small business owners naturally turn their attention to strategies for minimizing their business taxes, through various tax services. To optimize their financial position, they can explore a range of year-end tax planning tactics. These tactics encompass leveraging available credits and deductions, skillfully timing revenues and expenses, and more. Implementing these strategies can be pivotal in diminishing the overall tax liability, resulting in greater retained earnings for the business. By diligently examining their financial landscape and employing these five fundamental strategies, every small business owner can streamline taxation process and enhance their financial health and retain a more substantial portion of their earnings, thus bolstering their business’s fiscal strength.
Consider a Tax Status Change
As a small business owner, choosing the right business structure is a crucial decision that profoundly affects your taxes and overall business operations. You have several options, including operating as a sole proprietor, forming a partnership, establishing a limited liability company (LLC), opting for an S corporation, or setting up a C corporation. Each structure has its unique implications for taxation and liability.
If your business has experienced growth or evolving needs over the past year, you might consider changing your business structure to better align with your goals. For instance, LLCs have the flexibility to elect C corporation taxation status by submitting IRS Form 8832. This option was less common in the past when the corporate tax rate was 35%, but the Tax Cuts and Jobs Act of 2017 (TCJA) significantly reduced it to 21%, making it a more appealing choice for some businesses.
Changing your business structure is a strategic move that requires careful consideration of your financial, legal, and operational requirements. Consulting with a tax advisor or attorney can help you make an informed decision that optimizes your tax situation and supports your business’s growth.
Corporations Vs. Pass-Through Businesses
Pass-through businesses, including sole proprietorships, partnerships, LLCs, and S corporations, enjoy a unique tax advantage. Unlike traditional corporations, they are not subject to corporate income tax. Instead, the profits and losses “pass through” to the individual tax returns of their owners. This means that the highest individual tax bracket, which currently stands at 37%, is applied to the net income of these businesses.
For high-earning LLC members, changing their tax status can yield substantial tax savings. However, it’s crucial to note that the Inflation Reduction Act of 2022 reintroduced the corporate alternative minimum tax (AMT). Fortunately, this change won’t impact small businesses. The new 15% corporate AMT specifically targets C corporations with an average annual income exceeding $1 billion.
While tax savings can be a compelling reason to consider altering your business’s tax structure, it’s not the sole factor to weigh. Prior to making any such adjustments, it’s advisable to consult a seasoned tax professional. They can assist you in performing a thorough cost-benefit analysis, ensuring you make the best decision for your small business’s financial health.
Take Advantage of Tax Deductions
The Qualified Business Income (QBI) deduction is a valuable benefit offered to pass-through business proprietors, permitting them to avail a deduction equating to a maximum of 20% of their portion of the business’s earnings. Nevertheless, it is crucial to note that this deduction is accompanied by a series of regulations and constraints.
In cases where individuals are proprietors of Specified Service Trades or Businesses (SSTBs) and their income surpasses a certain threshold, they may be ineligible to claim this deduction. SSTBs are typically defined as service-oriented enterprises, with the exception of engineering and architecture firms, wherein the business’s success is contingent upon the reputation or expertise of its employees or proprietors. Examples of these types of SSTBs include:
- Law firms
- Medical practices
- Consulting firms
- Professional athletes
- Performing artists
- Accountants
- Financial advisers
- Investment managers
If your business falls under the category of a Specified Service Trade or Business (SSTB), the Qualified Business Income (QBI) deduction you are eligible for will begin to phase out once your total taxable income exceeds specific thresholds. For the tax year 2022, these thresholds are set at $170,050 for single filers and $340,100 for those who are married and filing a joint return.
To calculate your QBI deduction under these circumstances, you will need to utilize Part II of Form 8995-A. However, it’s important to note that once your income surpasses $220,050 for single filers or $440,100 for those married and filing jointly, you will no longer be eligible to claim this deduction.
In the event that your business does not qualify as an SSTB, but your total taxable income exceeds the upper limits mentioned above, you can still claim the QBI deduction. However, it will be subject to certain limitations. You may claim either:
- 50% of your portion of W-2 wages that your business has paid.
- 25% of those wages, in addition to 2.5% of your portion of qualified property.
Navigating the complexities of the QBI deduction can be challenging for small business owners. If you believe you may be eligible for this deduction, it is advisable to seek guidance from a qualified accountant to ensure accurate calculations and compliance with tax regulations.
Are You Eligible for Home Office Deduction?
The utilization of the home office deduction can prove to be a strategic asset for small business proprietors who operate from their residences. This tax planning avenue empowers them to offset expenses associated with the allocation of a portion of their home for business activities.
To qualify for this deduction, it is imperative that the designated space be consistently and exclusively utilized for business-related purposes.
There exist two distinct methodologies for computing this deduction. The simplified approach enables the deduction of $5 for every square foot of the home that is employed exclusively for business operations, with a maximum cap set at 300 square feet.
Alternatively, under the actual expenses method, the calculation revolves around determining the percentage of your home’s total square footage dedicated to business activities. Subsequently, this percentage is applied to eligible expenses such as mortgage interest or rent, real estate taxes, utilities, and expenditures on repairs and maintenance. This method allows for a more precise reflection of the actual costs incurred in utilizing the home for business endeavors.
Leverage tax Credits
Tax credits help businesses reduce their tax burden directly, distinct from deductions. Here are key credits:
Work Opportunity Tax Credit (WOTC): Aids hiring individuals from target groups facing employment barriers. Offers up to $2,400 per eligible new hire. Small businesses must hire from these groups, complete Form 8850, and submit it to the state agency within 28 days of hire.
Disabled Access Credit (DAC): Helps small businesses make their facilities accessible for people with disabilities. Provides a 50% credit on up to $10,000 in expenses, with the initial $250 ineligible. Eligibility requires revenue under $1 million and fewer than 30 full-time employees.
Credit for Small Employer Health Insurance Premiums: Available to small businesses with under 25 full-time equivalent employees, paying average wages below an annually adjusted threshold. You must purchase group health insurance through the Small Business Health Options Program Marketplace and cover at least 50% of employee-only premiums. The credit is up to 50% of premiums and can be claimed for two consecutive tax years.
These credits offer financial benefits to businesses, especially when following eligibility requirements and procedures meticulously.
Defer – or Accelerate – Income
Numerous small enterprises employ the cash accounting method for their financial records and tax filings. Under this methodology, a business records revenue upon receipt and expenses when disbursed, aligning with the actual cash transactions. This approach offers several intriguing opportunities for tax planning.
If an entity anticipates a lower tax bracket in the forthcoming fiscal year, it may be prudent to defer the recognition of income to that period. By doing so, the business can potentially benefit from a reduced tax liability, taking advantage of the lower tax rate applicable in the subsequent year.
When to Differ Income
For instance, in the scenario where services were rendered to a client in December 2022, but the invoicing process has not been initiated, the option to delay the billing until January 2023 presents an opportunity to defer income to the subsequent fiscal year. This strategic approach can effectively contribute to reducing the tax liability for the year 2022.
When to Accelerate Income
On the contrary, it may be prudent to consider expediting the recognition of income within the current fiscal year, particularly if there is a prevailing expectation of forthcoming tax rate increases. In such a scenario, proactively issuing your invoice and securing payment from your client in the year 2022 would result in a larger portion of your income being subject to taxation at your present tax rate.
This principle is equally applicable when it comes to managing expenses. If you currently find yourself in a higher tax bracket for the current year, it may be advisable to expedite the deduction of expenses in 2022 as a strategic measure to curtail your taxable income. To aid in making these decisions, we have provided a practical guideline on when to accelerate or defer the recognition of income and expenses.
| Defer income, accelerate expenses when: | Accelerate income, defer expenses when: |
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Set Up – Or Contribute to – A Retirement Plan
Establishing or contributing to a retirement account offers tax benefits and is a valuable financial planning tool for business owners. There are various options available for retirement savings for both business proprietors and their employees.
- If you initiate a 401(k) plan before the conclusion of the tax year, you can deduct the contributions you make to this plan when you file your tax return. The plan’s terms determine the allowable employer contributions. In 2022, the total combined contributions from employees and employers are limited to the lesser of an employee’s compensation or $61,000.
- Should you miss the deadline for establishing a 401(k) plan in 2023, you still have the option to set up a Simplified Employee Pension Plan (SEP). You are permitted to create a SEP until the due date of your tax return, including extensions. Contributions made by the employer to a SEP are limited to 25% of the employee’s compensation, with a cap of $61,000 for the year 2022.
Beginning a 401(k) or SEP not only enables you to deduct contributions but also makes you eligible for the Retirement Plans Startup Costs Tax Credit. This credit is available to employers who meet the following criteria:
- Employed 100 or fewer individuals who received a minimum of $5,000 in compensation during the year.
- Had at least one participant in the plan who was not classified as a highly compensated employee.
- Have not sponsored another employer-sponsored retirement plan in the preceding three years.
This credit is valued at 50% of the startup costs for the plan, up to a maximum of $5,000.
Final Thoughts
In conclusion, the significance of effective tax strategies for small business owners cannot be overstated. These strategies encompass a range of tactics, from considering a tax status change to taking advantage of deductions and credits, deferring or accelerating income, and setting up retirement plans. Each of these measures can significantly impact a business’s overall financial health, leading to reduced tax liabilities and increased retained earnings. Remote Books Online, as a premier tax services provider, recognizes the critical role we play in assisting businesses to navigate the complex landscape of tax planning. We understand that implementing these strategies can be daunting, and that’s why we are here to offer expert guidance and support.
Our team of experienced tax professionals is well-versed in the intricacies of tax laws and regulations, and we are committed to helping small businesses streamline taxes and optimize their financial position. With Remote Books Online by your side, you can be confident that your business will benefit from tailored tax solutions, maximizing your financial well-being. We are dedicated to empowering small business owners with the knowledge and resources they need to thrive. Make informed decisions, minimize your tax burdens, and secure a prosperous future with Remote Books Online as your trusted bookkeeping and tax services partner. Your financial success is our top priority.