(This column originally appeared in the Philadelphia Inquirer)
No one enjoys thinking about taxes. But for many small business owners, it’s the most significant expense incurred every year. With just a little forethought, there are plenty of things to do to minimize it.
The first and most important thing to do — and as early as possible — is to meet with your accountant, review the year together, and make estimates for the remaining months. Make sure you’ve paid in all of your estimated taxes to date — or make changes to these estimates because you don’t want to pay in too much or too little.
Also, take the time to make sure all of your documentation is ready for your accountant to review and to maximize your deductions.
“One of the things many of our clients overlook is keeping good travel logs so that they can take full advantage of the $0.585 per mile deduction that the IRS allows,” says Joanne Bryson, a principal at CPA Help Now in Norristown. “They’re missing out on significant tax savings, particularly during these times of high energy costs.”
Another strategy worth consideration is to buy capital assets such as furniture and fixtures, machinery and equipment, and even automobiles. Most businesses can deduct up to $1,080,000 in expenditures for these items, and the main requirement is that the asset be placed into service by the end of the year. That means that even if you finance the purchase (and manage to defer your loan payments), you can still get the full deduction for the purchase price.
“Despite the potential of an economic slowdown, 2022 was a pretty decent year for many of our clients,” says Robert Simpson, a partner at accounting firm Brinker Simpson & Company in Springfield. “We’re advising them to pay out bonuses to their employees before the end of the year, if they can.”
Paying out bonuses not only will reduce an employer’s taxes but could help to retain key people in these times of tight labor.
Ciro Adams, a certified public accountant based in Wilmington, recommends cleaning up your balance sheet, accelerating your expenses, and deferring income where possible.
“If you have long overdue accounts receivables from customers, then take a hard look and consider writing them off because you can’t get a tax deduction unless they’ve been removed from your balance sheet,” he says. “The same goes for inventory — walk around and dispose of any old materials lying around so you can write those amounts off your balance sheet, too.”
If you report income and expenses as you receive and disburse cash, then you’re a cash-basis taxpayer. For these taxpayers, Adams also recommends looking for expenses such as insurance and other purchases that you can accelerate into this year to take the deduction. “Conversely, if you’re able to defer cash collections until 2023, that move will help reduce your income in 2022,” he says.
If your company has a 401(k) plan, you and your employees can save up to $20,500 this year tax-free and, assuming your company is in compliance with IRS “discrimination” rules (which test to ensure highly compensated individuals aren’t contributing more than other employees), you and your employees can receive up to an additional $40,500 in tax-free matching contributions. People over the age of 50 can receive even more. The employer’s matching contribution can be made as late as April 18, 2023, for the 2022 calendar year.
If you have a regular Individual Retirement Account, or IRA, you may want to consider converting to a Roth IRA. “Because of the down markets, many of our clients are doing Roth IRA conversions this year,” says Simpson. “You pay taxes on the conversion, but the tax bill is less because assets have declined. Going forward after you put the money into a Roth IRA, the appreciation in those assets won’t be taxable.”
Many business owners I know have outside investments that have unfortunately fallen in value this year along with the stock market. If you’re one of them, you may want to consider selling some of these investments and offsetting these capital losses against any capital gains you may have so that you don’t have to pay taxes on the gains. If your capital losses exceed your capital gains, you can offset up to $3,000 of those excess losses against your ordinary income too. Under IRS rules, you have to wait 30 days if you want to buy any of these stocks back or otherwise you’ll incur penalties.
Finally, start thinking about 2023. If you’re co-mingling your personal and business transactions in one bank account, you should open up a new bank account and segregate those transactions for better reporting. If you’re just reporting your business income on your personal tax return using Schedule C forms, then it may be a good time to incorporate yourself and create a new tax filing entity like an S Corporation or a partnership. That way you can separate your business and your personal financial activities, give yourself more legal protections, and take distributions instead of salary to lower your taxes.
“If you’re an S-Corporation, you can pay yourself a reasonable salary and then take distributions so that you can potentially avoid the 15.3% self-employment tax,” Bryson says. “It could be a substantial saving for 2023.”