Year-End Business Newsletter
December 5th, 2023/Tax
To Our Clients and Friends:
2023 YEAR END BUSINESS INCOME TAX PLANNING STRATEGIES
As another year ends with interest rates and markets in flux, one thing remains certain: Reducing your company’s tax bill can improve your cash flow and your bottom line. Below are a few timely strategies that you can execute before year end to minimize your company’s tax liability.
Take Advantage of the Pass-Through Entity (PTE) Tax Deduction (if available)
The Tax Cuts and Jobs Act (TCJA) imposed a $10,000 limit on the federal income tax deduction for state and local taxes (SALT). In response, more than 30 states (including California) have enacted some type of “workaround” to provide relief to PTE owners who pay individual income tax on their share of their business’ income.
While PTE tax deductions vary by state, they generally allow partnerships, limited liability companies and S corporations to pay a mandatory or elective entity-level state tax on business income with an offsetting owner-level benefit. The benefit typically is a full or partial tax credit, deduction or exclusion that owners can apply to their individual state income tax. The business can claim a federal business expense deduction for the full amount of its payment of the tax, as the SALT limit doesn’t apply to businesses.
Establish a Cash Balance Retirement Plan
Cash balance retirement plans are regaining popularity for businesses with high earners who regularly max out their 401(k) plans. The plans combine the higher contribution limits of defined contribution plans with the higher maximum benefits and deduction limits of defined benefit plans. A business can claim much larger deductions for cash balance contributions than 401(k) contributions.
In 2023, for example, the maximum employer/employee 401(k) contribution for a 55-year-old is $73,500 (including a catch-up contribution of $7,500). Meanwhile, a business can contribute up to $265,000 to a cash balance plan (depending on the participant’s age), in addition to the 401(k) plan contribution. Contribution limits increase with age, creating a valuable opportunity for those nearing retirement to add to their retirement savings as well as a substantial deduction for the business.
Under the original SECURE Act, businesses have until their federal filing deadline (including extensions) to launch a cash balance plan. But it can take some time to prepare the necessary documents, calculate the contributions and handle other administrative tasks, so you’d be wise to get the ball rolling sooner rather than later.
Time Income and Expenses
If your business uses the cash method of income tax reporting and you would like to lower income for 2023, consider accelerating year-end deductions into December and deferring income until January. For example, you can accelerate deductions by paying any bills or employee bonuses related to 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.
Alternatively, if you expect to see significantly higher profits next year, flip the approach and accelerate income and push deductions into the future when they’ll be more valuable. Also, bear in mind that reducing your income could reduce your qualified business income (QBI) deduction (noted below), if you have a pass-through entity.
Maximize the Qualified Business Income (QBI) Deduction
The deduction based on QBI from pass-through entities was a key element of 2017 tax reform. For tax years through 2025, the deduction can be up to 20% of a pass-through entity owner’s QBI, subject to certain limitations based on W-2 wages paid, the unadjusted basis of qualified property and taxable income. Accelerated depreciation reduces your QBI (in addition to certain other tax breaks that depend on taxable income) and thus your deduction.
Take Action on Asset Purchases
First-year bonus depreciation is still available for qualified new and used property that is acquired and placed in service in 2023, but the benefit is shrinking by 20% each year and will be completely gone in 2027 if no related congressional action is taken. Currently it is 80% for 2023.
First-year bonus depreciation is available for computer systems, software, vehicles, machinery, equipment, office furniture and qualified improvement property (generally, certain improvements to nonresidential property, including roofs, HVAC, fire protection and alarm systems, and security systems).
Usually, though, it’s advisable to first apply the IRC Section 179 expensing election to asset purchases. Sec. 179 allows you to deduct 100% of the purchase price of new and used eligible assets. Eligible assets include machinery, office and computer equipment, software, certain business vehicles, and qualified improvement property.
The maximum Sec. 179 “deduction” for 2023 is $1.16 million. It begins phasing out on a dollar-for-dollar basis when a business’s qualifying property purchases exceed $2.89 million. The maximum deduction is limited to the amount of your income from business activity, but you can carry forward unused amounts indefinitely or claim the excess amounts as bonus depreciation, which is subject to no limits or phaseouts. (Note: If financing asset purchases, consider the impact of high interest rates in addition to the potential tax savings.)
Claim 100% Gain Exclusion for Qualified Small Business Stock
There is a 100% federal income tax gain exclusion for eligible sales of Qualified Small Business Corporation (QSBC) stock that was acquired after September 27, 2010. QSBC shares must be held for more than five years to be eligible for the gain exclusion. Please consult with your tax and legal counsel if you are considering establishing a new corporate business. Since the stock might be eligible for the gain exclusion, advance planning may be required to lock in the exclusion privilege.
Employing Family Members
Employing family members can be a useful strategy to reduce overall tax liability. If the family member is a bona fide employee, the taxpayer can deduct the wages and benefits, including medical benefits, paid to the employee on Schedule C or F as a business expense, thus reducing the proprietor’s self-employment tax liability. In addition, wages paid to your child under the age of 18 are not subject to federal employment taxes, will be deductible at your marginal tax rate, are taxable at the child’s marginal tax rate, and can be offset by up to $13,850 (your child’s maximum standard deduction for 2023). However, your family member must be a bona fide employee, and basic business practices, such as keeping time reports, filing payroll returns, and basing pay on the actual work performed, should be followed.
Seemingly small tax decisions may have costly unintended consequences under different tax provisions. We can help your business make the right year-end tax planning moves.
Happy Holidays to You and Yours!