How Business Owners Can Reduce Their Taxes in 2022

 
How Business Owners Can Reduce Their Taxes in 2022

For business owners taxes are a financial and administrative burden that directly impact their ability to invest in their business, their employees, and compete. 77% of small business owners (defined as having fewer than 100 employees) reported that federal business income taxes were very or moderately burdensome according the NFIB’s 2021 Tax Survey.1 Why are taxes so burdensome for business owners? Taxes reduce cashflow and profits. Cashflow is needed to increase wages and hire more people, make capital investments, and to obtain financing for expansion. Business owners rely on profits to support a business during declines. Profits allow a business to continue paying employees and operating costs when revenues decline, or inflation creates higher costs. I’ve often heard business owners say they won’t hire additional people, raise wages, or expand their business because 40-60% of their business income could be lost to taxes.

Some may believe that business taxes are similar to individual taxes and determined by the amount of net income or profit that a company earns. However, business taxes are complex because they are affected by the company’s structure, type of business, and state tax laws. Businesses also pay multiple types of taxes: income, self-employment, payroll, and sales taxes.2 Business owners who want to reduce their taxes need to consider factors such as their company’s registration, state tax laws, and their personal tax return. A tax planning expert or CPA can help owners understand their options and avoid costly mistakes.

Many business owners would like to receive proactive tax planning advice from their advisors and are dismayed by surprise tax bills. They may feel that tax planning is only for the ultra-rich and there isn’t anything they can do to legally reduce their taxes. They may end up paying more taxes than they need to. Thankfully this isn’t doesn’t have to be the case. Through consistent, proactive planning with their advisors business owners can understand and evaluate their options to reduce their taxes.

We recommend that business owners meet with their CPA and financial advisor at the end of each calendar year to review the following inputs: business income and projected taxes, personal income and projected taxes, deductions, capital gains and losses, taxes paid year-to-date, and any operating gains and losses. At Summit Hill Wealth Management we use this information to create a projected tax return for clients and partner with their CPA to explore how different deductions or changes might be able to save them money. We also confirm whether clients have contributed sufficient taxes or need to increase withholdings or make larger estimated tax payments to avoid surprise tax bills. This approach helps clients explore options to reduce taxes based on their unique situation, creates coordination between their CPA and their financial advisor, and helps to eliminate surprise tax bills.

While every business is different here are some common deductions and tax strategies we explore with clients and their CPAs to reduce their taxes. We encourage business owners to explore these strategies with their own tax advisors.

  1. Claim 100% bonus depreciation for asset additions: The Tax Cut & Jobs Act (“TCJA”) allows a 100% first-year bonus depreciation for qualified new and used property that is acquired and placed in service in calendar year 2020 and before January 1, 2023.3 Your business may be able to write off the entire cost of some or all of your asset additions on this year’s return. Contact your tax advisor to discuss what property is eligible but examples include some building improvements, computers, software, machinery, equipment, and office furniture.

  1. Establish or expand a retirement plan: If your business doesn’t yet offer a retirement plan you might consider establishing one. Current rules allow for significant contributions to retirement plans that reduce current year taxable income. These contributions help you and your employees save for retirement. Any money you contribute as an employee reduces your taxable income. Any contributions the business makes are qualified expenses and reduce taxable business income. For example, if you are self-employed, you can establish a SEP-IRA and contribute up to 20% of your earnings, up to $61,000 in 2020. If you are employed by your own corporation up to 25% of your salary can be contributed to your own account, up to $61,000 using a solo 401(k). If you are 50 or older you can increase the annual savings amount by $6,500.4

    If you own a business with employees, you can set up a company 401(k) plan and make contributions as an employee and as an employer. You can also set up a profit-sharing feature to distribute additional funds to yourself and employees at your discretion.

    A business can also consider adding a defined benefit cash balance plan. This is a type of qualified retirement plan that allows business owners to save far more than an IRA or 401(k)s alone. The contribution amounts are based on the age of the owner(s) with older participants able to accumulate more. By combining a 401(k), profit-sharing, and cash balance plans business owners could save significant amounts each year. The 2022 limits are:5

2022 Cash Balance Plan Maximum Contribution

The plan specifies an annual contribution amount based on a formula. Business owners who are older than 40, would like to contribute more than the annual maximum of $57,000, are willing to contribute to employee’s retirement, and have consistent revenue and profits may be candidates for a cash balance plan.

  1. Hire One of Your Children: Business owners can hire one of their children as legitimate employees and receive multiple tax benefits. The child’s salary can count as a business expense and lower your business or personal taxes. The income your child earns can be used to contribute to a Roth IRA and has the potential to grow for decades. The earnings your child receives are tax free up to $12,950 for single taxpayers in 2022.6 This strategy requires careful adherence to State and Federal Laws. The IRS is on the lookout for taxpayers who claim the benefit but don’t have their children do any work. Owners should research their state laws, ensure their children is a real employee, compensation is reasonable, and comply with legal requirements for employers.7

  1. Consider a Cost Segregation study for buildings: Cost Segregation studies allow businesses to carefully examine their properties and shorten their depreciation time for tax purposes. By shortening the depreciation time for qualified assets business owners incur a higher annual depreciation expense and lower their tax bill. Cost Segregation studies are an engineering-based approach to allocate building costs among the various building components to maximize depreciation expense by classifying qualified assets into shorter lives. IRS rules generally allow businesses to depreciate commercial buildings over 39 years. Often a business will depreciate the structural components (walls, windows, HVAC, plumbing, wiring, etc.) with the same depreciation life. A cost segregation study identifies and reclassifies a building’s non-structural elements, land improvements, and indirect construction costs to identify those items that can be depreciated over a shorter tax life from the building itself. For example, a building’s walls, flooring, ceiling, and plumbing can be depreciated over shorter time frames, such as 5, 7, and 15 years, than the standard depreciation of 39 years for non-residential real property. These benefits are now even greater with the Tax Cut & Jobs Act.8

    Cost Segregation studies involve working with your tax advisor and a qualified engineering firm. The engineering firm performs a non-invasive inventory and review of your building and property and classifies each item according to its proper depreciation time. The studies often cost between $8,000 and $15,000 and can yield significant tax savings.9 Contact your tax advisor to discuss whether a cost segregation study could benefit your business.

  1. Cash in on more generous Section 179 deduction rules for qualified equipment and property: For qualifying property placed in service in tax years beginning in 2018, the TCJA almost doubled the maximum Section 179 deduction to $1,080,000 (up from $1,050,000 for 2021).10 More favorable treatment for property used for lodging and qualifying real property were added. Be sure to consult with your tax advisor on the various limitations of Section 179 deductions given your corporate structure.
  1. Maximize the deduction for pass-through business income: The deduction based on qualified business income (QBI) from pass-through entities was a key element of the TCJA tax reform. For tax years 2018-2025, the deduction can be up to 20% of a pass-through entity owners qualified business income, subject to restrictions that apply at higher income levels and restrictions on the owner’s taxable income. For QBI pass-through entities are defined as sole proprietorships, single-member LLCs, partnerships, LLCs that are treated as partnerships for tax purposes, and S corporations. The QBI deduction can also be claimed for up to 20% of income from qualified REIT (real estate investment trust) dividends and 20% of qualified income from publicly traded partnerships.11 Because of the various imitations on the QBI deduction and the potential costs of changing your corporate structure, consult with your tax advisor to evaluate this deduction for your business.

  1. Make multi-year charitable gifts in one year: The Tax Cut & Jobs Act significantly increased the personal standard deduction ($12,550 for an individual or $25,100 for a married couple in 2022).12 The standard deduction provides a simple way for taxpayers to reduce their taxes. However, one effect of increasing the standard deduction was to remove the benefit of many personal itemized deductions. One example of this is charitable deductions. They are only deductible as itemized deductions. In order to itemize, taxpayers need combined itemized expenses for the tax year to be greater than their standard deduction amount (see above).13

    Generally, itemized deductions in 2022 include medical/dental expenses (which include only those expenses paid which are greater than 7.5% of adjusted gross income); state and local income and property taxes (but not more than $10,000 each year); home mortgage interest (limited to interest on acquisition indebtedness of $750,000; $1,000,000 for debt acquired before 2018); and charitable gifts (60% annual AGI for cash; 50%, 30% or 20% limits on other property items, depending on what type of charitable organizations the assets are given to and whether the asset is ordinary income property or capital gain property); and casualty losses (with limitations) Unfortunately, the TCJA eliminated the deduction for miscellaneous itemized deductions for tax years 2018 through 2026.14

    Taxpayers can itemize their charitable gifts (and other personal deductions) by strategically giving more to charities in certain years. By making multi-year charitable gifts taxpayers can aim to go beyond their standard deduction and receive the benefit of their charitable gift that year.15 For example, if a married business owner generally makes charitable gifts of $10,000 per year, they could make a $30,000 charitable gift in one year and itemize it on their taxes because it is over their standard deduction (assuming no other itemized deductions). They would then not make charitable gifts in the next two years and take the standard deduction.

    One way to make multi-year gifts is to use a Donor-Advised Fund. These funds are sponsored by 501(c)3 approved charities and receive charitable gifts in a given tax year and allow donors to distribute the funds in future years at the donor’s request.16 So, in our illustration above, if a business owner made a contribution of $30,000 to a donor-advised fund she would receive a current year tax deduction for the $30,000 contribution. She could then distribute the funds in portions of $10,000 per year over the next three years to continue supporting her preferred charities in a consistent manner. Business owners can speak with their tax advisor about their itemized deductions for this year and if it makes sense to make a multi-year charitable gift directly to a charity or using a tool such as a Donor-Advised Fund.

  1. Offer fringe benefit plans for employees: Additional wages trigger employment tax costs for businesses, but if the business pays for some fringe benefits for employees these taxes can be mitigated, which is another way to reduce your taxable income. In addition, offering greater benefits can help you attract and retain employees in a tight job market.

Tax-exempt benefits you can consider offering to employees include:

  • Health benefits
  • Long-term care insurance
  • Group term life insurance
  • Disability insurance
  • Educational assistance
  • Dependent care assistance
  • Transportation benefits

  • Meals provided for employee convenience

    A key benefit that business owners can consider offering is a Health Savings Account (HSA) through a Section 125 plan (also known as a cafeteria plan). This allows employees (including owners) to contribute to a special type of account for qualified medical costs. The contributions reduce taxable income, can grow tax free, and distributions are tax free when used for qualified expenses. Many business owners use their HSA to save money for medical expenses in retirement.17

    The IRS has a helpful publication on the tax benefits of fringe benefit plans “Employers Tax Guide to Fringe Benefits” (IRS Publication 15-B, 2020)18

  1. Consider the Research & Development tax credit: The Federal R&D tax credit, also known as the Research and Experimentation (R&E) tax credit, was first introduced in 1981. Its purpose is to reward U.S. companies for increasing their involvement in R&D in the current tax year. President Obama signed the PATH act of 2015 that expanded many of the aspects of this credit. It is available to any business that attempts to develop new, improved, or technologically advanced products or trade processes. The credit may also be available to taxpayers that have improved upon the performance, functionality, reliability, or quality of existing products or trade processes. The IRS outlines specific types of Qualified Research Expenses (QRE) that can include wages to employees, supplies, contract research expenses, and basic research expenses paid to qualified educational institutions. Taxpayers must show that the activities are intended to resolve technological uncertainty; rely on hard science (such as engineering, computer science, biological science, or physical science), relate to the development of a new or improved business component, and constitute a process of experimentation involving testing and evaluation of alternatives.19
  1. Investigate State incentives and credits: Many states offer businesses incentives and credits to encourage economic growth and encourage specific business growth and activity. While these programs can be challenging to find and understand they can provide access to low-cost financing, tax credits, and grants. For example, Colorado offers Enterprise Tax zone credits, access to low-cost financing, and sales tax refunds. Businesses in Colorado can access a comprehensive list of State programs here:

These strategies can help owners engage in proactive tax planning and help grow their businesses. As with all tax planning strategies, it is important to consult with your tax professional and advisory team to evaluate them carefully. If you’re interested in how we help clients coordinate their personal and business tax planning, please contact us at info@summithillwealth.com for a complimentary consultation.

Advisory services are offered through Summit Hill Wealth Management, LLC, a Registered Investment Advisor in the State of Colorado. Summit Hill Wealth Management, LLC partners with client’s tax advisors to evaluate and explore tax strategies. All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. All information and ideas should be discussed in detail with your individual adviser prior to implementation.

 
Summit Hill Wealth Management