As year-end approaches, small business owners should review their tax situations to determine ways to lower federal income taxes for the current tax year and beyond. Fortunately, no significant unfavorable federal tax law changes that would affect 2023 or 2024 are expected. Here are five ideas to help reduce business taxes for your 2023 tax year.
- Manage the Timing of Business Income and Deductions
If you conduct your business as a pass-through entity, meaning a sole proprietorship, S corporation, partnership, or limited liability company (LLC) taxed as a sole proprietorship or partnership, your share(s) of the tax items from the business are passed through to you and reported on your return. As year-end draws near, evaluate whether you'll be in the same or a lower federal income tax bracket in 2024. If you think that will be the case, the traditional year-end strategy of deferring taxable income into next year while accelerating deductible expenditures into this year makes sense. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2023 until 2024. On the other hand, if you expect to be in a higher tax bracket in 2024, take the opposite approach; accelerate income into this year and postpone deductible expenditures until 2024. That way, more income will be taxed at this year's lower rate instead of next year's higher rate.
- Make Last-Minute Asset Additions
Under current tax law, qualified new and used property acquired and placed in service in calendar year 2023 is eligible for 80% first-year bonus depreciation (down from 100% in 2022). The first-year bonus depreciation percentages for most eligible assets are scheduled to be further reduced as follows:
- 60% for assets placed in service in calendar year 2024,
- 40% for 2025, and
- 20% for 2026.
For certain properties with longer production periods, these reductions are delayed by one year. In 2023, there's a maximum Section 179 deduction of $1.16 million, and a phaseout rule applies if you put more than $2.89 million worth of assets into service. It's important to note that this deduction cannot result in a negative taxable income for your business. If it does, you might consider claiming 80% first-year bonus depreciation for any remaining asset costs. However, if you anticipate significant tax rate increases in the future, you may find it advantageous to forego first-year bonus depreciation and Section 179 write-offs. Instead, you can spread the depreciation of newly acquired assets over multiple years, potentially making those future deductions more valuable than an immediate deduction. The good news is that you have flexibility in making this decision. You can wait until the deadline for filing your current-year federal income tax return, including extensions. For businesses using the calendar year for tax purposes, the extended filing deadline is October 15, 2024, for 2023 returns if you're a sole proprietorship or C corporation. For partnerships, LLCs taxed as partnerships, and S corporations, the extended deadline is September 16, 2024. Extending your return gives you time to adapt to potential changes in tax laws.
- Write Off Heavy SUV, Pickup, or Van Purchases
The current federal income tax rules for depreciating new and used heavy vehicles used over 50% for business are highly favorable. That's because heavy SUVs, pickups, and vans are treated for federal income tax purposes as transportation equipment. That means the business-use percentage of the cost qualifies for 80% bonus depreciation if placed in service in the calendar year 2023 and/or you take a first-year Sec. 179 deduction on the current year's federal income tax return. These generous tax breaks are available when the SUV, pickup, or van has a manufacturer's gross vehicle weight rating (GVWR) above 6,000 pounds. You can verify this by looking at the manufacturer's label that's usually found on the inside edge of the driver's side door where the door hinges meet the frame. If you're considering buying an eligible vehicle, placing it in service before year-end could deliver a sizable write-off on this year's return. However, see the preceding caveat about possible tax rate increases in future years. You have until the deadline for filing your current-year federal income tax return, including any extension, to decide how to depreciate a newly acquired heavy vehicle used in your business.
- Maximize Your QBI Deduction
The deduction based on an individual's qualified business income (QBI) from pass-through entities was a key element of the Tax Cuts and Jobs Act (TCJA). The deduction can be up to 20% of a pass-through entity owner's QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner's taxable income. For QBI deduction purposes, pass-through entities include:
- Sole proprietorships,
- Single-member LLCs that are treated as sole proprietorships for tax purposes,
- Partnerships,
- LLCs that are treated as partnerships for tax purposes and
- S corporations.
You can also claim the QBI deduction for up to 20% of qualified REIT dividends and up to 20% of qualified income from publicly traded partnerships. Because of the income limitations on the QBI deduction, year-end tax planning moves can increase or decrease your allowable QBI deduction. For instance, year-end moves that reduce this year's taxable income — such as claiming first-year depreciation deductions or making deductible retirement plan contributions — can reduce this year's allowable QBI deduction. Work with your tax advisor to optimize your overall tax results.
- Establish a Tax-Favored Retirement Plan
If your business doesn't already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant annual deductible contributions. For example, if you're self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $66,000 for the 2023 tax year. If you're employed by your corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $66,000. If you're in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2023 by a whopping $21,120 (32% times $66,000). Other small business retirement plan options include:
- 401(k) plans, which can even be set up for just one person (called solo 401(k)s),
- Defined benefit pension plans, and
- SIMPLE-IRAs.
Depending on your circumstances, these other plans may allow more considerable deductible contributions. Thanks to a change made by the SECURE Act of 2019, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer's federal income tax return for the adoption year. The plan can then receive deductible employer contributions made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year. These strategies can be highly effective in reducing your tax liability, but it's crucial to act promptly. Consult an R+R tax advisor who can tailor these approaches to your situation, considering your income, business structure, and long-term financial goals. Year-end tax planning is time-sensitive, and there may be additional tax-saving opportunities specific to your business.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve. Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.
