It’s been a tumultuous year for many businesses, and the current economic climate promises more
uncertainty for the short term, if not longer. Regardless of how your company has fared so far in 2022,
there’s still time to make moves that may reduce your federal tax liability.
The standard year-end approach of deferring income and accelerating deductions to minimize taxes will likely produce the best results for most businesses, as will bunching deductible expenses into this year or next to maximize their tax value.
If you expect to be in a higher tax bracket next year, opposite strategies may produce better results. For example, you could pull income into 2022 to be taxed at lower rates, and defer deductible expenses until 2023, when they can be claimed to offset higher-taxed income.
Read on for some additional strategies worth your consideration.
Maximize your QBI deduction
Pass-through entities (that is, sole proprietors, partnerships, limited liability companies and
S corporations) may be entitled to a deduction of up to 20% of their qualified business income (QBI). For 2022, if taxable income exceeds $340,100 for married couples filing jointly (half that amount for others), the deduction may be limited based on: whether the taxpayer is engaged in a service-type business (such as law, health or consulting), the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business. The limitations are phased in.
The deduction, created by the Tax Cuts and Jobs Act (TCJA), is set to expire after 2025, absent congressional action, so make the most of it while you can.
Taxpayers may be able to salvage some or all of the QBI deduction by deferring income or accelerating deductions to keep income under the dollar thresholds (or be subject to a smaller deduction phaseout). You also may be able to increase the deduction by increasing W-2 wages before year-end. (Of course, these moves usually have other consequences, such as higher payroll taxes, that you should weigh before proceeding.) The rules are complex, so consult us before acting.
Cash vs. accrual accounting
More small businesses are able to use the cash (rather than the accrual) method of accounting for federal tax purposes than were allowed to do so in previous years. To qualify as a small business under current law, a taxpayer must (among other requirements) satisfy a gross receipts test. For 2022, it’s satisfied if, during a three-year testing period, average annual gross receipts don’t exceed $27 million. Not that long ago, it was only $5 million. Cash method taxpayers may find it easier to defer income by holding off billings until next year, paying bills early or making certain prepayments.
Section 179 deduction
Consider making expenditures that qualify for the Section 179 expensing option. For 2022, the expensing limit is $1.08 million, and the investment ceiling limit is $2.7 million. Expensing is generally available for most depreciable property (other than buildings) including equipment, off-the-shelf computer software, interior improvements to a building, HVAC and security systems.
The high dollar ceilings mean that many small- and medium-sized businesses will be able to currently deduct most or all of their outlays for machinery and equipment. What’s more, the deduction isn’t prorated for the time an asset is in service during the year. Just place eligible property in service by the last days of 2022 and you can claim a full deduction for the year.
The maximum deduction also is limited to the amount of your income from the business, although unused amounts can be carried forward indefinitely.
Businesses also can generally claim a 100% bonus first year depreciation deduction for qualified improvement property and machinery and equipment bought new or used, if purchased and placed in service this year. Again, the full write-off is available even if qualifying assets are in service for only a few days in 2022. Beginning next year, the allowable deduction will drop by 20% each year until it evaporates altogether in 2027 (again, absent congressional action).
For all their immediate appeal, bonus depreciation and Sec. 179 expensing aren’t always advisable. You may, for example, want to skip accelerated depreciation if you claim the QBI deduction. The deduction is limited by your taxable income, and depreciation reduces such income.
It might be wise to have some depreciation available to offset your income in 2023 through 2025 so you can claim the QBI deduction while it’s still around. You might think twice, too, if you have expiring net operating losses, charitable contributions or credit carryforwards that are affected by taxable income.
The good news is that you don’t have to decide now. As long as you place qualified property in service by December 31, 2022, you have the option of choosing the most advantageous approach when you file your tax return in 2023.
Get real about your bad debts
Business owners are sometimes slow to accept that they’re going to go unpaid for services rendered or goods delivered. If you use accrual-basis accounting, though, facing the facts can land you a bad debt deduction.
The IRS allows businesses to deduct “worthless” debts, in full or in part, that they’ve previously included in their income. To show that a debt is worthless, you need to show that you’ve taken reasonable steps to collect but without success. You aren’t required to go to court if you can show that a judgment from a court would be uncollectible.
You still have time to take reasonable steps to collect outstanding debts. It’s important to keep detailed records of these efforts. If you determine you can’t collect, you may be able to deduct some or all of those debts for 2022.
Start or replace your retirement plan
If you’ve put off establishing a retirement plan, or simply outgrown the plan you started years ago, you have time to possibly trim your taxes this year — and likely improve your employee recruitment and retention at the same time — by starting a new plan. Eligible employers can claim a tax credit of up to $5,000, for the first three years, for the costs of starting a SEP IRA, SIMPLE IRA or a qualified plan such as a 401(k) plan.
The credit is 50% of your costs to set up and administer the plan and educate your employees about it. You can claim up to the greater of $500 or the lesser of:
- $250 multiplied by the number of non-highly compensated employees who are eligible to participate in the plan, or
You can begin to claim the credit in the tax year before the year the plan becomes effective. And, if you add an auto-enrollment feature, you can claim a tax credit of $500 per year for a three-year period beginning in the first taxable year the feature is included.
Turn to us for planning advice
Many of the strategies detailed here involve tradeoffs that require thoughtful evaluation and analysis. We can help you make the right choices to minimize your company’s tax bill. Reach out to your DunlapSLK team member with any questions you may have.