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Tax Planning for Small Businesses: 5 Strategies for 2022
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For most small businesses, every penny counts. Not only do you want to optimize revenue, but you also need to minimize your tax liability.
Fortunately, there’s still time to do some year-end tax planning to lower your 2021 federal income tax bill before filing in 2022. You might also be able to take advantage of new tax incentives put into place by the Coronavirus Aid, Relief and Economic Security (CARES) Act, the American Rescue Plan Act and other legislation passed to help small businesses during the pandemic.
5 small business tax-planning strategies
Here are a few small business tax planning strategies you might implement.
1. Consider a tax status change
As a small business owner, you have several options for structuring your business. You can operate as a sole proprietor, partnership, limited liability company (LLC), S corporation or C corporation. Your business structure will impact how to file taxes for small business owners.
If you’ve outgrown your current business structure in the past year, you may be able to change to one that’s a better fit. For example, LLCs can elect to be taxed like a C corporation by filing Form 8832 with the IRS.
Making such an election used to be rare, as the top corporate tax rate was 35%, but the Tax Cuts and Jobs Act of 2017 (TCJA) dropped the top corporate income tax rate from 35% to 21%.
Corporations vs. pass-through businesses
Pass-through businesses, such as sole proprietorships, partnerships, LLCs and S corporations, don’t pay a corporate income tax. Instead, the company’s net income “passes through” to the owner’s individual tax return, where the highest tax bracket is 37%. For LLC members in the top tax bracket, a tax status change can result in significant tax savings.
However, it remains to be seen if that 21% corporate tax rate will last. A proposal introduced by the House Ways and Means Committee would increase the corporate tax rate to 26.5%.
Of course, tax savings aren’t the only factor that goes into selecting a structure for your small business. Before changing your tax status, consult with a tax professional who can help you crunch the numbers and run a cost-benefit analysis.
2. Take advantage of tax reform
The TCJA also created the qualified business income (QBI) deduction, which provides pass-through business owners a deduction worth up to 20% of their share of the business’s income — though it does come with many rules and limitations.
Owners of specified service trades or businesses (SSTBs) lose out on the deduction if their income is too high. SSTBs generally include any service-based business — other than engineering and architecture firms — where the business depends on its employees’ or owners’ reputation or skill.
Examples of these types of SSTBs include:
- Law firms
- Medical practices
- Consulting firms
- Professional athletes
- Performing artists
- Financial advisers
- Investment managers
If your business is an SSTB, your QBI deduction starts to phase out once your total taxable income exceeds a certain amount. For the 2021 tax year, those thresholds are $164,900 if single or $329,800 if married filing a joint return. You’ll need to use Part II of Form 8995-A to calculate your deduction; however, once your income is over $214,900 for single filers ($429,800 for married filing jointly), you can’t take the deduction.
If your business isn’t an SSTB, but your total taxable income is above those upper limits, you can claim the deduction, but it’s limited to:
- 50% of your share of W-2 wages paid by the business; or
- 25% of those wages, plus 2.5% of your share of qualified property
Confused? You’re not alone. The QBI deduction can provide a generous deduction for small business owner taxes but figuring out who can claim it and then calculating the deduction is no easy task. Talk to your accountant if you think you might qualify.
3. Leverage coronavirus tax relief
Congress has passed several pieces of legislation in the past two years to help small business owners through the COVID-19 crisis, including:
- Families First Coronavirus Response Act (FFCRA)
- Coronavirus Aid, Relief and Economic Security Act (CARES)
- Coronavirus Response and Relief Supplemental Appropriations Act (CRRSAA)
- American Rescue Plan Act of 2021 (ARPA)
Here’s a look at some provisions of these laws that impact small business owners.
Employee retention credit
Businesses that kept idle workers on payroll during the pandemic may qualify for a tax credit to help offset the cost of employee wages and health plan costs. The credit initially applied to wages paid from March 13, 2020, through Dec. 31, 2020, and was worth up to $5,000 per employee. For 2021, the credit was extended and expanded, making it worth up to $7,000 per employee per quarter.
To qualify, your business must prove:
- It fully or partially suspended operations due to governmental orders limiting commerce, travel or group meetings due to the pandemic during any part of the quarter; or
- It experienced a 20% decline in gross receipts compared to either the same quarter in 2019 or the immediately preceding quarter in 2020 or 2021.
Businesses can claim the credit by reducing payroll tax deposits. If those deposits aren’t enough to cover the full credit, the business can request an advance from the IRS by filing Form 7200.
Paid leave tax credits
Recent legislation made it more affordable for businesses to provide paid leave to employees.
Sick and family leave credits
Employers who pay employees while out on sick or family leave can receive a fully refundable tax credit equal to the following sick or family leave benefit payments.
- Employees who are sick or quarantined due to COVID-19 are entitled to up to two weeks (80 hours) of paid leave benefits. The paid leave is worth up to $511 per day or $5,110 in the aggregate.
- Employees who are caring for someone who is quarantined or caring for a child whose school or daycare is closed can receive up to two-thirds of their normal pay, capped at $200 per day for 12 weeks ($12,000 in total).
These credits apply for wages paid through Sept. 30, 2021.
Business owners can claim the credit against their share of Social Security and Medicare taxes when they file Form 941, Employer’s Quarterly Federal Tax Return, or request an advance of the credit by filing Form 7200.
Paid leave credit for vaccines
The American Rescue Plan Act expanded the sick and family leave credits to include providing paid time off to employees to get a COVID-19 vaccination, recover from the vaccine, accompany a family member or other member of their household getting a vaccine or care for a household member recovering from the immunization.
The credit is available to businesses and tax-exempt organizations with less than 500 employees and some government entities. A similar credit is available to self-employed taxpayers.
Charitable deductions for donated inventory
The CARES Act also temporarily modified the rules for businesses that deduct donations of unused inventory. Typically, businesses can deduct donations of food inventory up to 15% of the business’s taxable income. For 2020 and 2021, that limit was increased to 25% of the business’s taxable income.
The deduction applies to corporations and non-corporate taxpayers, including small businesses that use the cash basis of accounting and don’t keep inventories — this might be especially useful for restaurants hard-hit in the pandemic. The deduction is limited to the cost of the donated food inventory, plus half of the profit the business would have received if it had sold the donated food.
4. Defer — or accelerate — income
Many small businesses use the cash method of accounting on their books and tax returns. Under the cash method, a company recognizes income when it’s received and expenses when paid — in other words, when cash actually changes hands. That creates some interesting tax planning strategies.
If you expect to be in a lower tax bracket next year, you might want to defer income to next year, when you’ll pay taxes at a lower rate.
When to Defer Income
For example, say you did some work for a client in December 2021, but you haven’t yet billed the client for your services. If you wait until January 2022 to invoice your client for the work you did in December, you could defer income to the next year and lower your 2021 tax bill.
When to Accelerate Income
On the other hand, it might make more sense to accelerate income into this year — especially if you think tax rates will increase in the near future. In that case, you might want to send your invoice and try to collect payment from your client in 2021, so more income will be taxed at your current tax rate.
The same concept works with expenses. If you’re in a high tax bracket this year, you might want to accelerate expenses in 2021 to reduce your taxable income. Here’s a handy guide for when to accelerate or defer income and expenses.
|Defer income, accelerate expenses when:||Accelerate income, defer expenses when:|
5. Set up — or contribute to — a retirement account
Setting up or contributing to a retirement account can reduce your taxable income. Business owners have several options for retirement savings, both for themselves and their employees.
- If you set up a 401(k) plan before the end of the tax year, you can deduct any contributions made to the plan when you file your tax return. The plan’s terms dictate how much an employer can contribute. For 2021, total employee and employer contributions are limited to the lesser of an employee’s compensation or $58,000.
- If you miss the cutoff to set up a 401(k) plan in 2021, you might still be able to set up a simplified employee pension plan, also known as a SEP. You have until the due date of your return (including extensions) to set up a SEP. The employer’s contribution to a SEP is limited to 25% of the employee’s compensation, capped at $58,000 for 2021.
If you start up a 401(k) or SEP, not only can you deduct contributions to the plan, but you may qualify for the retirement plans startup costs tax credit, available to employers that:
- Had 100 or fewer employees who received at least $5,000 in compensation during the year
- Had at least one plan participant who was a non-highly compensated employee
- Have not had another employer-sponsored retirement plan in the past three years
The credit is worth 50% of the plan’s startup costs, up to a maximum of $5,000.
Important 2022 tax filing deadlines
Tax day typically falls on April 15 for most people, but if that date falls on a weekend or holiday, the IRS pushes the deadline to the following business day. But tax day isn’t the only important date for small business owners. Here are a few other important dates to mark on your tax filing calendar in 2022:
|Jan. 18, 2022||Fourth-quarter 2021 estimated tax payments due|
|March 15, 2022||Partnership and S corporation tax returns due for the 2021 tax year|
|April 15, 2022||Last date to make a 2021 IRA contribution|
|April 18, 2022|| |
|June 15, 2022||Second-quarter 2022 estimated tax payments due|
|Sept. 15, 2022|| |
|Oct. 17, 2022||Extended individual tax returns due|
|Jan. 17, 2023||Fourth-quarter 2022 estimated tax payments due|
Every business’s tax situation is unique, so it’s important to discuss these small business tax planning strategies with your tax professional before making any significant moves. Still, these strategies should help you to prepare for your year-end tax planning meeting and understand more about how your small business can minimize taxes.