Year-End Tax Planning Strategies for Your Business
With year-end rapidly approaching, now is the perfect time to assess your business’s taxable income and 2023 tax obligations to see what steps you can take to reduce your overall tax bill. The sooner you begin this process, the more time you’ll have to ensure your plans are in place by December 31. Here are four key areas to consider as part of the overall planning process.
After a profitable year, one of the first places business owners look to “spend down” taxable earnings are discretionary payouts. This can be in the form of employee bonuses, owner bonuses or retirement plan contributions. For accrual basis taxpayers, employee bonuses can be accrued as of December 31 so long as they are paid out by March 15 of the following year. However, bonuses to those who own more than 2% of the company must be paid out in cash prior to year-end.
Pass-through entities, such as S corporations and partnerships, should carefully consider the method of paying discretionary earnings to owners. Bonuses paid through payroll (for S corporation shareholders) or as guaranteed payments (for partners) aren’t eligible for the 20% Qualified Business Income Deduction (QBID) under Internal Revenue Code (IRC) §199A. Instead, distributions from equity (for S corporations) or draws (for partnerships) should be maximized to the extent possible.
Discretionary retirement plan contributions are an excellent way for both accrual basis and cash basis taxpayers to reduce taxes while rewarding employees and owners. Since funding of these contributions can be delayed until the due date of the business’s tax returns, including extensions, this planning opportunity has the added benefit of preserving cash flow through year-end.
Year’s end is also a great time to review your business’s fixed asset needs, whether it be improvements to facilities, investment in equipment or software, or the replacement of vehicles. With the inflation-adjusted limit for IRC §179 at $1,160,000 for 2023, small to mid-size businesses can completely deduct most fixed asset additions in the first year. Keep in mind that assets eligible for §179 expensing must be used in an active trade or business, and that the deduction is reduced dollar-for-dollar by the amount of qualified property placed in service exceeding $2,890,000 (for 2023). Furthermore, the current year deduction is limited to the taxpayer’s taxable income.
In addition to §179, another accelerated depreciation opportunity exists in the form of bonus depreciation under IRC §168(k). Unlike §179 expensing, bonus depreciation is not subject to an annual maximum, doesn’t phase out for additions over a threshold amount, and isn’t limited to taxable income. The deduction, however, has been reduced from 100% in 2022 to 80% in 2023, and it will continue to decrease until it reaches zero by 2027. Careful planning should also be undertaken to consider the state tax consequences of utilizing bonus depreciation, since most states, including New York, decouple from this provision of the Internal Revenue Code.
Another planning strategy to reduce taxable income involves prepaying expenses (not debt) that your business will incur at the beginning of the next tax year to obtain a tax deduction. For cash basis taxpayers, allowable deductions are generally considered in the taxable year in which they are paid, subject to the “12-month rule.” Under Treasury Regulation §1.263(a), a taxpayer is not required to capitalize (i.e., is permitted to deduct) amounts so long as the benefit obtained doesn’t extend beyond the earlier of 12 months or the end of the taxable year after the year in which it’s paid. Cash basis taxpayers should also be sure to pay any existing accounts payable balances prior to year-end.
For accrual basis taxpayers to deduct a prepayment, there are three requirements that must be met. First, the liability being prepaid must be fixed and owing. Second, the amount of the liability must be determinable with reasonable accuracy. Finally, economic performance must have occurred. For services to be provided to the taxpayer, economic performance is deemed to have occurred if those services are provided within three and a half months of payment. For some expenses, particularly insurances, warranty or service contracts, and state and property taxes, the payment constitutes economic performance so long as the liability is fixed and owing, and the amount can be reasonably determined.
Leverage Tax Credits
It’s important that your business takes advantage of all applicable tax credits available. While the list of possible credits is long and depends greatly on your particular line of business, a few important ones to consider are the Credit for Increasing Research Activities, the Empowerment Zone Employment Credit and the Work Opportunity Credit.
Many opportunities exist to reduce the tax obligations facing your business, but it’s critical to start the planning process early and determine which strategies match the needs and cash flow considerations of your situation. Equally important is the need to work closely with your tax advisor to ensure that exceptions, limitations and opportunities are carefully considered.
For more information on tax planning for your business, contact us today.
Contributing author: Deborah E. Finch, CPA/ABV, CVA, CDA is a tax partner at Dannible & McKee, LLP. Deb has extensive experience providing tax and consulting services to a wide range of clients, including individuals and privately held companies. If you have questions or need assistance with strategic tax planning or tax compliance, contact Deb at firstname.lastname@example.org or (315) 472-9127.