Want to start a conversation with a small business owner? Then ask them about taxes. It’s an issue that almost always lurks in the back of the mind of an owner, sole proprietor or contractor.
Despite the concern that nearly every small business owner or sole proprietor has with taxes, however, rarely does the issue arise when asked generally about problems small businesses face. For instance, the National Federation of Independent Business (NFIB) asked companies that saw a decline in profits what was the reason in its monthly optimism index for September. The highest cause was the rise of cost for materials at 42%, while 21% blamed weaker sales. Only 3% stated higher taxes or regulatory costs as the reason.
A similar result came from the most recent small business index released by the US Chamber of Commerce and MetLife
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Yet, in another survey by the NFIB in 2021, looking into the biggest tax concerns for small businesses, 90% of respondents said the federal income tax was a financial burden.
This dichotomy about the impact of taxes on results may exist because many small business owners and solo practitioners only actively think about taxes once they’re due. But taking steps now, as the year ends, can ease the tax burden come April.
There are plenty of last-minute to-dos before closing shop for the holidays. Whether it’s fulfilling the final orders for the year, rushing to submit your work for invoicing or planning for 2023, it’s a busy time for small business owners of all ilk.
But one item you should also add to your to-do list: make your last-minute tax maneuvers to reduce your bill come April. This will help reduce your concern over taxes throughout the year.
Bunch Expenses
For those that had a strong 2022 and know they plan on big spending in early 2023, then consider making the purchases now.
To add items to your business expenses, you do not need to have used the item in the current year. You only must have made the purchase (for most taxpayers). This allows freelancers or contractors to purchase items that they can then include in the list of their business expenses. Most of these expenses can then be deducted while calculating adjusted gross income (AGI).
Say, for instance, you plan to take a skill-building program in January. By purchasing it today, there’s a chance you can include it as a business expense in 2022 if it’s to advance your business, even if you wait until January 2023 to take the class.
If you expect your income to drop next year, by bunching expenses into 2022, then you can gain a greater advantage from deducting the expense from revenues earned this year.
Prepare estimated taxes
In mid-January, you’ll have to pay estimated taxes for the fourth quarter. This offers a good time to assess your year to determine what you should pay in estimated taxes, reducing any surprises come Tax Day.
You want to pay the least amount required, based on your yearly results, while avoiding penalties. For those that have seen profits rise, then they will need to ensure that they pay enough to guarantee that while your accountant may figure out ways to save later, you’re not adding penalties to the total bill today. To do so, it requires that you at least pay 100% of the tax liability that you had the previous year. If your 2021 adjusted gross income – or the income minus your business expenses and other reductions – is above $150,000, then you need to at least pay 110% of the tax liability from 2021, to avoid penalty.
If you’ve paid estimated taxes throughout the year, you can then determine what additional amount you will need to pay to avoid penalties.
If, instead, profits fell, then you may only need to pre-pay 90% of the current year’s total tax liability in estimated taxes. You can choose to pre-pay the lowest amount, among these three estimated payment options. But to pay 90% of current estimated taxes requires understanding what your total liability will be in 2022. If your estimated taxes were based on higher profit levels from 2021, then it’s possible that you’ve paid enough in estimated taxes already.
If you’re in this position, then connecting with your accountant to determine your total expected tax bill may be worthwhile.
Decide if You Want S-Corp Status
One underutilized method to reduce taxes among small business owners is the use of the S-Corp designation. While many companies and single entities will sign up for a limited liability company (LLC) as its business design, it will then choose to be taxed as a sole proprietor. This results in all the income that you make in the year counting as self-employment income, resulting in a 15.3% tax for Social Security and Medicare (as a small business owner, you can deduct half of the amount).
But by designating the S-Corp status, you can actually give yourself a salary. The salary, as long as it’s reasonable for the position you hold in the company and the sector you work in, does not need to include all of your revenues.
Say as a solo practitioner computer engineer contractor, you make $200,000 in 2022. If you elect to be taxed as a sole practitioner, then you will have to pay the self-employment tax on the $200,000 ($147,000 of which is taxed at the 15.3% level and $53,000 taxed at 2.9%). But if you choose the S-Corp design, then you can give yourself a salary of, say, $125,000 if that’s reasonable for the profession and distribute $75,000 in profits to yourself as owner of the business. This means you are only taxed for self-employment taxes on the $125,000, while the $75,000 additional is taxed as ordinary income but does not include Social Security and Medicare taxes.
While the deadline for this maneuver is March 15, 2023, it’s important to begin making this calculus now if you expect pay to surpass what you would reasonably earn in a similar position if you worked in-house somewhere.
Give to Charity
When it comes to investing in an IRA or retirement account, while it goes towards 2022 taxes, you typically have until April 2023 to add funds to reach the annual limit. But when it comes to charitable giving, to add it to your itemized deductions, it must be done prior to December 31.
Beyond the goal of simply giving for a good cause, charitable giving can be powerful to ensure you increase the amount you’re deducting to go beyond the standard deduction. With it more difficult to itemize deductions – most business expenses are taken out earlier in the tax calculation, prior to itemized deductions – charitable gifts can be used to increase the amount.
This move is particularly valuable if you’re a big giver or you’re near the cutoff for the standard deduction of $25,900 if filing jointly or $12,950 if a single filer.
The receipt of the gift must be stamped before the clock strikes midnight on 2022. It’s one of those last-minute details that can be forgotten in the run-up to the holidays but can reduce a business owner’s stress throughout 2023.