Lowering your tax burden can improve your cash flow and enhance profitability. Here are five strategies, including a mix of established methods and timely approaches, that you can implement to minimize your tax liability.
Utilize the Pass-Through Entity (PTE) Tax Deduction
The Tax Cuts and Jobs Act (TCJA) imposed a $10,000 limit on the federal income tax deduction for state and local taxes (SALT). Consequently, over 30 states have enacted various workaround measures to alleviate the tax burden for PTE owners who pay individual income tax on their share of their business’ earnings.
PTE tax deductions differ from state to state, generally allowing partnerships, limited liability companies, and S-Corporations to pay a mandatory or elective entity-level state tax on business income with an offsetting owner-level benefit. This benefit often takes the form of a full or partial tax credit, deduction, or exclusion that owners can apply to their individual state income tax. Moreover, the business can claim an IRC Section 164 business expense deduction for the entire tax payment, as the SALT limit does not apply.
Implement a Cash Balance Retirement Plan
Cash balance retirement plans are experiencing a resurgence among businesses with high-earning individuals who consistently max out their 401(k) plans. These plans combine the higher contribution limits seen in defined contribution plans and the increased maximum benefits and deduction limits associated with defined benefit plans. Compared to 401(k) contributions, businesses can claim substantially larger deductions for cash balance contributions.
For instance, in 2023, the maximum employer/employee 401(k) contribution for a 55-year-old is $73,500, including a catch-up contribution of $7,500. In contrast, a business can contribute up to $265,000 to a cash balance plan, subject to the participant’s age, in addition to the 401(k) plan contribution. Contribution limits increase with age, creating an advantageous opportunity for those nearing retirement to add to their retirement savings while securing a significant deduction for the business.
Initially introduced under the SECURE Act, businesses have until their federal filing deadline, including extensions, to establish a cash balance plan. However, given the time required for preparation, including document preparation, contribution calculations, and other administrative tasks, it is advisable to initiate the process sooner rather than later.
Take Action on Asset Purchases
Timing your asset purchases to place items "in service" before year-end can reduce taxes. However, a ticking clock now complicates matters. The Tax Cuts and Jobs Act gradually reduces the 100 percent first-year bonus depreciation by 20 percent each tax year until it completely phases out in 2027, barring congressional action. The deduction has already dropped to 80 percent for 2023.
First-year bonus depreciation applies to assets, including computer systems, software, vehicles, machinery, equipment, office furniture, and qualified improvement property, encompassing specific enhancements to nonresidential properties such as roofs, HVAC systems, fire protection and alarm systems, and security systems.
You can apply the IRC Section 179 expensing election for asset purchases. Section 179 allows you to deduct 100 percent of the purchase price for new and used eligible assets. These assets include machinery, office and computer equipment, software, certain business vehicles, and qualified improvement property.
For 2023, the maximum Section 179 deduction is $1.16 million. This deduction begins phasing out on a dollar-for-dollar basis once a business's qualifying property purchases exceed $2.89 million. The deduction is capped by your business income and unused amounts can be carried forward indefinitely or claimed as bonus depreciation without limits or phaseouts. When financing asset purchases, factor in the impact of high-interest rates and potential tax savings.
Maximize the Qualified Business Income (QBI) Deduction
One consideration concerning depreciation deductions is their potential impact on the QBI deduction for Pass-Through Entity (PTE) owners. Note that the QBI deduction is set to expire in 2025. If this happens, PTE income might be subject to rates as high as 39.6 percent.
Currently, PTE owners can deduct up to 20 percent of their QBI, subject to certain limitations based on W-2 wages paid, the unadjusted basis of qualified property, and taxable income. Accelerated depreciation reduces your QBI and certain other tax breaks tied to taxable income, consequently impacting your deduction.
Conversely, you can increase the deduction by increasing W-2 wages or purchasing qualified property. Furthermore, you can bypass income limits on the QBI deduction by strategically timing your income and deductions.
Timing Income and Expenses
Given the approaching election next November, it is unlikely that significant alterations to tax laws will occur in 2024. As a result, strategically timing income and expenses is worth pursuing for those utilizing cash-basis accounting.
Here to Help Lower Your Tax Burden
Seemingly minor tax decisions could lead to costly unintended consequences under various tax provisions. Fortunately, we are here to help you make the right strategic moves. We build value-added relationships with each client to understand their business structure to provide solid solutions, and our approach offers direct access to the firm's decision-makers. Our innovative cross-functional services help businesses address the challenges ahead. Contact us to let us know how we can best support you.