It may feel like you just filed your 2022 taxes, but now is the time for you to lower your 2023 tax bill. Year’s end will be here before you know it, and this is the deadline for several valuable tax-planning strategies available to the self-employed. If you don’t want to leave the IRS a considerable tip, keep reading about how to lower your 2023 tax bill.
The higher your income, the more valuable proactive tax planning can be, especially for those in high-tax states like California, with a top state tax rate of 13.3 percent. This is on top of the current highest federal tax bracket of 37 percent. Sadly, many business owners work to get their taxes filed and, for the most part, skip over any opportunities to implement tax-minimizing strategies.
Review Your 2023 Estimated Self-Employment Income
Over the past year, I’ve spoken with many self-employed people earning record incomes in 2023. Even if you have a below-average year, paying fewer taxes can still increase your net after-tax take-home pay. With a lower income, you may even be eligible for tax credits or tax deductions that you haven’t been able to take in the past. Understanding your 2023 income will help determine how aggressive you should be with tax planning before the year’s end.
Is Your Business Set Up Properly?
Are you running a sole proprietorship or another business entity? Could running your business as an S-Corp, LLC, Partnership, or C-Corp lower your tax liabilities? Even if you have gotten guidance on this topic in the past, as your business and income grow, the best structure for your business may change.
If you are earning $100,000 (or less), the time and effort (and cost) of setting up an S-Corp likely isn’t worth it. However, the tax-planning benefits increase by incorporating your business as your income grows. You should review this with your tax professional and tax-planning Certified Financial Planner™ every few years (more often if your business is growing rapidly or if there have been changes to the ownership of your business).
Choose The Optimal Retirement Plan
Maximizing the benefits of a small business retirement plan is a fabulous way to minimize your taxes each year and increase your financial security in retirement. Would you rather write a check to the IRS or your retirement account? The choice is yours. High-income, self-employed business owners could potentially defer income taxes on hundreds of thousands of dollars annually.
Here are a few of the most common retirement plans for high-income-earning small business owners.
SEP-IRA – If you are self-employed, you can contribute 20 percent of your self-employment earnings into a SEP-IRA per year. The maximum contribution to a SEP-IRA is $66,000 for 2023. There are no catch-up contributions for SEP-IRAs. With no year-end deadline, a SEP-IRA can be set up and funded just before filing your taxes for the previous year.
Solo 401(k) – Typically, a Solo 401(k) will allow for the largest pre-tax contributions, which should translate into the largest tax savings. Business employees can contribute up to $22,500 for 2023 plus a $6,500 catch-up contribution if they are at least 50. Additionally, the business can make a profit-sharing contribution of up to 25% of payroll. That means $66,000 (or $73,500 for those 50 and older) in allowable 401(k) contributions in 2023.
You can also benefit from a Roth Solo 401(k) for the employee portion of your contributions, $22,500, plus a $6,500 catch-up contribution for business owners 50 and older. If your spouse also works with you in the business, they can be included in the plan, doubling the amount you can contribute and the tax savings.
Cash Balance Pension Plan – For business owners looking to save even more, the Cash Balance Plan (combined with a 401(k)) could allow your business to shelter several hundred thousand dollars in income each year. You may also hear this called a Defined Benefit Pension Plan; more likely, your basic financial advisor or CPA won’t mention it all (sadly).
Defined benefit pension plans are the most complicated of the small business retirement plans because the plan design is complex and time-consuming. If you are nearing 50 (or older), are already maxing your 401(k) and want to save even more, talk with your tax-planning financial planner ASAP. If they can’t help you determine if a Cash Balance Plan is right for you, talk with someone who can. Many financial advisors are unable or unwilling to do the work to set up a Cash Balance Plan.
Do You Qualify For The Home Office Deduction?
The pandemic has led many more businesses to be run from home. If this sounds like you, your business may be eligible for the home office tax deduction. The great thing about this tax break is that you are already spending the money on your home and other expenses like utilities and internet.
Here is what you need to know to determine if you qualify and better understand how this often scary home office deduction works.
Keep Up With Your Bookkeeping
You need to track your spending to avoid missing valuable tax deductions. Bookkeeping isn’t fun, but neither is overpaying your taxes. Plan to spend a little time throughout the year to stay updated on your bookkeeping (or hire someone to do it for you).
Claim First-Year Bonus Depreciation
One of the positive changes from the Tax Cuts and Jobs Act (TCJA) is that you can now get an 80% first-year bonus depreciation for qualified used and new property acquired and placed in service during your 2023 business year. These tax benefits begin to phase out further after 2023, so consider this when planning for future tax years.
Choose When To Make Big Purchases
If your income is higher in 2023 than expected in 2024, you will likely want to make purchases now. On the other hand, if your income may be substantially higher next year, you may want to put off large purchases.
Be Proactive With Your Tax-Planning Strategies
What is the point if you set up the best retirement account but never fund it? Similarly, what is the point if you have a bunch of tax-deductible expenses but don’t track them (and miss out on tax deductions)? Tax planning is not a once-a-year meeting with your tax preparer.
With proper timing (from proactive tax planning), you can make your income more valuable in terms of net take-home pay. For those who use pass-through entities (Sole Proprietor, S Corp, LLC, or Partnership), your portion of the business profit and deductions are passed through to you and eventually taxed on your personal tax returns. Taxes are based on your overall household income and filing status.
When you are self-employed, minimizing taxes is one of the best ways to increase the net profitability of all your hard work. Be proactive and work with your tax-planning Certified Financial Planner™ and CPA to develop a strategy to make proactive tax-planning choices to help you keep more of your hard-earned money. Would you rather write a check to yourself or the IRS regarding retirement accounts? The choice is yours.
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