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The year is almost coming to a close. With the few months left in 2022, here are a few basic planning tips that can help you minimize taxes. It is recommended that you consult with a tax professional for more detailed and customized guidance.
Make sure you paid enough taxes for the year. No one wants to see a surprise tax bill in April, so now would be the best time to check to see if you are withholding enough taxes. If you are an employee, check your income tax withholdings and compare them to your income and the tax due on the IRS tax table. If you are self-employed, in addition to income tax withholdings, you should take into account self-employment tax which is 15.3% for the first $147,000 of your business income and 2.9% for income above that. You could also be subject to an additional Medicare tax if your income is above $200,000 for single filers or $250,000 for joint filers.
If your withholdings are not enough, you have a few months to make a final estimated tax payment which is due on January 15, 2023.
Give some clients a break until the new year. For self-employed people, you may have some customers or clients who might be struggling to pay your bill. For trustworthy clients who promise to pay your bill in the new year, instead of suing them into debt slavery, you might want to take them up on their offer. By getting paid and reporting the income in 2023, you will be able to take advantage of the higher tax brackets and possibly pay less taxes on the same income.
This should not be confused with clients who offer payment, which you decline solely for tax avoidance reasons. First, the clients might issue you a 1099 for the amount they paid so you will have to report the income anyway. But also, if you are audited, the IRS could consider this as constructive receipt of the income in the year you earned the money.
Buy that SUV now to get the 100% write off. Normally, for major business asset purchases that are expected to last more than one year, a portion of the cost of the asset can be deducted from income over a period of years depending on the type of asset. But for certain qualified property, the bonus depreciation rule allows them to deduct up to 100% of the cost so long as it is put in service in the same year it is bought.
However, starting in 2023, the bonus depreciation will be reduced 20% and an additional 20% for the four years until the bonus depreciation is zero.
In general, qualified property is any asset that has a useful life of 20 years or less. Automobiles are one of the most common assets that take advantage of bonus depreciation.
Before purchasing a vehicle and expensing the entire cost from your taxable business income, keep the following in mind. First, you must take delivery and place it in service in 2022 to get the full 100% deduction. In other words, simply ordering and putting a deposit toward the car will not be enough, even if there is a supply chain issue that is delaying delivery until 2023. Second, if you later sell the car, the sales price will have to added back into taxable income. This is known as depreciation recapture.
Consider incorporating your practice. If you recently started your own practice, you probably reported your income and expenses as a sole proprietor on the Schedule C. But as your income grows, you might be better off incorporating your practice. It provides some limited liability protection and tax benefits. Specifically, you may be able to save some self-employment taxes by strategically paying yourself a salary through your corporation. However, the IRS knows about this tactic and so they require S-corporation to pay owners a “reasonable salary” as an employee of the corporation.
However, setting up and maintaining a corporation also has its own costs which may negate the tax benefits. Generally it is advisable to set up a corporation once you consistently make a significant profit. It is advised to see a tax professional and do a tax benefit analysis.
Prepare for the SALT deduction workaround. Some states allow taxpayers to get around the state and local tax deduction limitation of $10,000 per year. This is typically done by setting up a pass-through entity that pays the state tax on the taxpayer’s behalf and the deduction is passed through to the taxpayer’s personal tax return. The state gives a taxpayer an equal tax credit for the amount of state tax paid. The state tax payment can be substantial and the requirements can be very strict. So it would be best for taxpayers to estimate what their state tax will be at the end of the year and make plans to pay it before 2023 in order to take advantage of the workaround.
Might want to start thinking about estate planning. The estate tax lifetime exclusion in 2023 will be $12.92 million and will be adjusted for inflation in subsequent years. Any gift or inheritance transfers above this amount will be subject to estate taxes. However, in 2026, this exemption is expected to decrease by at least 50%. Given rising property values and inflation, it is possible to have an estate above $6 million in several decades assuming current estate tax limitation is not made permanent.
While the Elon Musks of the world probably cannot avoid the estate tax, those at the fringes should start planning to avoid or minimize estate taxes. Annual gifts of $15,000 do not count toward the lifetime exclusion. But transfers to spouses and unlimited payments for education and medical expenses are also disregarded.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.