There are just a few weeks left before the end of the year, which means it’s time for small business owners to get their books together and start talking with their accountants about what they need to do to save on their tax bills.
There are not a lot of new tax laws on the books for 2023, local accountants say, but there are some new complications at the state level — and at least one big tax savings opportunity that started in 2022 — that some small business owners may not know about.
Pass-Through Entity Election
Colorado small business owners could have a huge tax savings opportunity in the Pass-Through Entity Election, and they may be able to turn back the clock and take advantage of it retroactively through their 2018 taxes.
The Federal Tax Cuts and Jobs Act of 2017 limits the deduction of state and local taxes paid by individuals to $10,000. But Colorado enacted a law that went into effect in 2022 allowing S-corporations, Partnerships and some other entity types to pay those individual state income taxes and deduct them on their federal returns, which could result in big tax savings.
“It doesn’t make sense for everyone to do it,” says Josh Olson, senior tax manager at Stockman Kast Ryan + Company. “It really makes sense for those in the higher tax brackets.”
Those who take advantage of the PTE election are still able to itemize their personal taxes or take the standard deduction.
Of course, small business owners should be paying themselves a fair wage, Olson says. And the PTE election only applies to business income reported on a K-1, not the W2 income.
“As an example,” Olson says, “if an S-corporation generated $200,000 of taxable K-1 income, the Colorado tax is 4.4 percent or $8,800, which would be paid at the entity level instead of the individual level. This could possibly result in a federal tax benefit which would be $8,800 multiplied by the individual’s effective tax rate.”
Taking advantage of the PTE election also requires that the entity add any income that was deducted as part of the 20 percent Qualified Business Income on the federal tax return back into the total income for the state return, which would reverse some of the savings.
“It gets very complicated,” Olson said. “Taxpayers should consult their tax adviser.”
For some high-income small business owners it may also be worth investigating Colorado’s new allowance for filers to take advantage of the PTE election retroactively, Olson says.
Just about all small business owners really need to hire a professional payroll service. — John Kopenhafer
Beginning this September through July 1, 2024, the state will allow entities to file amended returns dating back to 2018 to take advantage of the PTE election.
“They will need to look at the numbers and do a cost-benefit analysis to see if it’s worth doing,” Olson says. “It might not be worth the accounting fees for preparing the amended returns. Mostly, I think it’s important that business owners know this is an opportunity so they can talk with their accountants about whether it makes sense for them.”
Complicated payroll changes for Colorado
Beginning at the start of 2022, Colorado small business owners had to withhold for the Family and Medical Leave Insurance Program, which was created when voters passed an act in 2020 to create a program that will compensate workers who have to take uncompensated leave to care for loved ones. The act includes leave for new parents.
All employees are required to pay into the insurance program, and all employers, regardless of their size, are required to withhold the employee premiums. Those businesses with 10 or more employees are required to pay an additional employer contribution into the program.
“Colorado payroll requirements are getting a bit burdensome for the small business owner,” says John Kopenhafer, CPA and principal at Williams & Kopenhafer PC.
He notes that the state also began requiring all employers to contribute to employee retirement plans beginning in 2023.
“It has gotten to the point where just about all small business owners really need to hire a professional payroll service,” Kopenhafer says. “They need someone to keep track of all the regulations and make sure they’re meeting the requirements.”
Small businesses could get into trouble if they haven’t been keeping up with the state requirements, he says.
General year-end tips
There are a few year-end tips that are relevant every year, but that warrant a mention and maybe a little heightened attention in 2023.
“If you’re thinking about buying new equipment, and it makes sense to buy it this year, you should get it done before Dec. 31,” Kopenhafer says.
The Tax Cuts and Jobs Act of 2017 established a Bonus Depreciation rule that allowed business owners to write off the entire amount of an investment in new equipment in the year in which it was purchased and put into service instead of depreciating it over the term of its asset life, which typically ranges from five to 20 years. The 100 percent depreciation ended in 2022 and has dropped to 80 percent in 2023. In 2024, it will drop again to 60 percent.
That means business owners will be able to write off more at once from big investments this year than they will be able to next year. So if companies need equipment and have tax liability, it makes sense to try to get the purchase made before the end of the year, accountants say.
“It’s a good opportunity assuming you need the deduction — and you need the equipment,” Olson says. “I don’t tell people to buy a truck unless they need a truck.”
He adds that any purchase under $2,500 doesn’t have to be depreciated and can be expensed in whole, so the Bonus Depreciation benefit is reserved for larger capital investments.
In addition to equipment investments, Kopenhafer says small business owners need to be sure they get their 401(k) and other qualified retirement plan contributions made before the end of the year.
Not including catch-up contributions for those over the age of 50, employees are allowed to contribute $22,500 to 401(k)s in 2023, according to the IRS. Employers can contribute up to 25 percent of an employee’s salary, up to a combined total contribution from employer and employee of $66,000. All of those contributions can be deducted from total income to reduce tax liability for small business owners, Olson says.
Another tax deduction to consider before year-end is charitable contributions, Olson says. A taxpayer needs to benefit from itemizing in order to deduct charitable contributions on their taxes, meaning they will need to itemize more than the $27,700 standard deduction for those joint filers.
Olson says a good strategy for maximizing the deduction for charitable contributions is to group two years of contributions in one year and to skip every other year so the taxpayer can deduct more in an itemized tax return.
Hiring a professional
While there have not been any major changes to tax code in 2023, Kopenhafer says tax filing for small businesses has become increasingly complex in recent years and it’s important for business owners to consult professionals who can help. If they aren’t working with someone who is current on tax code or new requirements, they can get into trouble or they could miss out on valuable tax deductions.
Both Kopenhafer and Olson recommend business owners work on getting their books together — which they see many struggle to organize — before the end of the year so they can talk with their accountants about what to expect and if there’s anything they can get done before the end of the year.
“I’d say it’s a good idea to get the bulk of your tax information to your CPA before the end of the year, even if it’s not complete,” Olson says. “That way you can just work on filling in the gaps during tax season when everyone is overwhelmed.”