The fourth quarter is the time for some proactive tax planning to lower your 2021 tax bill.
For business owners, tax planning shouldn’t be a once-a-year exercise when filing your taxes. However, many of us make that mistake. Which is why we’re sharing some common tax planning moves that may help lower your total tax bill.
Review Your Business Retirement Plan
One of the best ways for small business owners to slash their tax burden is to invest in a retirement plan. This could be anything from a SEP IRA to a Solo 401(k), up to the combination of a 401(k) with a defined-benefit pension plan.
SEP IRA. If you are self-employed, you can contribute 20% of your self-employment earnings into a SEP IRA, per year, with a maximum contribution of $58,000 for 2021. There are no catch-up contributions for SEP IRAs. With no year-end deadline, a SEP IRA can be set up just before filing your taxes for the previous year.
Solo 401(k). Business employees are allowed to contribute up to $19,500 for 2021 plus a $6,500 catch-up contribution if they are at least 50 years old. Additionally, the business will be able to make a profit-sharing contribution, up to 25% of payroll. That means a grand total of $58,000 (or $64,500 for those over 50) could be saved provided the individual contributes the maximum amount allowed by the IRS ($19,500 for 2021) and the business contributed the maximum allowable amount for payroll.
You can also benefit from a Roth Solo 401(k) for the employee portion of your contributions, $19,500 plus a $6,500 catch-up contribution for business owners over the age of 50.
Defined-Benefit Pension Plans are the most complicated of the small business retirement plans to set up because the plan design is complex and time-consuming. Contribution limits will depend on age and income, but they can often run north of $150,000 per business owner per year. The tax savings can be huge, especially for those in high-tax states like California, New York, and New Jersey.
Claim First-Year Bonus Depreciation
One of the positive changes from the Tax Cuts and Jobs Act (TCJA) is that you can now get a 100% first-year bonus depreciation for qualified used and new property that was acquired and placed in service during your 2021 business year. To put this more plainly, you may be able to get a tax break for the entire cost of assets purchased in 2021. If you are having a big income year, you may want to consider moving up some planned purchases before December 31, 2021.
Be Proactive
As it stands now, the 2021 federal income tax brackets are like the 2020 brackets, with a few small adjustments for inflation. If you expect to be in a similar or lower tax bracket next year, you may want to try and defer some income into 2022. Likewise, you may also want to move some tax deductions up into 2021. You would take the opposite approach if you are expecting to be in a higher tax bracket in 2022.
For the self-employed, minimizing taxation is one of the best ways to increase the net profitability of your small business. Be proactive and work with your certified financial planner and CPA to develop a strategy.
Not sure where to start? We would love to help! Send us an email at hello@gofigureaccounting.net
