As a business owner, you work incredibly hard to build your company and serve your customers. But complex tax codes mean there may be overlooked opportunities to potentially reduce your tax liability - money left on the table that could have stayed in your pocket. Proper tax planning is essential for business owners looking to maximize growth and true profits.
In our meetings with business owner clients, we discuss everything from little-known credits and deductions to setting up the optimal corporate structure and benefits packages to legally seek to minimize the taxes you pay.
Here are the 15 actionable tax planning strategies business owners should consider and review each year.
Read on to discover creative tax savings approaches that could pay dividends for your bottom line for years to come.
Table of Contents:
- Understanding Qualified Opportunity Zones
- Potentially Maximizing Benefits with Section 179 Accelerated Depreciation
- Establishing a Cash Balance Plan
- The Strategy of Tax-Loss Harvesting
- Financial Benefits of Paying Your Children
- Utilizing the Augusta Rule
- Qualified Plan Review and Funding
- Leveraging Cost Segregation
- Exploring R&D Tax Credits
- Overall Savings Strategy Review
- Making the Most of HSAs
- Maximizing Charitable Contributions
- Understanding Mega Backdoor Roth Conversion
- The Importance of Working with a CPA
- Reviewing Your Benefits Package
- Your Next Tax Planning Steps
Understanding Qualified Opportunity Zones
Senior Wealth Advisor Drew Allen, CFP®, CLU®, CEPA, ChFC®, RICP® and CEO David Silver CFP®, CEPA® discuss Qualified Opportunity Zones.
Qualified Opportunity Zones (QOZs) were created under the 2017 Tax Cuts and Jobs Act as a way to incentivize investment in underserved communities. Here’s how they work to potentially benefit both investors and communities:
What Are Qualified Opportunity Zones?
Qualified Opportunity Zones are economically distressed areas that meet certain income and poverty thresholds. Each state governor has the ability to nominate a certain number of census tracts to become federally certified QOZs.
The Potential Benefits of Investing in Qualified Opportunity Funds
Those who invest capital gains into Qualified Opportunity Funds that are set up to invest in QOZ businesses and properties could receive substantial tax incentives:
- Eliminate 10% of the deferred capital gains tax if invested for at least 5 years
- Eliminate 15% of the deferred capital gains tax if invested for at least 7 years
- If held at least 10 years, eliminate new gains realized from the QOZ investment*
**From IRS.Gov: If the investor holds the investment in the QOF for at least 10 years, the investor is eligible to elect to adjust the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged.
This allows investors to potentially compound money over the long-term in low income areas that need the capital.
How to Invest in Qualified Opportunity Zones
To receive QOZ tax incentives, taxpayers must:
- Generate a capital gain from another investment (can be stocks, bonds, real estate sale, etc.)
- Reinvest that capital gain within 180 days into a Qualified Opportunity Fund
- Hold the investment in the Opportunity Fund for at least 5-7 years*
*Note: As mentioned above, if held 10 years, the investor can also eliminate all capital gains taxes realized from the QOZ asset (the investor will still owe taxes on the original asset)
Opportunity Funds pool money and invest specifically in businesses, real estate deals, and other assets located within federally designated Qualified Opportunity Zones.
Potentially Maximizing Benefits with Section 179 Accelerated Depreciation
Senior Wealth Advisor Drew Allen, CFP®, CLU®, CEPA, ChFC®, RICP® and CEO David Silver CFP®, CEPA® share insights on Section 179 for business owners.
Section 179 allows business owners to fully deduct the purchase cost of eligible capital assets in the first year, rather than slowly depreciating deductions over several years. This could provide an immediate boost in tax savings and cash flow in the current tax year.
For example, rather than only deducting 20% depreciation on a $50,000 vehicle purchase each year for 5 years under normal depreciation, the full $50,000 could be expensed via Section 179 in Year 1.
Section 179 Eligible Properties & Limits
What Capital Assets Qualify for Section 179?
To take the Section 179 deduction on capital expenditures, the equipment must be purchased for active business use rather than passive investment purposes. Common eligible Section 179 property includes:
- Vehicles, machinery, and computers
- Software, office equipment, and appliances
- Some building improvements like HVAC and lighting
Section 179 Deduction Limits
There is an overall annual dollar limitation on the total Section 179 deduction available, as well as limits on deductions for specific asset types. For 2023, business owners can deduct*:
- Up to $1,160,000 in total Section 179 equipment purchases
*See IRS.gov article here on Section 179
Consult an accountant to review eligible purchases and seek to maximize your Section 179 deduction under current limits.
Establishing a Cash Balance Plan
A cash balance plan is a defined benefit retirement plan that functions similarly to a 401(k) but offers substantially higher contribution limits for business owners and key employees.
Each participant receives an annual pay credit contribution from the employer (based on salary and age) which grows over time with interest credits.
This allows older business owners to potentially save exponentially more for retirement in tax-advantaged accounts than 401(k)s and IRAs permit – over $300,000 per year in some cases.
Benefits for Business Owners
Cash balance plans provide major tax deductions and a fixed rate of return on contributions. Differentiators include:
- Much higher annual contribution limits than other retirement plans
- Contributions are at the employer’s discretion each year
- Allowed to change or stop contributions if business needs cash
- Tax deductible for the business as compensation expense
- Funds grow tax-deferred with mandatory interest credits
- Moderately flexible for rewarding key employees
A cash balance plan paired with a 401(k) can allow business owners over age 50 to put away over $400,000 annually in tax-deductible retirement savings.
Does a cash balance plan strategy make sense for you and your unique situation? We recommend consulting a financial advisor to help you sort through the different options available to you.
The Strategy of Tax-Loss Harvesting
Tax-loss harvesting is the strategic selling of investments, such as stocks or mutual funds, at a loss to offset capital gains taxes.
By realizing losses, this reduces tax liability on any gains realized elsewhere in a portfolio. The sold security can then be repurchased after 30 days if still desired.
Potential Benefits of Tax-Loss Harvesting
Savvy investors utilize tax-loss harvesting to help save significantly on their tax bills. Potential benefits include:
- Offsetting realized capital gains from other sales
- Offsetting up to $3,000 in ordinary income annually
- Carrying forward unused capital losses to offset taxes in future years
- Diversify portfolios away from declining positions
- Ability to repurchase sold assets after 30 days
Over long time horizons, this could add up to major tax savings.
How to Implement Tax-Loss Harvesting
- Work closely with a tax professional to effectively utilize this strategy by:
- Evaluating portfolio for tax lots trading below cost basis
- Selling losing positions for capital losses
- Using losses to offset gains and lower net tax liability
- Considering rebalancing portfolio away from losing holdings
- Repurchasing desired liquidated positions after 30 days
Be aware of “wash sale rules” that disallow claiming a tax loss if buying back substantially identical securities within 30 days of selling.
Tax-loss harvesting takes careful planning and timing but could be an excellent tax reduction tool.
Financial Benefits of Paying Your Children
Employing your children in a family business or paying them for work as an independent contractor could provide worthwhile income for them as well as tax deductions for your business. But special rules and limits apply, so proper planning is key.
Legal Considerations
- Children must complete legitimate work to justify pay
- Need to pay market wages relative to duties
- Must comply with state and federal labor laws
- Need employment or independent contractor agreement
Document hours worked and responsibilities to demonstrate evidence in case of any legal challenge.
Potential Tax Benefits and Limits
As long as legitimate pay requirements are met, potential benefits include:
- Tax deduction as wages or contract labor costs
- Avoid payroll taxes on children under age 18
- Income to the child is income tax free up to the standard deduction 13,900 in 2023
- If used to fund a Roth IRA up to the annual limit of 6,500 in 2023, the growth can be tax free as well
However, pay must remain reasonable compared to duties and meet IRS standards. Excessive pay can result in partial or total loss of deductions plus penalties.
We recommend consulting a tax professional to ensure you remain compliant while benefiting your family and business.
Utilizing the Augusta Rule
The Augusta Rule, known in the tax code as Section 280A, allows homeowners to rent out their primary residence to their own business for up to 14 days per year without needing to claim the rental income personally.
So for example, a business owner could:
- Rent their home to their own corporation for a company party, business meeting, etc.
- The corporation can claim a tax deduction on that rental expense
- Meanwhile, the homeowner does not have to report that rental income personally
This essentially allows business owners to get a deduction through their company for the use of their home, while also letting them receive that rental income tax-free individually by keeping it under 14 days per year.
Section 280A provides a commonly overlooked deduction opportunity. Business owners simply need to ensure the home rental stays within 14 days annually for business meetings, parties, planning sessions etc to take advantage tax-free.
Qualified Plan Review and Funding
Retirement plans like 401(k)s and pensions provide major tax savings for business owners. But laws change, plans evolve, and opportunities arise to contribute more. That’s why ongoing reviews are critical.
Importance of Qualified Plan Reviews
Annual qualified plan reviews help uncover:
- New or increased tax deduction opportunities
- Plan design limitations to address
- Opportunities to reward key employees
- Funding shortfalls requiring catch-up contributions
- Updated compliance issues or regulatory changes
Significant tax and retirement savings can be gained from ongoing plan optimization and funding adjustments.
Strategies for Optimal Funding
Work closely with your financial advisor or accountant to analyze your current qualified retirement plans. Strategies may include:
- Increasing company match percentages as profits grow
- Contributing the annual profit sharing maximum
- Running annual catch-up contribution calculations
- Seeing if a Cash Balance Plan could complement current offerings
- Determining if key executives can afford to save more pre-tax
The time invested in an annual review could lead to maximized savings for both the company and your future self. Don’t leave these crucial tax-advantaged investment vehicles running on auto-pilot.
Leveraging Cost Segregation
Cost segregation is an often overlooked tax strategy for real estate investors and business property owners that can generate major depreciation deductions.
What is Cost Segregation?
Cost segregation is an IRS approved method of reclassifying components of a commercial property into shorter depreciable life categories. This accelerates tax deductions compared to traditional straight-line depreciation.
For example, parts of a building like wiring, plumbing, and HVAC systems can get bumped from a 39 year schedule to 5-7 years. This essentially pulls forward deductions into earlier years.
Potential Benefits for Property Owners
Owners who utilize cost segregation could enjoy major benefits including:
- Accelerating depreciation tax deductions into earlier years
- Increasing annual cash flow with lower tax liability
- Potentially qualifying for Section 179 deductions on portions of the property
- Potentially maximizing deductions upon sale with proven lower basis
This all could lead to substantial tax savings and increased cash flow in the early years of a property investment. A commercial real estate CPA can assess if cost segregation makes sense for your property. Proper implementation can yield hundreds of thousands in tax savings.
Exploring R&D Tax Credits
Many businesses are eligible for substantial tax credits related to research and development activities without realizing it.
Eligibility for R&D Tax Credits
Contrary to what many believe, R&D tax credits don’t just apply to formal scientific or medical research. Eligible activities include:
- Software development
- Design and prototype creation
- Testing/quality control processes
- Exploring alternative materials, devices, or processes
- Developing or improving products and manufacturing procedures
Essentially, exploring uncertainty in attempts to develop improved products, processes, performance, reliability, or quality can qualify.
How to Claim the Credit
While rules can be complex to fully maximize claims, the four basic steps are:
- Document activities tied to uncertainty and experimentation
- Identify costs associated with these R&D efforts
- Calculate the applicable credit based on costs
- Claim the credit to receive the tax refund
Most companies are performing many more eligible activities than they realize. A tax professional who specializes in R&Ds can assess qualifications and file your R&D tax credit.
The reward for this under-the-radar incentive could potentially equate to hundreds of thousands back to reinvest and grow your business.
Overall Savings Strategy Review
Reviewing your entire savings strategy annually provides huge potentially opportunities to better position assets in more tax-advantaged accounts or investments.
Assessing Current Savings Strategies
A proper review analyzes:
- Tax efficiency of current investment asset allocation - For example, determining whether too much income is being generated needlessly in taxable accounts versus strategically locating high dividend stocks solely within IRAs.
- Fees and expenses paid within accounts - Quantifying total costs for account administration, trading commissions, expense ratios, and advisors allows assessment of reasonability and potentially negotiating reductions.
- Fund location optimization (taxable vs non-taxable accounts) - Determining if adjustments are prudent such as holding only municipal bonds and non-dividend growth stocks in taxable accounts while prioritizing high yield bonds
- Maximization of tax-preferred account contributions - For example, ensuring backdoor Roth IRA conversions are done each year, catching up on any deferred 401k contribution room, and exploiting qualified plan and HSA limits before taxable savings.
This allows refinement and improvement for amplified growth.
Recommendations for Improvement
After thorough analysis, recommendations may include:
- Consolidating accounts with duplicative investments
- Maximizing HSA, 401(k), IRA use before taxable accounts
- Asset location to balance taxes
- Implementing direct indexing investing
Work with a savvy financial advisor to regularly review strategies and determine if any revisions or tweaks need to be made.
Making the Most of HSAs
When used strategically, Health Savings Accounts offer a triple tax advantage. Yet most Americans with access don’t maximize them.
HSA Benefits
HSAs offer unique benefits including:
- Tax deductible contributions
- Tax-deferred growth
- Tax-free withdrawals for medical expenses
Funds roll over year after year for future health costs. After age 65, money can get withdrawn for any purpose with just ordinary tax owed.
Maximizing Contributions
Consider strategies like:
- Contributing annual IRS maximums - For 2024, that means putting in $4,150 for individual coverage or $8,300 for a family, which could yield significant tax savings over time. (See IRS.Gov article here for more information)
- Investing rather than cash savings - Once an emergency fund is set aside, remaining HSA balances can be invested to allow for market growth rather than stagnant cash interest, helping to amplify the account over decades.
- Paying medical expenses out of pocket to grow balance - While HSAs can be used to pay current healthcare costs, allowing the account to keep growing instead could build significant savings for future medical needs in retirement.
- Letting it compound into retirement - Given their unique triple tax benefits, maximizing HSAs early on and never tapping them helps allow exponential growth so they can greatly supplement retirement healthcare costs.
Be sure to save all medical receipts. When strategically leveraged, HSAs could contribute significantly in growing long-term wealth.
Charitable Contributions
Strategically planning charitable gifting allows potentially maximizing tax deductions while furthering your philanthropic impact.
Tax Implications
Items to evaluate with an advisor include:
- Annual income level and related deduction caps - Higher income earners are limited to a maximum 60% AGI deduction annually, whereas lower income filers have fewer restrictions.
- Carryforward rules on excess deductions - If income changes cause a spike in donations beyond typical limits, the 5 year carryforward provision allows stretching excess contributions.
- Itemizing deductions vs. standard deduction impact - For those close to the standard deduction threshold, strategic bundling of charitable giving into certain years can help maximize overall deductions claimed.
- Appreciated asset gifting to bypass capital gains tax - By donating stocks directly to charity instead of selling, both the capital gains tax is avoided and a fair market value deduction can be claimed.
Strategic Gifting Ideas & Tactics
Additional avenues to explore include:
- Donor advised funds offering immediate deductions with grant flexibility - These qualified intermediaries seek to provide maximum deductions now while allowing more control over distributing funds to various charities over time.
- Qualified charitable distributions from IRA accounts - QCDs provide efficient charitable gifting directly from IRA accounts to satisfy RMDs without triggering income taxation on withdrawals
- Multi-year gifting providing current year deductions - By gifting multiple years worth up front, deductions get maximized in one tax year through a series of post-dated checks or via donor advised account
There are many ways to give. Depending on your situation, you may have options that are more tax-efficient and should be considered to accomplish your charitable goals.
The Importance of Working with a CPA
While tax software and trying to optimize deductions on your own can work for simple tax situations, most business owners need professional guidance to help maximize savings.
Potential Benefits of Professional Advice
An experienced CPA can provide:
- Guidance on ever-changing regulations and obscure loopholes
- Strategies seeking to leave no deductions unclaimed
- Potentially significant tax savings typically dwarfing their fees
- Helping avoid compliance mistakes resulting in penalties
- Proactive planning and advisory products
- Potential time savings over trying to self-navigate complex tax codes
Even basic planning like expense categorization can be optimized by a professional.
How to Choose the Right CPA
You probably have your own preferences for working relationships, but we recommend looking for a responsive CPA who:
- Specializes in your type/size of business
- Takes an active advisory role year-round
- Communicates complex concepts clearly
- Has reasonable and transparent fee structure
- Is respected by peers and clients they have retained
Investing in a CPA could yield dividends through maximized deductions, avoided penalties, and significant time savings. Make sure to run an annual tax planning meeting involving your financial advisor to help ensure continuity in your strategy.
Reviewing Your Benefits Package
An employee benefits package consists of various non-wage compensations companies offer to retain top talent. Structuring these creatively presents potential tax optimization opportunities.
Key Components of Benefits Packages
Typical benefits may encompass:
- Health, dental, and vision insurance
- Retirement plan contributions
- Additional PTO, leave, and work schedule flexibility
- Educational assistance programs
- Child care and family support resources
- Wellness programs, gym discounts, and more
Providing competitive benefits can reduce turnover. Optimizing them can create recruitment advantages and tax savings.
Tax Implications and Potential Opportunities
Analyze your current offerings and structure considering:
- Tax treatment of various benefit types - For instance, certain wellness-related benefits can qualify for preferred deductibility while others like gym discounts may provide more employee satisfaction than bottom line company savings.
- Classes of employees/executives who qualify - Customizing offerings with preferences and limits between employee tiers, such as offering an executive health plan or restricting tuition assistance maximums by tenure, provides added control.
- Annual limit thresholds and discrimination testing - Rules generally prevent benefits from overly favoring highly compensated employees, with testing required to prove annual compensation remains balanced by the plan’s design.
- Which benefits employees value most - Surveying staff needs and assessing industry benchmarks on popular offerings provides insight into which benefits foster the highest perceived value and thus retention, recruitment and talent optimization per dollar spent.
Understanding Mega Backdoor Roth Conversions
The Mega Backdoor Roth Conversion allows high-income earning employees to contribute well beyond typical 401(k) limits into a Roth account with tax-free growth potential.
What is a Mega Backdoor Roth?
A Mega Backdoor Roth involves making non-Roth after-tax contributions to a 401(k) plan up to $61,000 annually. These after-tax dollars can then get rolled over into a Roth IRA annually.
This provides a way to get up to $41,000 more into tax-advantaged Roth accounts per year than the standard $20,500 pre-tax 401(k) limits.
Steps to Implement and Potential Benefits
The process involves:
- Making maximum $20,500 salary deferral 401(k) contribution
- Contributing after-tax dollars to 401(k) up to $61,000 total
- Converting after-tax portion to Roth IRA shortly after each contribution
This advanced strategy requires employer plan allowance but allows potentially amplifying Roth retirement savings significantly.
Consultation with a knowledgeable financial planner is key for successful implementation and potentially maximizing contributions. When leveraged fully over decades, the Mega Backdoor Roth could unlock enormous tax-free growth potential for retirement.
Your Next Tax Planning Steps
Implementing comprehensive business tax minimization strategies requires advanced planning, but the long-term savings can be substantial.
With constantly evolving regulations and ambiguity in complex tax code applications, one-time planning is not enough. Work closely with both expert CPAs and financial advisors to analyze savings opportunities in an ongoing, comprehensive fashion.
Being proactive allows responding to regulatory changes with continuity in optimized overall tax reduction approach year after year. An annual review also uncovers easy-to-implement savings strategies hiding in plain sight.
Have a question about your specific situation or want to talk to one of our team members here at Instrumental Wealth? Schedule a meeting here.
We look forward to speaking with you!
Not an Offer: This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, prospective investors are encouraged to contact Instrumental Wealth or consult with the professional advisor of their choosing.