Midyear Tax Planning Considerations for Small Businesses and Individuals

Summer 2023 is here – and it’s also a terrific time to consider mid-year tax planning for small businesses and individuals.

Midyear planning is an important strategy because with tax planning considerations, sooner rather than later is always a promising idea. 

We encourage you to take time now to review the summary of planning ideas provided below and to contact your Herbein tax consultant to discuss how to implement tax planning strategies that may potentially reduce your 2023 tax bill.

Small business tax planning ideas

Tax-favored retirement plans

Does your business have a retirement plan? If not, this might be a good time to consider it. A self-employed individual can contribute up to 20% of their self-employment income with a maximum of $66,000 for 2023. A business owner employed by their company can contribute up to 25% of their salary, with the max still being $66,000. Depending on your business income, other options such as 401(k) plans, defined benefit plans, or the SIMPLE-IRA may be a better benefit. Note that if you have employees, they may be required to be covered by whatever plan you choose. 

Also, if you filed an extension of time to file your 2022 Form 1040, you may still be able to make deductible 2022 pension plan contribution to a SEP or 401(k) plan if you pay contribution by 10/16/2023. 

Generous tax depreciation rules

Current federal tax rules give business owners the option for first-year depreciation write-offs for certain assets placed in service during the tax year. If the asset is eligible and placed in service during to 2023 tax year and beyond, the maximum deduction for Section 179 expense is $1.16 million. There are phaseouts if too much property is placed in service, and the deduction cannot cause a loss in taxable business income. 

First-year bonus depreciation is another beneficial accelerated asset addition deduction. Beginning in tax year 2023, first-year bonus depreciation is limited to 80%. Planning and coordinated action may be prudent to take optimum advantage of both Section 179 and bonus depreciation.

There continue to be special depreciation rules for vehicles used in a business. Purchases of heavy SUVs, pickups, and vans (with a Gross Vehicle Weight Rating above 6,000 pounds) used over 50% for business qualify for both Section 179 and 80% bonus depreciation. However, for passenger vehicles, cars, light SUVs, light trucks, and light vans, the luxury auto depreciation limitations apply, and limit the amount of bonus depreciation and annual business depreciation deductions.

For other considerations regarding tax aspects of vehicles, please review our earlier blogs: Tax considerations for vehicle operations in inflationary times and Lease Workaround to Qualify for Electric Vehicle Tax Credit

Tax savings by the timing of business income and deductions

If you are an owner of a sole proprietorship, S corporation, LLC, or partnership, your share of the income and deductions from the business are subject to the personal tax rates on your income tax return. If there are no federal tax law changes before the next filing season, the tax rates will be the same as last year, and the bracket thresholds should increase due to inflation adjustments. 

Therefore, assuming no actual tax rate changes, but higher income thresholds for the lower rates, it may be beneficial to consider planning regarding the timing of income and deductions this year. For example, based on your expectations for your taxable income for 2024, if you expect to be in the same or lower tax bracket next year you may want to consider deferring income and accelerating deductions. At a minimum, deferring income and accelerating deductions will postpone part of your tax liability from 2023 to 2024. On the other hand, if you expect to be in a higher tax bracket, then deferring expenses and accelerating income may be more beneficial. Contact us through the form below and together we can devise a plan that would give you the best tax benefit.

Family members as employees

Small business owners may realize overall tax savings by employing family members. If you have family members that are bona fide employees of your business, you can deduct the wage and benefits paid to them as business expenses on a Schedule C or F. Also, wages paid to your child under 18 are not subject to pay federal employment taxes.

Individual Tax Planning Ideas

Consider adjusting your tax withholding or estimated payments

No one likes to be surprised with a large tax bill (or a smaller-than-anticipated refund) when they file their annual income tax return. In most cases, this occurs because individuals do not adjust their tax withholding or estimated payments to account for changes in income. Fortunately, there’s still time to make sure the right amount of federal income tax is withheld from your paycheck for 2023.

You can use IRS Form W-4 to tell your employer the amount of tax to withhold from each paycheck. Some taxpayers simply do not have the correct amount of tax withheld. The IRS has a tool to assist taxpayers in completing Form W-4. If you have not reviewed your withholding recently, you should consider using the IRS’s “Tax Withholding Estimator." You will need your most recent pay stubs (for both spouses if married filing a joint return), details of other sources of income, and a copy of your most recent tax return. However, keep in mind that the calculator is not perfect. If you want more precise results, we would be happy to put together a 2023 tax projection for you.

If you make estimated tax payments throughout the year (if you’re self-employed, for example), we can take a closer look at your tax situation for 2023 to make sure you’re not underpaying or overpaying.

Bunch itemized deductions to optimize generous standard deduction allowances

The 2023 standard deduction amounts are $13,850 for singles and those who use married filing separate status, $27,700 for married joint-filing couples, and $20,800 for heads of household. If your total annual itemizable deductions for 2023 will be close to your standard deduction amount, consider making enough additional expenditures for itemized deduction items between now and year-end to exceed your standard deduction. That will lower this year’s tax bill. Next year, you can always claim the standard deduction, which will increase due to inflation adjustments.

An easy deductible expense to accelerate the interest component of mortgage payments due on January 1. Accelerating that payment into this year will give you 13 months’ worth of interest in 2023. Although the 2017 tax reform put stricter limits on itemized deductions for home mortgage interest, you are probably unaffected. Check with us if you are uncertain.

Also, consider making bigger charitable donations this year and smaller ones next year to compensate. That could cause your itemized deductions to exceed your standard deduction this year. Next year, you can always claim the standard deduction.

Finally, consider accelerating elective medical procedures, dental work, and vision care. For 2023, medical expenses are deductible to the extent they exceed 7.5% of your Adjusted Gross Income (AGI), assuming you itemize.

Carefully manage investment gains and losses in taxable accounts

If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have held for over 12 months. The federal income tax rate on long-term capital gains recognized in 2023 is only 15% for most individuals, but it can reach the maximum 20% rate at higher income levels. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.

To the extent you have recognized capital losses earlier this year or capital loss carryovers from pre-2023 years, selling winners this year will not result in any tax hit. 

If you have investments that are in a loss position, it may make sense to harvest those losses to offset capital gains or up to $3,000 ($1,500 if you use married filing separate status) of 2023 ordinary income from salaries, bonuses, self-employment income, interest, royalties, etc. 

Any excess net capital loss from this year can be carried forward to next year and beyond. In fact, having a capital loss carry over into next year and beyond could turn out to be a rather good deal. The carryover can shelter both short-term gains and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years because you will not have to hold appreciated securities for over a year to get a lower tax rate.

Take advantage of 0% tax rate on certain investment income

Another huge federal tax benefit is the 0% bracket on certain long-term capital gains and qualified dividends. For 2023, you may qualify for the 0% bracket if your taxable income is $44,625 or less for single filers, $89,250 or less for married couples filing jointly, or $59,750 or less for heads of household.

While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in the 0% bracket. If so, consider giving them some appreciated stock or mutual fund shares that they can then sell and pay 0% tax on the resulting long-term gains. Gains will be long-term if your ownership period plus the gift recipient’s ownership period (before the recipient sells) equals at least a year and a day.

Giving away stocks that pay dividends is another tax-smart idea. If the dividends fall within the gift recipient’s 0% rate bracket, they will be federal-income-tax-free.

Warning: If you give securities to someone who is under the age of 24, the Kiddie Tax Rules could potentially cause a portion of the resulting capital gains and dividends to be taxable at the parent’s higher marginal federal income tax rate. That would defeat the purpose. Please contact us if you have questions about exposure to the Kiddie Tax.

Consider gifting strategies

If you want to make gifts to favorite relatives, other loved ones, and/or charities, consider making them in conjunction with an overall revamping of your taxable account stock and equity mutual fund portfolios. Plan to make your gifts according to the following tax-smart principles:

Gifts to Relatives and Other Loved Ones. Don’t give away loser shares (currently worth less than what you paid for them.) Instead, you should sell the shares and book the resulting tax-saving capital loss. Then, give the cash sales proceeds to your loved one.

On the other hand, you should give away winner shares. Your gift recipient will pay lower tax rates than you would pay if you sold the same shares. As explained earlier, loved ones in the 0% federal income tax bracket for long-term capital gains and qualified dividends will pay a 0% federal tax rate on gains from shares held for over a year before being sold. For purposes of meeting the more-than-one-year rule for gifted shares, count your ownership period plus the gift recipient’s ownership period. Even if the winner shares were held for a year or less before being sold, your loved one will pay a lower tax rate on the gain than you would.

Gifts to Charities. The principles for tax-smart gifts to relatives and other loved ones also apply to donations to IRS-approved charities. You should sell loser shares and collect the resulting tax-saving capital losses. Then, you can give the cash sales proceeds to favored charities and claim the resulting tax-saving charitable deduction (assuming you itemize.) Following this strategy delivers a double tax benefit: tax-saving capital losses plus a deductible charitable donation.

On the other hand, you should donate winner shares instead of giving away cash. Why? Because donations of publicly traded shares that you have owned over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift (assuming you itemize). Plus, when you donate winner shares, you escape any capital gains taxes on those shares. So, this idea is another double tax-saver: you avoid capital gains taxes while getting a tax-saving donation deduction (assuming you itemize). Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to the IRS.

Possibly convert traditional IRAs into Roth accounts

The best profile for the Roth conversion strategy is when you expect to be in the same or higher tax bracket during your retirement years. If that turns out to be true, the current tax hit from a conversion done this year could be a small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. In effect, a Roth IRA can insure part or all your retirement savings against future tax rate increases.

Remember estate planning

The unified federal estate and gift tax exemption for 2023 are a historically huge $12.92 million, or effectively $25.84 million for married couples. Even though these exemptions may mean you are not currently close to being subject to the federal estate tax, your estate plan may need updating to reflect the current tax regime. Also, you may need to make some changes for reasons that have nothing to do with taxes, such as various life changes.

Finally, be aware that in 2026, the unified federal estate and gift tax exemption amounts are scheduled to revert to what it was before the 2017 tax reform, with a cumulative inflation adjustment for 2018–2025. That might put it in the $7 million to $8 million range, depending on what inflation turns out to be through 2025. Depending on political developments, the exemption cutback could happen before 2026.

Final thoughts

We hope we have summarized potential mid-year tax planning ideas for small businesses and individuals in a way that helps you and provides ideas for your 2023 tax planning.
Please contact your Herbein tax consultant for a further discussion of any of these tax planning suggestions.

Article contributed by Richard Williams