Here’s a new thought. Let Uncle Sam pay for your holiday gifts and entertainment.
No, I’m not talking about anything illegal. You cannot purchase personal gifts and charge them to your company. That’s called fraud. But if your business uses the cash method of accounting (as most sole proprietorships do), you may be able to legally lower your tax bill by hundreds or thousands of dollars by making a few strategic decisions for your business between now and the end of the year. If you’re a sole proprietor, you may need little more than an online tax bracket calculator. In the end, those tax savings can more than cover your vacation expenses.
Here’s how to do this.
- 1 Defer income
- 2 Use the cost deduction of article 179
- 3 Maximize other ordinary expenses of running your business
- 4 Put your kids to work on weekends and holiday breaks
- 5 Give your retired parents or in-laws a job during the holidays
- 6 Organize a Christmas party for your employees
- 7 Finance your retirement
Are you having an exceptionally good year this year? That windfall might now look good in your accounting software. But come tax time, Uncle Sam and his state and local cousins could take a big chunk out of it — especially if the windfall bumps you into a different tax bracket.
One way to minimize that tax burden this year is to postpone some year-end income to 2023. You can do that by waiting to send invoices until the first week of January. That will keep you from receiving checks or ACH payments until next year. You can also postpone calling or sending reminders to late payers until the start of the new year.
You still have to pay tax on the profit next year, but you reduce your tax for this year.
A warning: Holding checks you receive this year and waiting until 2023 to deposit them won’t work. For cash-based businesses, the IRS considers the year you constructively received a check as the year the income is earned, not the year you deposit it in the bank. “Receiving constructive income” means you have control over what happens to it.
How does the IRS know when you’ve received checks? Those 1099 statements that your clients send you are also sent to the IRS.
If a customer dates a check as of December 31 and includes it in your 2022 1099, but you don’t receive the check until January 2023, the income for 2023 must be reported. But you may need to add a note when you file your tax return to explain the difference in your 2022 income. Ask your accountant for advice.
Use the cost deduction of article 179
Some purchases you make for your business are considered capital expenditures. These are things like tangible items that you use and don’t run out of, such as a computer, desk, or machine. The traditional way to deduct the cost of such items is to write them off over a number of years. In other words, you deduct a portion of the cost each year over the useful life of the item.
However, under Section 179 of the Tax Code, you can choose to deduct the full cost of such business purchases in one year rather than amortize them over time. This is called “spending” the cost. For example, article 179 is often referred to as the cost deduction.
So if you’ve had a profitable year and you’ve been thinking about buying some equipment, now could be the time to do it. Making the purchase and getting it up and running before the end of the year can save you big on your taxes. Here’s how:
Suppose you operate as a sole proprietorship for tax purposes and you show a profit of $107,000 for this year, which will be passed on your income tax return. Assuming your federal income tax plus self-employment tax is 23% of your income, you pay about $24,610 in taxes.
There is some equipment you want to buy for the company that costs $24,000.
If you buy and spend (deduct) that $24,000 equipment on this year’s tax return, the profit that goes to your personal tax return drops to $83,000 ($107,000-$24,000). Assuming you still pay 23% in taxes, you’ll pay $19,920 in taxes instead of $24,610 — a savings of $4,690.
What kind of real estate qualifies for the expense deduction?
The expense deduction can be used for any type of physical property.
Depending on the nature of your business, you can take a 179 deduction for things like computers, telephones, a 3D printer, lab equipment, machinery, mechanical tools, office furniture, or even a new SUV as the primary use for the business.
If you plan to make a substantial purchase to take advantage of the 179 deduction, talk to your accountant first. They’ll help you decide whether it’s better to deduct the expense in one year or write it off over time.
Can you make use of the cost deduction 179 if you have a claim?
If you operate as a sole proprietorship for tax purposes and you have a business loss for the year, you can still benefit from Section 179. If you have other personal income (e.g. W-2 income), the loss from the business would carry over to your personal return and reduce the taxes due on your personal income.
If you have no other personal income to offset a loss, the loss is carried over to a future year when you do make a profit.
If you operate as a corporation or S corporation for tax purposes, you cannot deduct a business loss from personal income. If you take the 179 expense deduction, the loss carries over to future years when you make a profit.
Article 179 Restrictions
For the year 2022, the maximum Section 179 expense deduction is $1,080,000. That amount is reduced if your company puts more than $2,700,000 of Section 179 property into use in the year. In addition, the Section 179 maximum expense deduction for SUVs brought into service in your business in tax years beginning in 2022 is $27,000.
Maximize other ordinary expenses of running your business
All common and necessary expenses for running your business are tax deductible. So, if you’re having a peak year, consider speeding up the purchase of some items that qualify as common expenses. Your annual income will be lower due to the increased deductions. There are plenty of options. For example:
- If you have a monthly subscription to a photo licensing site, change it to an annual subscription and now pay for the full year. In addition to the tax deduction, you can get a price advantage by switching to an annual price instead of a monthly price.
- Load ink cartridges for your printer now.
- For several months, order paper, mailing boxes, labels and other office supplies that you use regularly.
- Replace the worn chair mat in your office.
- Order new candy or soap molds for your craft business.
- Provide new signage for your shop window or a new display for your exhibition stand.
- Have your office repainted.
- Order promotional products such as pens or magnets to hand out to your customers.
Put your kids to work on weekends and holiday breaks
Let them earn the money they spend on gifts instead of just giving it to them. You benefit by turning a personal expense into deductible business expenses (your child’s salary) and by helping your children learn the value of a dollar. They benefit by earning money and learning real job skills that can help them find a job elsewhere later on.
If your child is under 18, the salary you pay him is not subject to Social Security and Medicare taxes if your business is a sole proprietorship or a partnership owned jointly by the two parents. Salary is not subject to FUTA if the children are under 21. But in either case, the income is still subject to income tax withholding. Read more about hiring a family on the tax authorities website.
Give your retired parents or in-laws a job during the holidays
This assumes that your retired relatives want to work, and what you pay them won’t negatively affect their Social Security benefits. They benefit from the extra income they earn which, depending on their income, may be taxed at a lower rate than yours. They can also benefit from the satisfaction they feel from contributing their skills and knowledge to your success. You get a tax deduction for the money you pay to your parents – money you might otherwise just give to them if they are in financial distress.
Here’s what you need to know:
A person can earn an unlimited amount of money from a job and still receive full Social Security benefits once they reach full retirement age.
But if they’re making money from a job and haven’t reached full retirement age, there’s a cap on how much they can earn from the paid job without losing a portion of their Social Security income.
There are two different income limits. One is for the years prior to the year you reach your full retirement age. A different limit applies to the year in which you reach full retirement age.
For 2022, the limit is $19,560 for those who do not reach full retirement age in 2022. Once you reach that income limit, the IRS deducts $1 in Social Security benefits for every $2 earned.
The earning limit changes in the year that you reach full retirement age. So for individuals who reach full retirement age in 2022 (e.g., July 1, 2022), the income limit is $51,960. The IRS deducts $1 in benefits for every $3 earned above $51,960. But it only counts earnings before the month in which you reach full retirement age. From that point on, there is no reduction in earnings, no matter how much you earn.
Confusing? A little. But when has the IRS ever made things easy to understand?
Organize a Christmas party for your employees
Unlike other entertainment expenses, holiday parties or company picnics are fully deductible. That is because they act as an incentive to boost company morale and team spirit. The only problem is that you have to invite all employees, and the parties have to be special events, not routine occurrences.
Finance your retirement
If you haven’t already done so, make sure you set up and fund a qualified retirement plan if you are self-employed. Depending on the type of plan you have set up, you may be able to put anywhere from $6,000 to more than $300,000 dollars into a tax-deferred account. Rules and requirements are complicated for anything other than a traditional IRA. So if you have the income to put away a lot, talk to your accountant to determine the right retirement savings plan for you.
Janet Attard is the author of The answer book for home offices and small businesses (published by Henry Holt & Company) and van Business Know-How: An Operations Guide for Home and Micro Businesses on Budgets (published by Adams Media, Inc.).
Disclaimer: The content on this page is for informational purposes only and does not constitute legal, tax or accounting advice. If you have specific questions about any of these topics, seek advice from a licensed professional.