Proactive tax planning is a year-round endeavor, but the year’s end presents business owners with opportunities to maximize their tax savings.
Here are a few key strategies to consider before ringing in 2022.
Fill Up Your Retirement Funds
It’s essential to save as much as you can for retirement in tax-advantaged accounts like 401(k)s or IRAs.
Apart from setting yourself up for success, it’s an excellent way to manage your taxes so that you keep as much of your earnings as possible (and lower your taxable income along the way).
If you have the funds, contribute the maximum amount possible in these accounts every year— it’ll grow exponentially and provide you with financial security for your ideal retirement plan. In 2021 you can save the following amounts:
- 401(k): $19,500 with an extra $6,500 for those over 50 (the same limits apply to a Solo and Roth 401(k))
- SEP-IRA: Employers can contribute up to 25% of an employee’s salary
- SIMPLE IRA: $13,500 with $3,000 in catch-up contributions (other stipulations apply)
- IRA (Traditional and Roth): $6,000 with an extra $1,000
- HSA: $3,600 for single coverage and $7,200 for family coverage
In addition to simply choosing to save, proactive tax planning can help you understand how to save.
Tax-Conscious Investing Considerations
Given that it’s year-end, you can procure a reasonably accurate estimate of your earnings for the year. Based on your projections, consider what tax bracket you’ll be in and whether you expect it to be higher or lower in retirement.
This year, does it make sense to contribute more in traditional or Roth accounts? Here is a general rule of thumb.
- Tax-deferred accounts make more sense if your income is higher now since you’ll be able to deduct your contributions and avoid a higher tax bracket.
- If it looks like your tax bracket will be higher in retirement, then a Roth is often the better option because you’ll pay taxes on the funds at a lower rate now than in the future.
As a business owner, you should pay particular attention to a special depreciation opportunity provided by the Tax Cuts and Jobs Act. The TCJA allows for a “first-year bonus depreciation” of qualified used and new property that was acquired and placed into service during your 2021 business year. This is a good strategy to consider if your income will be significantly higher this year because it allows you to expense up to 100% of property that usually must be depreciated over many years. It can drastically reduce your taxable income.
You should also be proactive about the potential tax changes in 2022. Biden’s current proposal calls for tax increases on single filers who make over $400k and $450k for married couples that file a joint return.
Examine Your Stock Options & Equity Compensation
Are you getting equity or stock options as part of your compensation? Great! Equity compensation can add a significant boost to your income.
Just be mindful of how each type is taxed. Year-end is an excellent time to examine each and make any moves necessary to avoid higher-than-necessary taxes.
ISOs and NSOs
If you receive stock options, they will likely be either incentive stock options, ISOs, or nonqualified stock options, NSOs.
- If you have NSOs, you’ll incur an income tax liability for the difference between your exercise price and the fair market value on the day you exercise. Then, you’ll owe the appropriate capital gain tax – long or short term – on any capital gains you realize after you sell the shares.
- ISOs receive a more favorable tax treatment. You won’t have to incur a tax liability the day you exercise, and the difference between your exercise price and the fair market value (the spread) could ultimately become a long-term capital gain if you hold it long enough. Remember that while you don’t have to pay taxes the day you exercise, the spread will count towards your alternative minimum tax calculation (AMT). AMT is a secondary tax reporting system designed to ensure that high earners pay enough taxes. Our team can help you create a plan.
When you exercise, how much you exercise, and how long you hold the stock after exercise all affect your tax efficiency—plan for those decisions with your other taxable income in mind.
If you’re receiving restricted stock in the form of RSUs, they are taxed at the end of the vesting schedule when they convert to stock. So, check to see if any of your RSUs are vesting or have vested this year — it could make a big difference to your tax bill, as it’s counted as taxable income. There’s not much you can do to directly affect your tax liability from vesting RSUs, but it matters so you know to account for it in your other tax moves.
Regardless of the tax status of your equity comp, don’t forget about simple diversification. If you’re receiving stock options from your company, make sure you’re continually rebalancing your portfolio. You don’t want too much of your savings tied up in any single investment, especially your employer. Your human capital is already tied to the company you work for. By placing your investment capital into your company, you become severely under-diversified.
A non-qualified deferred compensation plan may also be a solution for those who max out their other retirement accounts. In NQDCPs, you have the option of postponing part of your pay until after you retire — and defer taxes on that compensation until after you retire. Spreading your income out could keep you in a lower marginal tax bracket.
Control Profits with Tax-Loss Harvesting
Capital gain tax applies to your net realized gains, so selling investments to realize losses is one way to control that. You can then use those losses to offset any taxable gains you have realized during the year and lower your net taxable gain. On top of that, if your losses are more than your gains, you can use up to $3,000 of excess loss to wipe out other taxable income.
You don’t have to do it on a year-by-year basis either. You can control when you realize those losses. Depending on your income today versus the future, those losses are better realized in either higher income earning years or years where tax rates increase (hint: potentially 2022!).
All these strategies start with reviewing your year and taking conscious, intentional next steps to maximize your tax breaks. If you need help with your tax planning, contact us today.