Another busy tax filing season is behind us and with a return to normalcy this year, without significant processing delays at the Internal Revenue Service (IRS), we can look forward. Now is the time to reflect on 2022 and to plan for 2023. What went wrong in 2022 that we want to avoid in 2023? What went right in 2022 that we want to replicate in 2023? Let’s look at some goals to set to make next year’s tax filing season a success for you as taxpayers.
Advanced Preparation
Preparing for tax season should be a year-round process. Are you always finding yourself working with your CPA right up until the deadline to file an accurate return? In my experience, many taxpayers get to the end of the year and must think back 12 months to properly document income and expense activity. Meanwhile, those that are organized and prepared experience less stress when the calendar flips to a new year.
Are you buying a house? Are you considering a job change? Are you going back to school? When a significant transaction or change in income occurs, notify your accountant at that time. Do not wait until the following April! Not only does this allow for better organization at tax filing time, but it will allow for an opportunity to mitigate the tax impact through proper planning upfront. It will also help to avoid those last-minute “SURPRISE” tax bills. I would encourage everyone to work together with their accountant throughout the year and to schedule a meeting with their CPA at least twice a year.
Planning Points to Reduce the 2023 Tax Burden
Now is the best time to review your overall income and develop a tax savings plan going forward. Here are a couple of easy ways to reduce your 2023 tax burden.
Review Entity Structure
For small businesses, the most important tax decision is choosing an entity structure. Now is a great time to re-evaluate whether a sole proprietorship, LLC, partnership, S corporation or Ccorporation is the right fit for your business. For closely held small businesses, typically the two options you are comparing are an LLC (taxed as a sole proprietorship or partnership) and an Scorporation.
1. LLC – The default classification of an LLC is either a partnership or a sole proprietorship, depending on whether there is one owner or more than one owner. The LLC does not pay income tax. Rather, the income is reported on the individual owner or owners’ income tax returns. This is called pass-through taxation. Below are some of the tax advantages of an LLC:
a. Ownership Flexibility – There are no restrictions on the number and type of owners.
b. Allocation of Income and Distribution of Profits – Profits and distributions are not required to be strictly based on ownership. If some members are contributing “sweat equity,” those members can be compensated with specifically allocated distributions.
2. S corporation – The same benefits of pass-through taxation are realized by an Scorporation. In contrast to the benefits of an LLC taxed as a partnership, an S corporation must have fewer than 100 shareholders that are individuals (with limited exceptions). Additionally, S corporation profits and distributions must be allocated by stock ownership percentages. The most significant benefit of an S corporation compared to an LLC would be the self-employment tax. Currently, S corporation pass-through income is not subject to self-employment tax, while active participants in an LLC are subject to the tax on partnership profits.
I cannot stress the importance of being proactive enough. Tax planning and preparation should be a year-round process. If it is left to figure out in “tax season,” then you will likely overpay. A simple change in procedures and a timelier review of your estimated tax liability are critical to reducing “tax season” stress and, more importantly, reducing your tax liability.