Posted Wednesday, December 4, 2024
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Year-End Tax Planning
The holidays are coming and people start thinking about year-end moves to minimize their taxes. Every day between Christmas and New Year’s Day we field a zillion questions on year-end tax planning. While some ideas are great, there are pitfalls and sucker-holes. We’ll talk about tax deductions in general. We’ll talk about last-minute tax moves. And Yes, we’ll talk about automobiles. They always seem to top the list of good ideas (or at least most business owners think so).
Also, we have a separate Tax Reduction article that is more aimed at general tax reduction strategies and not necessarily year-end tax moves. However, there is a lot of overlap.
There are two big objectives with end-of-year tax planning-
- Make some moves before December 31,
- Make plans for 2025.
Please don’t forget the “make plans for 2025” part since big changes in business income or other events in your life need to be addressed early, and perhaps before April 15, 2025 for Q1’s estimated tax payment. As such we will talk about this first.
2025 Outlook
If your business income is going to be higher in 2025 than 2024, then we should get a jump on your business tax planning with these considerations. Remember, there is no such thing as an accounting emergency; only poor planning.
Franchise or Business Tax
California is an easy target, but there are several other states which impose a franchise tax or some sort of “pleasure to do business in our state” tax. Additionally, these taxes are similar to income taxes where they must be paid quarterly in advance otherwise underpayment penalties and interest might be incurred.
Pass-Through Entity Tax (PTET)
PTET in a nutshell is the ability to pay your “human” state income taxes with business funds and thereby create a tax deduction for the business and eventually you as the owner. We discuss this in greater detail later. For now, there are two possible PTET dangers here so please pay attention- first, if 2025 is the first year of your pass-through entity such as an S corporation or partnership, and you want to participate in your state’s PTET program, then business tax planning is a must. Payments must be made on time (April, June, September, December) and in some cases, a timely registration and election must be made.
Second, if 2025 is going to be more profitable than 2024, then your PTET payments need to be increased to prevent underpayment penalties and interest. For example, you converted from W-2 to 1099 contractor in the summer of 2024, and 2025 is going to be the first full-year with your new contractor status, a business tax plan needs to be updated to account for your increased 2025 PTET payments (and likely your franchise tax or business tax imposed by the state).
Payroll Processing
If your business profit will jump up in 2025 as compared to 2024, then we must adjust your reasonable salary to accommodate for this change. More importantly, we must adjust your federal and state income tax withholdings. If we wait until tax planning season (May, June, July), two bad things happen- first, you get used to this new cash flow and start spending it, and second, the compression of waiting too long makes catching up painful.
Sooner than later is the motto.
January Business Tax Planning
January is a great time to update your 2025 business tax plan, but only if there is a material difference between 2024 and 2025. If you call up and say, “hey, my business is going to be up 5%, can I get an updated business tax plan?” We will say “Yes, absolutely… but let’s wait until summer.” January business tax planning is very compressed, and therefore we kindly want to reserve it for those who truly need it.
Otherwise, if you are curious about your Q1 or Q2 franchise or business tax, or your PTET payment, please use 2024 as a proxy for 2025 until we can tweak with an updated business tax plan in the summer.
Here is a comparison table for your perusal-
| 2024 | 2025 | |
| IRA | 7,000 | 7,000 |
| Roth IRA Income Limits | 146,000 single | 150,000 single |
| 230,000 married | 236,000 married | |
| 401k Employee | 23,000 | 23,500 |
| HSA Contribution | 4,150 self | 4,300 self |
| 8,300 family | 8,550 family | |
| Social Security Wage Limit | 168,600 | 176,100 |
| Standard Deduction | 14,600 single | 15,000 single |
| 29,200 married | 30,000 single | |
| Gift Limit | 18,000 | 19,000 |
| Foreign Income Exclusion | 126,500 | 130,000 |
| Mileage Deduction | 67 cents | Update in Dec |
Marginal Tax Rates
Quick lesson on tax deductions. When you write a check and it has a tax savings element (401k, IRA, charity, etc.) it is not a dollar-for-dollar savings. For example, if you are in the 22% marginal tax bracket, you must write a check for $4,000 just to save $880 in taxes. Keep this in mind as you read this information on year-end tax savings. Also keep in mind that cash is king, and that perhaps paying a few more taxes today with the added flexibility of cash in the bank can be comforting.
Another way to look at it is this- most people say “I want to save taxes” but really what they are saying is “I want to save cash.” In other words, most people are in the cash-saving business not the tax-saving business. If we can do both, great. However, most tax-savings moves take cash, and cash is what you want to keep. So, keep this concept in mind as review some of the year-end tax moves listed below.
Also!
Tax deductions and tax deferrals are not the same. Tax deferrals are tax bombs later in life; little IOU’s to the IRS and they will eventually call in the chit. But if you use the immediate tax savings to build wealth, then a tax deferral is worth it. Deferring taxes to pay for a cruise vacation might not always be the best approach (then again, live a little!).
Wait, there’s more!
Just because you go $1 into the next tax bracket does not mean all your dollars are taxed at that rate. So, if you are trying to thread the needle with a Roth conversion to not fly too close to the sun out of fear of blowing up your tax world, don’t sweat it too much. Sure, if you push $25,000 into the 32% marginal tax bracket when you could have delayed until next year, that is an 8% x $25,000 or a $2,000 mistake. Sidebar- the 8% is 32% less 24%.
Too Much SALT
The deduction for what you pay in state and local income, sales and property taxes is also getting squeezed. This is commonly referred to as SALT deductions (State And Local Tax). People commonly say SALT deductions and property taxes. Property taxes are inclusive of state and local tax… it is like saying drugs and alcohol. Alcohol is a drug. SALT deductions include all taxes imposed by your state or local jurisdiction. This was defined as such by the Revenue Act of 1913 and later clarified in 1964. Riveting. But somehow we’ve managed to say SALT deductions and property taxes as separate items. At least it is not as bad as saying ATM Machine or ABS Brakes. Who says that? We digress…
The Tax Cuts and Jobs Act of 2017, back when Despacito was the big hit, limited the amount of SALT deductions on Schedule A of your Form 1040 (individual tax return) to $10,000. Therefore, if you have property taxes of $6,000 and California income tax of $6,000, you are only able to deduct $10,000 of this $12,000. This leaves $2,000 on the table, or about $500 if you are in the 24% marginal tax bracket.
Crank this up a bit. How about $12,000 in property taxes and $12,000 in California income taxes? You are short-changed by about $3,400 in cash unless…
There is a work-around for business owners of S Corporations and Partnerships, or what we call pass-through entities or PTEs. About 37 states are allowing business owners to make a tax payment to the state based on net business income. This does two things- first, it reduces the amount of business income subject to federal income tax (your ultimate tax deduction). Second, the state provides a credit for this amount and reduces your state income tax calculation on your Form 1040 (some states don’t provide a direct tax credit, but rather decrease your taxable income by the amount of business profits… Georgia does this, for example, and you arrive at the same spot as a tax credit).
The IRS took note of the workaround, but understood it was perfectly legit. The IRS through Notice 2020-75 states,
Certain jurisdictions described in section 164(b)(2) have enacted, or are contemplating the enactment of, tax laws that impose either a mandatory or elective entity-level income tax on partnerships and S corporations that do business in the jurisdiction or have income derived from or connected with sources within the jurisdiction. In certain instances, the jurisdiction’s tax law provides a corresponding or offsetting, owner-level tax benefit, such as a full or partial credit, deduction, or exclusion.
The IRS continues by stating this practice is permitted under the notice until it can legislate this practice into regulations. Also, there are all kinds of rules, and not every business owner will benefit from making a pass-through entity tax election. As such, the tax planning for determining the efficacy of using this tax deduction is challenging.
Wow. That was a lot of gibberish, huh? Talk to your favorite tax pro at WCG CPAs & Advisors, and make sure you understand this amazing workaround for tax deductions being truncated by SALT limits. The cocktail party fodder term is “PTET election” or “SALT workaround,” where PTET stands for pass-through entity tax. There are some devils in the details, and not all states work the same. Yes, we are as surprised as you are.
The basics are this: Using Colorado as an example, you pay 4.55% of your estimated 2022 net business income to Colorado, and Colorado effectively reduces your tax due by this amount (and this amount reduces your federal income tax). Quick math: 4.55% x $200,000 in business income equals $9,100, and at 24% marginal tax rate puts $2,184 into your pocket if you are SALT limited.
All this nonsense likely sunsets in 2025 unless Congress can extend, so 2026 tax returns due in 2027 might not have this problem. It’s just around the corner everyone! The button below will take you to our Pass-Through Entity Tax (PTET) Deduction article that we posted in early summer of 2022.
Refund Kept by the IRS
Some taxpayers have their refunds kept by the IRS because of back taxes, or other obligations such as student loans. In these situations, you can put yourself in a “tax due” position by decreasing your withholdings on your pay checks and putting more money in your pocket today. Yes, you will still owe whatever it is you owe, but at least the extra cash you pay in the form of excess income taxes withheld won’t be used to accelerate your debt payoff.
Profit Harvesting
This is an oldie but a goodie. Speaking of liking cash: sell some of your profitable stocks along with your dogs. Not literally your dogs, but your under-performing securities. Sell enough to create a $3,000 gain and sell some more to add a $6,000 loss, and presto! You’ve pulled out some cash, yay, and created a $3,000 loss and tax deduction.
Here is another variant to the above year-end tax move: you sell securities whose price is stable yet is lower than what you paid. You use these losses to reduce the capital gains on securities you sold previously (profit harvesting). You wait 30 days to prevent wash sale triggers and re-purchase the securities that were sold at a loss (only if you believe it will eventually rebound in a timeframe that makes sense given inflation and other economic conditions).
Given market conditions now, this is a strong year-end strategy. There is another trick where you borrow against your unrealized gains. It is not necessarily a year-end tax move, however.
Adding Your Spouse to Payroll
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