2022 Tax Planning: Retirement Savings for the Self-Employed

Preface: Time is more valuable than money. You can get more money, but you cannot get more time. -Jim Rohn

2022 Tax Planning: Retirement Savings for the Self-Employed

Many tax-favored options are available to self-employed individuals to provide for their retirement. Tax planning for retirement can include deductible contributions to a traditional or Roth IRA, SEP plan, SIMPLE plan or a one-person 401(k) plan. You may wish to consider implementing one of these plans for yourself and/or your employees to benefit from a current tax year deduction and accumulate tax-deferred retirement savings.

 Each of these plans has advantages and disadvantages, and some may not be applicable to your situation. For example, a sole-owner 401(k) retirement plan allows a contribution for you as both an employer and as an employee. Therefore, a sole-owner 401(k) plan may provide for the largest deductible contribution. However, a sole-owner 401(k) is not available to the self-employed with employees other than a spouse or relative. As an alternative, a SEP or SIMPLE plan may have less administrative costs. Ultimately, the choice of savings vehicle will depend on factors related to your business and your retirement needs. Regardless of which plan you qualify for or what your retirement needs are, it is important to begin planning now for your retirement.

 Solo 401(k)s

 A one-participant or solo 401(k) plan is similar to a traditional 401(k), except that it covers only the business owner or owner plus spouse. These plans have the same rules and requirements (for the most part) as any other 401(k) plan. They can include the owner’s spouse, or partners and their spouses.

 The business owner is both employee and employer in a 401(k) plan, and contributions can be made to the plan in both capacities. The owner can contribute both: 

  • Elective deferrals up to 100 percent of compensation (earned income in the case of a self-employed individual) up to the annual contribution limit ($20,500 for 2022 and $19,500 for 2021, plus $6,500 if age 50 or older); and
  • Employer nonelective contributions up to 25 percent of compensation as defined by the plan (for self-employed individuals the amount is determined by using an IRS worksheet and in effect limits the deduction to 20 percent of earned income).

For 2022, the Solo 401(k) total contribution limit is $61,000 or $67,500 if you are age 50 or older. 

Traditional or Roth IRA 

A traditional IRA allows a taxpayer to deduct contributions on their income tax return or elect to treat those contributions as nondeductible. Earnings in the IRA are allowed to grow tax-deferred and are only subject to income tax when they are distributed. There is no age limit for making contributions. Distributions are required to be taken annually when the IRA owner reaches age 72. For 2021 and 2022, total contributions to a taxpayer’s traditional and Roth IRAs cannot be more than, the lesser of $6,000 ($7,000 if they are age 50 or older), or their taxable compensation for the year. In addition, the taxpayer may not be able to deduct all contributions if the taxpayer or the taxpayer’s spouse participates in another retirement plan at work. 

A Roth IRA is generally subject to the rules that apply to a traditional IRA. Unlike a traditional IRA, however, a taxpayer cannot deduct contributions to a Roth IRA and qualified distributions from a Roth IRA are tax free. For 2021 and 2022, total contributions to a taxpayer’s traditional and Roth IRAs cannot be more than the lesser of $6,000 ($7,000 if they are age 50 or older) or their taxable compensation for the year. In addition, the taxpayer’s Roth IRA contribution can also be limited based on filing status and income. 

Simplified Employee Pensions (SEPs)

 A SEP (Simplified Employee Pension Plan) IRA is a type of IRA for small business owners or self-employed individuals. This type of IRA allows the employer to make contributions to the accounts set up for employees. Contributions are tax-deductible and earnings are not taxable until withdrawal. One advantage of this type of IRA is the higher contribution limit. For 2022, employers can contribute up to 25% of income or $61,000, whichever is less.


 A SIMPLE (Savings Incentive Match Plan for Employees) IRA Plan is a plan, set up by an employer, in which employees can make contributions of a portion of their pre-tax wages. Employers must also make contributions whether or not an employee elects to defer a portion of their income to the plan. Contributions are tax deductible and investments grow tax deferred until the owner is ready to make withdrawals in retirement. It follows the same investment, distribution and rollover rules as traditional IRAs. SIMPLE IRAs have higher contribution limits than traditional and Roth IRAs and, unlike a SEP IRA, employees can make contributions to their accounts. Any employer that had no more than 100 employees with $5,000 or more in compensation during the preceding calendar year can establish a SIMPLE IRA plan. An employee may defer up to $14,000 in 2022 ($17,000 for employees age 50 or over).

 Please contact us to discuss the various retirement plan options and how they might apply to your business.

2022 Industry Planning: Income Averaging for Farmers and Fishermen

Preface: “Farming looks mighty easy when your plow is a pencil and you’re a thousand miles from the cornfield.” – Dwight D. Eisenhower.

2022 Industry Planning: Income Averaging for Farmers and Fishermen

Expectations with many of the farmers and fishermen in the United States, is that income has fluctuated widely during the past several years. Due to the extremely uncertain variables that affect farming revenues, including weather, drought, and other uncontrollable factors, it is common to have very little income in a poor year, with a large amount of income the subsequent year. By electing income averaging and spreading your farming income from a profitable year over a three-year period, you may be able to lower your tax liability for the successful year by avoiding the higher tax brackets. For example, if you have a high profit year after low-income years you would benefit as your farm income which otherwise would be taxed at the 25 percent rate or higher would be shifted to the 15 percent bracket for the prior years, thus saving taxes.

There are a number of rules you should understand in order to decide whether to make this election. You may make the tax election if you are a sole proprietor in a farming or fishing business, a partner in a partnership engaged in farming or fishing, or a shareholder of an S corporation engaged in farming or fishing. An estate or a trust may also not be selective with this election.

Under the election, the tax imposed in any tax year will equal the sum of the tax computed on your taxable income, reduced by the amount of farm income elected for averaging, plus the increase in tax that would result if taxable income for each of the three prior tax years were increased by an amount equal to one-third of your elected farm income. Your elected farm income is the amount of taxable income attributable to any farming business and which you specify under the election. Elected farming income can include gains from the sale or disposition of property or equipment, other than land, which you were regularly operating for a substantial period in your farming business.

For purposes of the income averaging election, a farming business includes operating a nursery or sod farm, raising or harvesting of trees bearing fruit, nuts or other crops or ornamental trees, or raising animals. Note that a farming business does not include the harvesting of crops grown by another person or the buying and reselling of plants or animals that are grown or raised by another person.

Although income averaging allows you to range the latitude of your farm income from a high-income year over the three prior years, it does not always result in a lower tax for the election year. In some cases, when the tax for a base year is calculated on the taxable income for that year plus one-third of the elected farm income, a higher tax rate may apply. Additionally, once the election is made, it can only be revoked only with the permission of the IRS, therefore it is important that all the relevant tax factors be considered.

Please contact our office if you would like to further discuss how income averaging might work for you as a farmer or fisherman.

Spending on Equipment and Saving on Taxes

Preface: Control your expenses better than your competition. This is where you can always find the competitive advantage. -Sam Walton

Spending on Equipment and Saving on Taxes

Credit: Jacob M. Dietz, CPA

Do you like to save on taxes? Most taxpayers do. Do you enjoy having the right equipment for the job? In some cases, taxpayers get the double blessing of purchasing the right equipment to run their business and sending in less taxes to the government. Although “depreciation” might sound like a boring word, the tax savings are not boring. Working hard with the right equipment does not have to be boring either.

Business taxpayers depreciate, or expense, fixed assets on their tax return. Certain things that businesses buy, such as expensive equipment, buildings, and so on, cannot simply be written off as an ordinary expense. Instead, it must be capitalized as an asset, and then expensed as depreciation. This depreciation is normally over a period of years. In some cases, the IRS allows the business to deduct it all in one year using bonus depreciation or section 179 expense.

Normally a business has a depreciation schedule that lists their fixed assets, when they bought it, what it cost, how much is being depreciated this year, and so on. Often the tax preparer maintains this schedule.
The complexity of depreciation could put some to sleep and irritate others. This article will not dive into all the details but cover certain areas of depreciation. For further information, or for help falling asleep, consider reading all 112 pages of IRS Publication 946 “How to Depreciate Property.”

In Service

Taxpayers should place property in service before depreciating it. IRS Publication 946 explains that it is in service “when it is ready and available for a specific use.” The “Farmer’s Tax Guide”, which is Publication 225, gives the example of a planter purchased in December. Since the planter was “ready and available” depreciation starts in December even though it is not planting season and the planter will not be used until spring.
The “Farmer’s Tax Guide” goes on to explain that if the planter was not assembled when it arrived, and the farmer does not assemble it until the next year, then depreciates starts in the year it is assembled. If you are still awake after reading IRS Publication 946, consider reading the 94 pages of the “Farmer’s Tax Guide” to help with insomnia.

Determining which year to start depreciation can sometimes be difficult. Another problem that can arise is a taxpayer might order a piece of equipment in one year, but it does not arrive until a future year is already well underway. In that situation, the equipment most likely is not ready and available for service in the year ordered. If you are counting on the depreciation from a large purchase to reduce your taxes, considering confirming with your accountant before the year is over to see if your equipment will qualify. If you are a taxpayer in Pennsylvania, and your equipment is sailing across the Atlantic from Europe on December 31st, then it probably is not ready and available for service. If your business is either fishing or recovery of sunken treasure, however, the answer may be different.

Getting in a Pattern

If your business operates multiple pieces of equipment that periodically wear out, you may want to consider a purchasing pattern. For example, suppose your business operates 5 forklifts. You expect them to last about 5 years. One option would be to buy 5 new forklifts every five years. That could put a strain on the finances in that 5th year. It could also give you a large depreciation deduction in that year.

Alternatively, you may want to develop a pattern of replacing a forklift about once a year. That would spread out the cash needs. It would potentially allow you to optimize the depreciation deduction each year. If you happened to have a bad year, you could consider delaying, if possible, the purchase until the next year when the tax deduction might be more helpful, and when you might have more income. On the other hand, if you were having an exceptionally good year, you might choose to accelerate your pattern and buy 2 forklifts in the same year.

Bonus Depreciation and 179 Expense

Although depreciation can take years, and in some cases decades, for the taxpayer to expense their costs, the tax code provides some taxpayer-friendly ways to accelerate the deduction. One is section 179 expense. Another is bonus depreciation. I will not go into all the complexities and details and differences of these two options, but I will say they can be very beneficial for a taxpayer looking for a quick tax deduction. Not all purchases qualify, however. If you are hoping to take bonus depreciation or to expense under section 179, you may want to talk with your accountant before the year ends and confirm if your property qualifies.

Election to Capitalize Repair and Maintenance Costs

The IRS provides an option to capitalize repair and maintenance costs. If a taxpayer elects to do so, they may capitalize and depreciate repairs and maintenance instead of expensing them as a repairs and maintenance. Why would a taxpayer make such an election? There could be multiple reasons. One reason would be to increase their income for that year and reduce it in future years with depreciation expense when the expense would be more helpful.

For example, suppose a business had a rough year and income is down. The business expects profits will pick up in the future. The business owner may see limited benefits of getting his income too low this year, but the owner might benefit more from the deduction in a future year. This election allows the owner to do that. If in the future the taxpayer is in a higher tax bracket, then each dollar of deduction might save more in taxes in the future.

De Minimis Safe Harbor Election

Have you ever studied a depreciation schedule? If so, perhaps your eyes glazed over. Now, imagine if that depreciation schedule were twice as long. That could be a challenge to track.

Fortunately, the IRS has a de minimis rule for amounts too trivial to worry about. Taxpayers can elect on their tax return to deduct certain amounts without capitalizing and depreciating them. The amounts that are considered de minimis can vary. $2,500 is a common threshold used.
How does that work? Suppose a business taxpayer buys a generator for $2,000 that will last for 5 years. Under the general rules of depreciation, that generator should be capitalized and depreciated. If the taxpayer is using the $2,500 de minimis safe harbor, however, then the taxpayer deducts that generator without ever putting it on the fixed asset schedule. Over a period of years, this threshold can keep a lot of de minimis tools from cluttering the depreciation schedule.

Tax Planning

Depreciation can play a significant role in tax planning. If a taxpayer had a good year, then the tax bill might be enough to cause a significant dip in the checking account. Placing equipment in service by the end of the year can significantly decrease taxes if section 179 or bonus depreciation is taken.
Caution should be exercised, however, before simply buying equipment to save on taxes.

First, will the purchase qualify for bonus depreciation or section 179 in the year you wish it would qualify? Sometimes an asset will not qualify for reasons such as what type of asset it is, or when it was placed in service, or from whom it was purchased. For example, the code prohibits taking section 179 expense on purchases from certain related parties.
Secondly, you will spend more money on equipment than you save in taxes. The exact percentage you pay in taxes will vary depending on multiple factors, including your level of income and the state in which you reside.

Let’s suppose someone is in a 30% tax bracket for federal, state, and local income tax combined. Suppose their accountant estimates their taxes for them in December, and the projected tax causes concern. What can be done? The business taxpayer could rush out and buy equipment costing $10,000. In that case, they just saved $3,000 (30% of $10,000) and they spent $10,000. The net result is decreased cash of $7,000. If the taxpayer doesn’t have a use for that equipment, then that could be a waste of $7,000. On the other hand, if the taxpayer had a good use for that equipment, then they essentially received $10,000 worth of equipment for an effective price of $7,000.

If you run a business that purchases significant amounts of equipment, then you are probably already aware of the benefits of both having the right equipment and depreciation. Buy wisely and depreciate wisely. Enjoy working hard with your new equipment and enjoy the tax savings from depreciation.

Proverbs 21:5 “The thoughts of the diligent tend only to plenteousness; but of every one that is hasty only to want.”

This article is general in nature, and it does not contain legal advice. Contact your advisors to discuss your specific situation.

What Is A Strong Balance Sheet?

Preface: “And just remember, every dollar we spend on outsourcing is spent on US goods or invested back in the US market. That’s accounting. – Arthur Laffer

What Is A Strong Balance Sheet?

Credit: Donald J. Sauder, CPA | CVA

A sage banker recently advised his client to have a strong balance sheet to prepare for the numerous developing shifts in regional and global marketplaces. Why? Because a business with a strong balance sheet is more likely to weather any overcast recessionary effects and be positioned to gain market share once fair-weather reemerges.

Most accountants will agree that assets = liabilities + equity. So the basic assumption of a strong balance sheet is to have more equity and fewer liabilities. Yet, there is much more to a strong balance sheet than equity.
As long a business can obtain a net profit for the year or quarter during a recessionary climate, the equity should hold fairly steady, albeit the business doesn’t require substantial distributions to finance owner personal obligations and investments (e.g., rental properties, funding for other debt such personal mortgage, taxes, or standard of living cash flows). Guarding against excess non-deductibles (owner draws, debt payments. etc.) helps insulate a balance sheet from atrophy.

Therefore, one of the primary considerations for a strong balance sheet is to analyze ongoing and recurring cashflow requirements for both business and personal obligations, e.g., non-deductible cash uses. What percent of business operating cashflows are available for financing activities, what allocations are discretionary, and what amounts are non-discretionary?

For instance, I recently heard a CPA talking about some quick analysis calculations for several clients to answer questions on appraising strong balance sheets with some back-of-the-envelope projections of what cashflows could look like if top-line sales ebbed 20% to 40% depending on the challenges expected with shifting economic winds in the marketplace.

In contrast, the worse thing a company can do is run out of money. Interestingly, based on increased interest costs, cashflow requirements for debt payments, and a caveat of higher taxes rates, it appears that some banks are willing to extend 20% or more in debt financing than can be comfortably managed in such trough scenarios by some borrowers, i.e., the companies could still be marginally profitable, and yet be in special assets situations in such scenarios, because their balance sheets are too unwieldy.

Another feature in analyzing a solid balance sheet is looking at working capital. Working capital is current assets – current liabilities. How much of your working capital is tied up in inventory, how much is cash, and what $ | % is allocable? Astute financial managers monitor working capital levels constantly and regularly prioritize optimization.

Experienced managers are proactive in balance sheet management and divest excess cash-intensive assets with low ROIs before they become a business detractor or decrease in value, e.g., surplus equipment, trucks, and vehicles. Business is not speculation. However, many business owners approach to inventory and asset management as such. It is best to remember that such speculative rewards are often simply a matter of time and chance. It’s like the Monopoly Chance card to pay for houses and hotels. It’s not a problem in the game of Monopoly unless someone speculates without considering the odds.

Although the definition of a strong balance sheet varies, the banker advising such in the second half of 2022 is astute. Do you have a strong balance sheet in your business (say 80%+ equity to assets), Congratulations! If you don’t know, talk with an advisor who can help you analyze and suggest actions to develop a plan to implement any necessary improvements.