From the Pinnacle CPA Advisory Group —
Dear Clients and Friends,
Today we conclude our three-week look at mid-year tax planning for 2022. In Part 3 of the series, we address cryptocurrency, reverse mortgages, and a number of strategies to pursue to mitigate your tax liabilities if you are a small business owner.
Virtual currency
Virtual currency (also known as cryptocurrency), such as Bitcoin, has been increasing in popularity. Virtual currency may be used to pay for goods or services, or held for investment. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency. For federal tax purposes, virtual currency is treated as property. As such, it can be classified as business property, investment property, or personal property. General tax principles applicable to property transactions apply to transactions using virtual currency.
Basis in virtual currency is the Fair Market Value (FMV) of the currency on the date it is received. If you receive virtual currency as payment for services, it is considered taxable income and will be subject to both income and Social Security taxes. Also, using virtual currency to obtain cash or purchase goods is a recognizable transaction. If the FMV of property you receive for the virtual currency exceeds your adjusted basis in the currency, you will have a taxable gain. A loss will occur if the FMV is less than your basis. The character of the gain or loss depends on whether the virtual currency is considered your capital asset.
One strategy to reduce your 2022 tax liability on virtual currency transactions is to use the Highest-in, First-out (HIFO) accounting method. To use this method, you will need to specifically identify which units you are transferring in the transaction. You also will need to keep detailed records of all virtual currency purchases to substantiate your basis on sale. If you do not keep detailed records, the IRS will default to the First-in, First-out (FIFO) method, which may result in a larger gain in 2022. Fortunately, since virtual currency is considered property and not stock, the wash sale rules do not apply, making it possible to harvest losses (and a deduction) on some of your units and then repurchase the same units immediately. (Note there have been legislative proposals to apply the wash sale rules to cryptocurrency, but none have passed to date).
For more information, check out the IRS guidance on virtual currency.
Reverse mortgages
Due to current inflation rates, some individuals are suffering from cash flow issues. If you are age 62 or older and have substantial equity in your residence, a reverse mortgage may be one way to meet current cash flow needs. A reverse mortgage allows you to receive loan proceeds over a certain period (by borrowing against equity in the home) while continuing to live in the house. Since the loan typically defers all repayment until the house is sold or the borrower dies, lending decisions may be based primarily on your home’s value rather than on your ability to make monthly payments.
To obtain a reverse mortgage, you must own the home outright or be able to pay off any balance with the reverse mortgage proceeds. To avoid default, you must maintain the home, pay property taxes, and provide insurance. Also, married taxpayers should make sure both spouses are listed on the mortgage deed so that any surviving spouse can remain in the home without having to pay off the mortgage.
While a reverse mortgage can help with current cash flow issues, it does not allow a current tax deduction for the interest that accrues on the loan. The interest will not be deductible until the loan is repaid. The repayment (and tax deduction for mortgage interest) generally occurs when you are no longer using the home as your principal residence, you refinance the property, you sell the home, or the home becomes part of your estate. When repaid, the interest is generally considered home equity indebtedness unless used to substantially improve the residence. Since interest on home equity indebtedness is not allowable until 2026 (and then only on $100,000 of indebtedness), you will wish to wait until at least 2026 before making any repayments on the reverse mortgage.
Planning for small businesses
If you own a business, consider the following strategies to minimize your tax bill for 2022:
Section 179 Expense and Bonus Depreciation If your business plans to purchase new or used machinery or equipment prior to year-end, you may be able to expense the entire cost in 2022. Under Section 179, taxpayers can elect to expense up to $1.08 million of qualified purchases, subject to taxable income limitations. Alternatively, your business can take advantage of 100% first-year bonus depreciation. Unlike the Section 179 deduction, claiming 100% bonus depreciation is not limited to taxable income, although another limitation could apply. Many factors can influence this decision, including current and future tax rates. With the possibility of higher rates in 2023, the best choice may be to wait and see if you are going to be subject to a higher tax rate before you acquire assets, if it is feasible to hold off. Also, under current law, 100% bonus depreciation is scheduled to be reduced to 80% for property placed in service in 2023. If you’re thinking of acquiring business property between now and the end of the year, we can help you navigate that decision. Please keep in mind we never want tax savings to be the only factor in the decision of when to acquire assets.
Retirement Plan Contributions Setting up a qualified retirement plan for your business allows you to make deductible contributions for 2022 while allowing the earnings in the plan to build up without taxation until the funds are withdrawn. Selecting the best qualified retirement plan will depend on the facts and circumstances of your business, including your level of income and whether you have employees. Types of available plans include defined benefit, defined contribution, one-person 401(k), Simplified Employee Pension (SEP), and SIMPLE IRAs. Each type of plan has advantages and disadvantages that we will gladly discuss with you to determine which plan is the right fit for your business.
There are limits on the deduction and amount that may be contributed to a plan, depending on the type of plan. Defined contribution plans and SEPs have a maximum contribution amount of $61,000 for 2022, while one-person 401(k) plans are limited to $20,500 for elective deferrals made by the employee and $61,000 for combined employee/employer contributions, and SIMPLE IRAs are generally limited to $14,000. If you are age 50 or older, you also can make additional catch-up contributions of $6,500 for a one person 401(k) plan or $3,000 for a SIMPLE IRA. Defined benefit plans can’t provide an annual benefit that exceeds the lesser of $245,000 or 100% of compensation for the three highest years.
One benefit of making contributions to a qualified retirement plan is that the contribution may not need to be made by the end of 2022. The employer portion of the contributions can sometimes be made as late as 10/16/23.
In addition to making current year deductions, you may be eligible for two tax credits. A small employer who starts a new retirement plan is eligible for a nonrefundable income tax credit of up to the greater of (1) $500 per year or (2) the lesser of $250 per eligible employee or $5,000 for the administrative and retirement-education expenses of adopting a new qualified defined benefit or defined contribution plan, a SIMPLE IRA plan, an annuity plan under 403(a), or a SEP. A second tax credit exists for small employers who include an auto-enrollment feature in a qualified plan. Eligible employers that include an Eligible Automatic Contribution Arrangement (EACA) in a qualified plan can claim an annual credit of $500 for up to three tax years. The credit also is available to employers who convert an existing plan to an automatic enrollment design.
Employing Family Members Employing family members can be a useful strategy to reduce overall tax liability. If the family member is a bona fide employee, the taxpayer can deduct the wages and benefits, including medical benefits, paid to the employee on Schedule C or F as a business expense, thus reducing the proprietor’s self-employment tax liability. In addition, wages paid to your child under the age of 18 are not subject to federal employment taxes, will be deductible at your marginal tax rate, are taxable at the child’s marginal tax rate, and can be offset by up to $12,950 (your child’s maximum standard deduction). However, your family member must be a bona fide employee, and basic business practices, such as keeping time reports, filing payroll returns, and basing pay on the actual work performed, should be followed.
Business Meal Expenses Normally, business meal expenses are limited to a deduction of 50% of the total costs. However, for 2022, food and beverages provided by a restaurant are allowed a 100% deduction. Taxpayers who use the per diem deduction method may treat the entire meal portion of the per diem rate paid or incurred in 2022 as being attributable to food or beverages provided by a restaurant, making the meal per diem 100% deductible. As such, you may want to move any business meals originally planned for early 2023 into late 2022 in order to obtain the higher deduction.
Contact the Pinnacle CPA Advisory Group
We hope you found some ideas in our mid-summer tax planning series that might be useful. If there is anything here that piqued your interest, please let us know. Our goal was to get you thinking about tax planning ideas and potential moves we can make to help maximize cash flow prior to the end of the year. Our Pinnacle CPA Advisory Group tax experts are available to handle all your individual and business accounting services. To set up an appointment to review any tax or accounting issue, call us at (614) 942-1990, send us email at info@cpaagi.com, or just fill out our Contact form at cpaagi.com/contact.