2022 Year-End Tax Planning for Professional Services Businesses

AMBER TEAGUE: Okay, welcome to Cherry Bekaert's professional services podcast series. I'm Amber Teague, a partner in our Austin office in our private client service group at Cherry Bekaert. With me today is Dale Hrapchak, a partner in our Austin office in the professional services group.

DALE HRAPCHAK: Hi, Amber. Nice to be here.

AMBER TEAGUE: Today we're going to talk about year-end tax planning for the professional services industry. Dale, why don't we get started? What are some basic tax planning items companies should be thinking about at year-end, for instance for an accrual-method taxpayer?

DALE HRAPCHAK: We get this question a lot. Clients call at year-end trying to decide what to do with year-end invoicing and year-end balances, and they're often focused on reducing taxable income while remembering that income may be benchmarked to compensation.

DALE HRAPCHAK: For accrual-basis companies, you can control invoicing timing. Consider whether invoicing should be sent before year-end or after. Focus on progress billing: if you don't need to send a progress bill before year-end, push it a few days to defer income into the next year.

DALE HRAPCHAK: Payables are harder because you rely on vendors. Make sure all vendor payables are recorded at year-end and reach out to larger vendors to request invoices dated before year-end. Remember that constructive receipt of payment is income regardless of whether you deposit it in your bank.

DALE HRAPCHAK: If you're a cash-method taxpayer, work with your clients to determine whether they will send payment for year-end invoices. To defer income, have clients hold payments until after year-end where possible. For payables, pay them before year-end to reduce taxable income.

AMBER TEAGUE: Great points. Any other year-end planning considerations?

DALE HRAPCHAK: A few. Fixed assets: place fixed assets in service before year-end to qualify for bonus depreciation. One hundred percent bonus depreciation applied in 2022 and begins to phase down after this year. Assets only need to be placed in service, not fully paid for, to qualify.

DALE HRAPCHAK: Payroll: if employees earned substantial compensation this year, consider paying bonuses before year-end to get the deduction now. Also, if you haven't evaluated the Employee Retention Credit (ERC), there may still be time to pursue it. ERC is not just tax savings; it can be real cash refunds. Contact our ERC team if you haven't evaluated eligibility.

DALE HRAPCHAK: Research and development activity is common among professional services clients, and you should evaluate R&D tax credits. Starting in 2023, Section 174 requires research and experimental expenses to be capitalized and amortized rather than currently deducted, with domestic amortization generally over five years and foreign over 15 years. If possible, accelerate R&D deductions into the current year to obtain current deductions.

DALE HRAPCHAK: Those are some basic tax planning tools. Since many professional services firms are pass-through entities, owners are taxed individually. If your business uses debt for asset acquisition or working capital, pay attention to debt-related rules because debt can affect deductibility of losses and the taxability of cash distributions. The interest expense limitation could also apply.

DALE HRAPCHAK: I strongly recommend calling your tax professional at Cherry Bekaert to discuss tax planning if you have debt on the books.

AMBER TEAGUE: Good point. For individuals, what should owners be thinking about for year-end planning?

DALE HRAPCHAK: I covered several business items. Amber, what should individuals consider?

AMBER TEAGUE: Start with your overall tax situation. Don't limit planning to your company's books or your individual return alone. They work together. Begin with an income statement and a tax projection; early December is a good time since you'll have 11 months of activity and can estimate the final month.

AMBER TEAGUE: Use that projection to identify planning opportunities in the remaining weeks of the year. Review capital gains activity with your financial advisor and consider tax-loss harvesting to offset gains. Be aware of your capital gains tax bracket; if you're in the 0% bracket for capital gains, you may not need to harvest losses this year.

AMBER TEAGUE: Review retirement contributions. If you're self-employed, consider a SEP for higher deductions and ensure you're maximizing 401(k) contributions. Look at health savings account contributions if you're in a high-deductible health plan, noting that Medicare recipients generally cannot contribute to an HSA.

AMBER TEAGUE: For deductions, decide whether to take the standard deduction or itemize. If itemizing, consider bunching deductible expenses into a single year, such as property taxes and charitable contributions, to exceed the standard deduction threshold.

AMBER TEAGUE: Charitable strategies include donor-advised funds, donating appreciated stock to avoid capital gains, and qualified charitable distributions (QCDs) from IRAs. QCDs are subject to a $100,000 limit and are available once you meet the age requirement of 70½.

AMBER TEAGUE: For tax payments, some clients prefer increasing withholding on retirement distributions instead of making additional estimated tax payments, because withholding is treated as paid throughout the year and can help avoid underpayment penalties.

AMBER TEAGUE: Every individual's situation differs, so consult your CPA before implementing planning ideas that colleagues recommend.

DALE HRAPCHAK: Start with a detailed income and tax projection. You need to know where you expect to be to evaluate whether specific planning tools will work and to quantify the tax savings of any actions.

AMBER TEAGUE: Also, update your tax plan whenever circumstances change. If a client experiences an unexpected income event, check in with your advisor to understand the impact and possible offsets.

DALE HRAPCHAK: It often seems the accountant is the last to know, but the accountant can help implement many of these planning ideas to save tax.

AMBER TEAGUE: At year-end, consider making gifts to family. The gift tax exclusion was $16,000 per donee in 2022 and increased to $17,000 for 2023.

DALE HRAPCHAK: Gifts are an estate planning and estate tax savings tool. Making annual exclusion gifts can materially reduce future estate tax exposure.

AMBER TEAGUE: Anything else we didn't touch on that professional services businesses should consider?

DALE HRAPCHAK: A few items that aren't top of mind but are important. The pass-through entity tax election is a state-level solution some states adopted to work around the federal SALT cap. Under this approach, state taxes can be paid at the entity level and deducted by the entity, producing a federal tax benefit for owners. State rules vary, so contact our state and local tax (SALT) team if you're a multi-state pass-through entity.

DALE HRAPCHAK: Retirement plans are among the best tax savings tools because they help you save while reducing taxable income. Our wealth management team offers retirement plan solutions that may allow high-dollar contributions beyond typical annual limits; contact us to learn more.

DALE HRAPCHAK: For A&E and other professional services firms working on energy-efficient building projects or government-related projects, the Section 179D deduction can provide substantial tax benefits. Our credits and accounting methods team has expertise in Section 179D.

DALE HRAPCHAK: Those are three off-the-wall items that can yield significant tax savings, and you should reach out so we can connect you with the right specialists.

AMBER TEAGUE: For individuals, if you experience a large unplanned income event, contact your CPA. You may have capital loss carryforwards or other items that reduce apparent tax liability, so consult your CPA to avoid surprises at tax time.

DALE HRAPCHAK: For professional service providers, income from providing services is generally taxable and difficult to eliminate. If you have cash from taxable income, find dual-purpose uses for that cash—retirement savings, charitable contributions, or business equipment—so the expenditure has both personal or business benefit and tax benefit. Avoid spending a dollar to save less than a dollar in tax; aim for dual benefits.

AMBER TEAGUE: If you have any questions, email me at ateague@cbh.com. Thank you for joining us today. Please join us again for our next podcast.