Tax Cliffs and Ladders
If you’ve followed my writings, you know by now I’m not a supporter of making business decisions that are solely based on saving taxes. Let common sense drive your decisions, not taxes.
There are a few scenarios, however, where I might stray from that advice:
- Greg and Jane are married with 5 children. They own a manufacturing business. Their income is targeted to land at $450,000.
Comment: Greg and Jane are at a unique tax cliff. Taxpayers with children are eligible for a $2,000 tax credit per child, which means they are eligible for $10,000 in tax savings. For married filing joint taxpayers, these credits begin to phase out at $400,000 and are completely gone at $440,000. By purchasing a machine that drops their income from $450,000 to $400,000, Greg and Jane would regain $10,000 in tax credits (in addition to normal tax savings).
- Barry is single and owns a consulting business. The business is on track to earn $230K in profits.
Comment: This is another cliff. Most small businesses are eligible for a 20% overall deduction against their taxable income. However, for many professional-type businesses, this deduction phases out as taxable income goes from $182,100 to $232,100 ($364,200 to $464,200 for married filing joint). By finding a business investment to bring his income down to $182,100, Barry would regain the 20% deduction against the remaining $182,100 of taxable income (approx. $36,000 deduction).
- Grant is single and owns a cash-basis consulting business that typically earns $175K per year in profits. This year profit dipped to $75K, due to a $100K customer payment that he will not receive until January 2024.
Comment: Grant is sliding down and up the bracket ladder. If the $100K arrives in 2023, most of it would land in the 22% and 24% brackets. If payment arrives in 2024 and is added to that year’s normal $175K profit for a total of $275K, most of the $100K will land in the 32% and 35% brackets. Grant’s effective tax rate on the same $100,000 payment will be at least 10% higher by receiving it in 2024. Grant would likely be ahead to offer his client a $5,000 discount if they pay him by December 31, 2023. (This important concept is called “bracket smoothing.”)
AS ALWAYS: These scenarios are only meant to get you thinking. Any final analysis should come down to you and your tax CPA working together to identify unique cliffs as described above. Also note, this advice is based on tax law as of 2023.
