Small business owners have faced unprecedented challenges over the last 18 months, and have had to adapt quickly to stay afloat. My grandfather founded a small business in 1932 that my father and uncle continue to operate today. Growing up around a family business, I have always been drawn to the entrepreneurial story and appreciate the need for innovation and strategic thinking in a constantly changing economic environment. As we approach the end of the pandemic, business owners must adapt to the “new normal” and look forward to potential changes like tax reform.
President Biden’s administration recently released the 2022 budget and proposed changes to tax laws. One change is an increased tax rate on long-term capital gains over a threshold to the top ordinary income rate. The proposed changes also would increase in the top ordinary income tax bracket from 37% to 39.6%. The effect of this change would increase the top tax rate for long-term capital gains from 20% currently to 39.6%, plus the 3.8% net investment income tax.
Business owners considering sale transactions could be particularly affected by this change. One option is to sell appreciated assets, including the business, before year-end to take advantage of the current lower rate. The budget for 2022 assumes the capital gains tax changes will be retroactive to April 2021, but it is unlikely that Congress will retroactively change policy more than halfway through the year. The shift in tax rates would likely take effect no earlier than January 1, 2022.
The Employee Retention Tax Credit (ERTC) created through the 2020 CARES Act allows businesses affected by COVID-19 to claim a refundable tax credit for qualifying employee wages. Initially, companies were allowed to take advantage of the Paycheck Protection Program (PPP) or the ERTC. However, Congress recently updated this ruling to enable businesses to take advantage of both the PPP and ERT credits through the end of 2021. Companies that qualify for the ERTC are eligible for a tax credit equal to 70% of qualifying wages, up to $10,000 per employee for each quarter during 2021. Furthermore, payroll tax returns can be amended to claim a 50% credit for 2020. To qualify, a business must have been fully or partially closed due to a government-mandated shutdown or experience a decline in gross receipts, qualified as more than 50% reduction for any quarter during 2020, and a 20% reduction in 2021 when compared to the same quarter in 2019.
Implementing an employee retirement plan is a great way to save if tax rates increase. There are several options for employer-sponsored retirement savings plans, including 401(k), SIMPLE IRA, SEP IRA, and Profit-Sharing Plans. These plans also function as a hiring and retention tool — a differentiator during today’s challenging labor market. The contributions that owners make for themselves and their employees may be tax-deductible. A business with steady revenues could benefit from a 401(k) Profit-Sharing Plan with a Cash Balance Pension Plan, which can provide significant retirement and tax savings. The annual 401(k) Profit Sharing plan contribution individual limit is $58,000 ($64,500 over age 50) for 2021, compared to a maximum of $343,000 in a Cash Balance Plan.
Many industries are dealing with rising input costs, including dramatic wage growth, as demand for goods and services surges. Business owners should not be afraid to raise prices to keep profit margins in line over the next few years. Consumers may even expect some price increases in the current marketplace.
In the rapidly changing post-COVID environment, business owners must have a strategic plan that maximizes revenues and minimizes taxes. Knowing how policy changes could affect your business will have a significant impact on your bottom line.
Sean Gould, CPA/PFS, CFP, is a senior wealth strategist at Waddell & Associates, a fee-only, SEC-registered wealth management firm in Memphis and Nashville. Gould is responsible for managing relationships with clients and providing financial planning services covering the areas of retirement, income tax, estate and gifting, risk management, and education.