Strategies to Get the Most Out of Your Tax Deductions

Many dealers, distributors, marketers and others in the propane industry rely on professionals or software programs for tax savings. Substantial tax savings are, however, largely the result of moves that are undertaken before the close of the tax year.

The old income-shifting strategy of accelerating income to offset unusually high expenses or postponing income until a later year when the tax bill may be lower only works for those using the cash basis method of accounting. Fortunately, more businesses can now use the cash basis method of accounting.

Income Now & Later

When it comes to income, the general rule for cash-basis propane businesses is that income doesn’t have to be reported until the year cash is received, or a check is in hand. Best of all, today most small businesses are allowed to use the cash method of accounting for tax purposes.

A business operating on a cash basis for tax purposes anticipating higher profits in 2023 than in previous years may want to defer revenue as a way of reducing taxable income for 2022. Consider billing late in December, or delaying the deliveries or providing services until January.

Alternatively, if the propane business is expected to be more profitable next year than in 2022, accelerating cash collection before Dec. 31 would allow those amounts to be taxed at a lower rate. And don’t forget the income limits for pass-through businesses.

Write-Offs & More Write-Offs

Rare is a propane business that doesn’t purchase computers, equipment, vehicles or other assets in a year. For those considering buying a new piece of equipment, upgrading technology, etc., the time to do so is before Dec. 31.

While the tax law offers the opportunity to depreciate those items over their useful life, faster write-offs are possible, allowing a 100% write-off for those with profits that require reduction. Of course, not all assets qualify for the faster depreciation write-offs.

Buildings and their structural components, for example, aren’t eligible, nor is property that isn’t “placed in service” and not actually used in 2022. On the plus side, propane dealers and distributors can now deduct or depreciate 100% of the cost of a vehicle or truck.

Remember, however, bonus depreciation is currently 100% but is scheduled to be gradually phased out by the end of the 2026 tax year. That means bonus depreciation will be only 80% of the cost of assets placed in service in the 2023 year.

Abandon for a Write-Off

If equipment or other assets have no value to the operation, the benefits of abandoning it rather than selling might be rewarding. Abandonment could generate an ordinary, fully deductible loss, rather than treating the loss as a capital loss, which is subject to limitations. Of course, abandonment must be documented, and the property really abandoned.

Repair, Don’t Capitalize

Rules created in 2013 and that came into effect in 2016 now allow some expenditures formerly labeled as improvements that must be capitalized and recoverable only via drawn-out depreciation deductions as materials and supplies for an immediate write-off. What’s more, the so-called “de minimis” safe harbor deduction for materials and supplies has been increased from $500 to $2,500, at least for those businesses without an applicable financial statement.

It is not too late to update the operation’s policy for differentiating repairs from capital expenditures to comply with the updated regulation.

Bad Debt Deductions Are Good

While no one wants to write off accounts receivable as uncollectable, doing so creates a deduction for “bad debts.” The tax rules allow businesses using the accrual method of accounting to deduct the bad debt from gross income. Of course, reasonable steps must have been taken to collect the debt with collection efforts occurring before the end of the tax year.

Using the final weeks of 2022 to attempt to collect all outstanding amounts, along with documenting those collection efforts, creates a bad debt deduction. After all, anything that feels like a lost cause can result in tax savings.

Don’t Forget Those Carryovers

Deductions for capital losses, net operating losses (NOLs), home office deductions and even large charitable donations that cannot be fully used in one year may be carried forward to future years. Because these items have a way of slipping through the cracks, make sure to track these deductions and note carryovers from the current tax year’s return. NOL carrybacks, of course, are no longer permitted.

When a propane business’s allowable deductions exceed its taxable income within a tax period, the result is an NOL. Most taxpayers no longer have the option to carryback an NOL, and although an NOL can now be carried forward indefinitely, NOLs carried forward to future tax years are limited to only 80% of the operation’s taxable income.

Provide a Retirement Plan

Offering a retirement plan can go a long way in keeping any propane business’s employees happy while serving as a magnet for new workers in today’s labor crunch. Not only can a retirement plan help retain talent, when the operation provides a qualified retirement plan or 401(k) plan, there are specific employer contributions and administrative fees that can be tax deductible.

As one example, eligible employers may be able to claim a tax credit — a dollar-for-dollar reduction of their tax bill, rather than a deduction — of up to $5,000 for three years for the ordinary and necessary costs of starting a Simplified Employee Pension (SEP), SIMPLE IRA or other qualified plan such as a 401(k) plan.

But, while in some cases actual contributions to these plans can be made after the end of the year, they must be established prior to the end of the year.

Reasonable Compensation

Beware of how much owners and key employees will be paid this year. The IRS can, and all too often will, challenge salary amounts they deem to be “unreasonable.” While the factors used by the IRS and the courts to determine reasonable compensation vary, the IRS typically looks at training and experience, duties and responsibilities, time and effort devoted to the business and more. The courts generally look at amounts paid by comparable businesses for similar services, the use of a bonus formula and the importance of the role played by the compensated individual.

Planning Before Year-End

As the end of the propane operation’s tax year approaches, several general rules might help guide it to real tax savings — savings that will remain consistent year after year:

• Don’t spend money simply to reduce that tax bill. After all, one dollar spent does not equal one dollar’s worth of tax saved or create a one dollar deduction.
• Know thy accounting method. Most year-end tax strategies work best for cash-basis taxpayers. Accrual-basis businesses report all income in the year it is earned and all expenses in the year they are incurred. So, just because the propane business prepays a 2023 expense in 2022 doesn’t always mean that it will result in an immediate deduction on the 2022 tax return.
• Worker classification matters. Every propane dealer, distributor and marketer must correctly determine whether workers are employees or independent contractors. Independent contractors are not, of course, subject to withholding, making them responsible for paying their own income taxes, plus Social Security and Medicare taxes.
• Don’t overlook expenditures for education. With many dealers, distributors and others in the industry cross-training employees because of the shortage of drivers and technicians, costs can add up and should be included on the tax return. Now might also be the time to establish a formal education plan. With such a plan in place, up to $5,250 in a worker’s educational expenses can be deducted. Best of all, no funds are necessary to fund the plan up front.
• Ensure that the operation will be taking every deduction available. Now is the time to keep abreast of our complex and fluid tax laws along with compiling the records that will be necessary to document all transactions, incoming or outgoing.

Above all, remember that the recently passed Inflation Reduction Act not only includes provisions impacting climate change and health care, but it also provides significant funding for the IRS to increase enforcement, create revenue and close the tax gap. In other words, every propane business, large and small, could see more audits.

Planning to Avoid, Not Evade, Is Legal

No less a body than the U.S. Supreme Court has ruled that striving for the lowest possible tax bill is perfectly legal. Thus, planning to produce the lowest possible tax bill should be the goal of every dealer, distributor, marketer and others in the propane industry. Accomplishing that goal year after year usually involves shifting income and deductions around to tax years where they will be the most productive.

Once the work is done and the alternatives tested, make sure the business is actually spending money and not just moving it around. While it is almost always recommended, few in the industry seem to get their tax professionals involved well before the end of the tax. But how can anyone hope to know whether income deferral or accelerated write-offs will be of the most help in reducing this year’s tax bill — and the tax bills in future years?