As year-end approaches, this is the ideal time for business owners to project their expected Federal income tax liability, identify potential opportunities for minimizing taxes, and execute the plans prior to year-end. In this spirit, we’ve assembled our list of Top 15 Tax Planning Tips for Business Owners.
1. Get Your Accounting in Order
The first requirement for solid tax planning is to have accurate and updated books and records for your business. The financial reports provide a basis, together with forecasted revenues, expenses, and collections, to project taxable income. Only then, is it possible to identify the particular tax strategies that may benefit both the business and business owner.
2. Evaluate Entity Structure
It’s a good idea to take a hard look at how your business or businesses are structured AND taxed. There are many considerations (and limitations) when making elections (or not making those elections) as to how an entity may be taxed so this requires thoughtfulness and solid guidance. Making the right move on how to structure their businesses can result in big savings, especially when it comes to self-employment taxes.
3. Do the Math – Accrual vs. Cash Basis Filing
Many business owners are not aware of whether their business is filing taxes on an accrual basis or a cash basis nor do they know why it was set up that way and how it impacts their tax liability. It’s important to do the math to see if making a change makes good financial sense. And be sure to recognize that there is a special form required by the IRS (Form 3115 – Application for Change in Accounting Method) to enact the switch from accrual to cash (or cash to accrual) for existing businesses.
4. Deductions, Deductions, Deductions
Many business owners fail to implement solid accounting practices which ensure that all valid business deductions are captured (i.e. not reconciling their bank/credit card accounts, not using business bank/credit card accounts exclusively). Double-check personal bank/credit card transactions to see if any business expenses were accidentally paid for with personal funds. If that occurred, write a check to reimburse these expenses and get them recorded so they can get deducted.
In this same vein, it’s important to make sure that expenses are classified appropriately to maximize the deductibility of expenses or comply with the many deduction limitations.
5. Write off Inventory
Under the Tax Cuts and Jobs Act, businesses qualified as cash basis taxpayers (less than $25 million in gross receipts on average) are allowed to treat their inventory as non-incidental materials and supplies which can be written off in the year purchased. This additional deduction can be extremely powerful depending upon the amount of inventory being carried. A Form 3115 will also be required to enact this change in accounting method on the business tax return.
6. Goldilocks the 199A Deduction
The Section 199A deduction created under the Tax Cuts and Jobs Act provides many owners of sole proprietorships, partnerships, S corporations, and some trusts and estates, a deduction of income from a qualified trade or business. The Section 199A or QBI deduction, at a very high level, is essentially the lesser of 20% of qualified business income or 50% of W-2 wages paid by the business. In some cases, W-2 wages aren’t sufficient to maximize the QBI deduction even though the business owner could have bonused themselves an extra paycheck to get more of it. Doing the math at year-end is really important to make sure the business has wages that are “just right” to optimize that 20% QBI deduction.
7. Set-up Retirement Plans
Whether it’s a 401(k), Cash Balance Plan, SEP IRA, or SIMPLE IRA, employer contributions to these retirement plans are tax-deductible. For some plans, cash basis taxpayers can accrue the amounts payable at year-end and take the deduction while being allowed to delay funding of the contributions until the entity return for the business is filed the following year.
8. Max Out Depreciation
If you are looking to purchase equipment that is needed in your business, whether you are paying cash for the assets or financing the purchases, the business is likely able to write off the entire amount of the asset either under bonus depreciation rules or Section 179. Also, remember that that IRS only requires assets of $2,500 per piece of property to be capitalized/depreciated, so anything less than that is just an expense.
9. Own a Building? – Do a Cost Segregation Study
If you own commercial property that is owner-occupied or commercial rental property generating a profit, then it would be worthwhile to complete a cost segregation study. Commercial buildings are typically depreciated over a 39-year life, which is a really long time. A Cost Segregation study essentially dissects the purchase price (or construction costs) to identify the property that could be depreciated over 5, 7 or 15 years, thus accelerating the depreciation deduction and creating additional tax savings.
10. Innovation Alert - Check out the R&D Tax Credit
A business that is developing/designing new or existing products, processes, prototypes or software programs may be able to participate in a government-sponsored tax incentive that rewards companies for conducting this R&D in the US. The R&D Tax Credit is available for businesses of all sizes and many company activities qualify.
11. Put Kids to Work
One of the benefits of being a business owner is that you can put kids to work (and they do have to work). If kids are paid less than the standard deduction and have no to little other income (and no FIT is withheld), then they have no personal tax filing requirement and the business gets the tax deduction. Furthermore, kids may be eligible to participate in retirement plans thus creating an opportunity to begin building their retirement at a young age.
12. Charitable Giving and the Donor Advised Fund
For those philanthropic taxpayers wishing to drive down taxable income, it may be worthwhile to consider making a contribution to a Donor Advised Fund. Contributions to a Donor Advised Fund are tax-deductible in the year given and then instructions are provided to the DAF regarding the timing of those contributions to the qualified charities. For example, a donation to a DAF of $100k may be made in 2020 and fully deducted. The DAF distributes $20k each of the next five years to the designated non-profit.
13. Eliminate Future Liabilities
If you are selling goods or services in a variety of states, be aware that sales taxes may need to be assessed to customers. Almost all states now require companies that have nexus – a presence or a level of sales that triggers legal obligation, to collect and remit sales tax. These obligations potentially affect many industries, from click-and-buy retail to distribution to software. Knowing where, when, and how to collect these taxes required under the legal precedence set by the Wayfair decision is the key to avoiding a future liability and associated penalties for non-compliance.
14. Eliminate Penalties
Penalties are non-deductible and a complete waste of money. When it comes to Federal taxes, make sure that conversations occur around the concept of safe harbor (paying at least 90% of the current tax year liability or 110% of last year’s tax liability) so penalties won’t be assessed by the IRS. Also, be sure to pay any remaining taxes beyond safe harbor by April 15th.
15. Special for 2020 - CARES Act
Taxpayers get the chance to carry back any losses incurred in 2018-2020 for up to five years. This act allows taxpayers to adjust and minimize profits that are taxable for years prior 2018. The corporate income tax rate was 35% then against 21% now and for individual taxpayers (with pass-through entities) top tax rates were 39.6% then versus 37% now. The CARES Act provides business owners the opportunity to increase their cash flows and reduce their tax obligations immediately, and in some cases long-term.
ABOUT THE AUTHOR:
Susan Bryant, CPA, Principal at The MB Group provides outsourced accounting and tax solutions so business owners have the freedom to dream big and focus on growth. Building on her experiences as an auditor, Susan works with clients to bring efficiency and discipline to the accounting function in their businesses through the use of our outsourced services. She thrives in crafting personalized and innovative strategies that allow business owners the freedom to dream big, focus on growth, and plan for taxes. As principal for MB Group, Susan has helped MBG to steadily grow to serve over 600 business owners, solopreneurs, and high net worth individuals. Outside the office, you’ll often find her in the kitchen cooking up a new recipe or running to keep up with her two teenage daughters.