With tax season quickly approaching, the time for many businesses to begin their annual tax planning strategies before the end of the tax year has begun. While many businesses may overlook tax planning as a valuable resource to their business, the potential missed savings from failing to plan for upcoming income tax liabilities can be massive. Often times, year-end tax planning strategies prove to be one of the most important cost-saving initiatives that a business can engage in each year. There are many different strategies that businesses can use to plan for tax season and ultimately improve their bottom line which are discussed below.
Perform a Year-end Projection of Taxable Income
One of the most effective ways that a business can plan for upcoming taxes is to have a year-end projection of their taxable income completed before the end of the current tax year. To have a greater understanding of the potential tax liabilities that lie ahead, a business must understand what their approximate taxable income will be by the end of the year. Year-end projections are one of the most critical planning procedures because they allow the business owner to have time before the end of the current tax year to adjust their operating strategy in a way that best suits them for tax purposes.
Use Forward Thinking – Forecast Taxable Income in Future Years
Once a year-end projection of taxable income has been completed for the current tax year, business owners should try their best to forecast their projected income in future tax years. This will help the business owner decide whether to try to take advantage of tax planning strategies to lower taxable income in the current year, or to plan to take advantage of tax planning benefits in future tax years. For example, if the business owner projects their income will grow exponentially in the future, the business owner may want to defer expenses to future years or try to accelerate income to be made in the current year to mitigate future increases in tax liability. There are many strategies a business owner can use to accelerate income or expenses and defer income or expenses to effectively manage their tax liability which will be discussed further below.
Prepaying for Products and Services
For tax purposes, many businesses file under the cash basis of accounting, which is an accounting method in which taxable income is recognized when received, and all expenses (tax deductions) are recognized once they have been paid for. One tax planning advantage offered by filing the corporate income tax return under the cash basis of accounting is that business owners can strategize on when to pay for their outstanding bills from vendors and suppliers shortly before the end of the tax year to manage their upcoming tax liabilities most effectively. For example, if a company has more taxable income than they prefer in the current tax year, and the business has upcoming services or products that they know they will need at some point in the future, the business might opt to pay in advance for those products and services to take advantage of the tax deductions in the current tax year rather than in a future year.
Purchasing Useful Equipment that is Eligible for Accelerated Depreciation
Another tax planning initiative that businesses can take advantage of is the purchase of equipment or other fixed assets that qualify for an accelerated depreciation methods for tax purposes. Certain methods of tax depreciation such as bonus depreciation and Section 179 depreciation allow a business to deduct more of a fixed asset’s depreciable value earlier than would be allowed under the standard straight-line method of depreciation for financial reporting purposes. If a business has taxable income and would like to lower their current income tax liability, a business may find it beneficial to purchase new equipment before the end of the tax year to take advantage of accelerated depreciation methods for tax purposes. While this strategy is a method that will immediately help the tax liability in current tax years, the depreciation allowed under accelerated depreciation methods will be lower than standard straight-line depreciation later on in the assets useful life, so the accelerated method is most advantageous for businesses with only an immediate need to lower their tax liability.
Paying Year-end Bonuses to Employees
Alternatively, aside from purchasing products, services and equipment, business owners can also use the tax planning strategy to of paying out a year-end bonus to employees as a method to lower taxable income before the end of the tax year. Paying out year-end bonuses to employees may also motivate staff and may provide improved operating efficiency from the staff and management alike. The most effective way to offer a bonus to employees is to have the business contribute to employees’ retirement plans so the employee receives pre-tax income to invest in their retirement plans.
Setting up a Retirement Account
Setting up a small business retirement account can provide many advantages when it comes to tax planning. Having a retirement account can provide many advantages. Contributions from the employer to the small business retirement account, and contributions from the employees are not taxable until distributed to the employee (other than Roth contributions). Contributions to small business retirement plans grow tax-free and distributions from small business retirement plans may be eligible for tax-favorable rollover options and/or transfers into other types of retirement programs.
Deferring or Accelerating Income
While accelerating or deferring expenses can be good ways of managing income tax liability, the business owner can also accelerate or defer income to lower their tax liability as well. For example, if a business owner desire to lower their tax liability in the current year, the business owner might prefer to wait before they charge their customers or clients for the products and services provided, or offer a longer payment period to their customers to allow for income to be collected in future tax years. On the other hand, if a business owner would prefer to increase their taxable income in the current year to better position themselves in the future, they may want to bill and collect income sooner rather than later by improving the collection of receivables.
Should you have any questions regarding year-end tax planning and potential tax saving options, Sasserath & Co. is here to help. Schedule a call with us by contacting us at (631) 368-3110.