Tax planning is a big topic for business owners, especially as we get closer to the end of the year. It’s important to have a strategy in place that will help you identify avoidable costs and ensure that you’re in compliance with federal, state, and local tax laws. This blog post will walk you through these considerations and how they can affect your tax return at the end of the year.
It’s never too late (or too early) to start thinking about your taxes! We hope this article helps you plan ahead for next year — and do what you can now — so that you won’t have any surprises come April 15th. Here are five tax planning strategies business owners can consider.
Rethink Your Tax Structure
When it comes to tax planning for business owners, few things play as big of a role as the business entity itself.
The way the business is structured, whether it be a single-member LLC or a C-corporation, has a significant impact on not only this year’s taxes, but future years as well. Taxes may not have been a consideration when you first started the business, but there’s no requirement that says you have to keep the initial business structure. By restructuring, you may be able to take advantage of different income and distribution strategies that can potentially deliver tax savings.
When corporate taxes were lowered in 2017 as part of the Tax Cuts and Jobs Act, being taxed as a C-corp became an attractive option for many business owners. However, C-corps are also subject to double taxation. This means revenue is taxed when it comes into the business — and taxed again on the way out when it’s distributed as income.
To avoid this double taxation, many small businesses benefit from being taxed as an S-corp, given its ability to avoid self-employment taxes. Income can be taken from the business at a consistent level and profits can be taken as distributions, which are not subject to self-employment taxes.
One of the main purposes behind forming a business entity is to reduce the amount of your personal liability. So while there are many different business structures, the right one ultimately comes down to your personal situation and how you would like income and profits to be distributed. If you’re not sure which one would be most beneficial for your situation, speak with an experienced tax planner who can lay out the pros and cons of each.
Plan Your Tax Savings Payments
Given that taxes aren’t automatically withheld out of revenue as it’s received, business owners are responsible for making periodic tax payments throughout the year (also known as estimated quarterly taxes).
The IRS wants to be paid regularly before the tax filing season, which means that business revenue must be estimated. These estimates won’t always be perfect, and that’s okay. If you overpay throughout the year and end up getting a refund, it could be treated as a bonus, reinvested back into the business, or put toward next year’s taxes. On the flip side, you don’t want to overpay by a large margin (as that would essentially amount to a loan you make to the IRS).
The safe harbor rule allows business owners to either pay 90% of the tax due for the current year or 100% of the taxes paid on the business’ last tax return. If the business has over $150,000 in adjusted gross income, that secondary amount is raised to 110%.
While specifics will depend on your situation and revenue numbers, it may be beneficial to aim higher with these quarterly payments and end up getting a small refund (rather than underpay and potentially be subject to penalties from the IRS). When it comes to taxes, it’s important to be proactive and plan ahead to avoid unnecessary headaches.
Contribute to a Retirement Plan
Contributing to a retirement plan is one of the most popular ways to reduce taxable income. Business owners have several options when it comes to retirement plans. Like in all financial decisions, it’s important to begin with your personal situation, goals, and resources. This approach can help determine which kind of plan makes the most sense.
Each available plan has specific contribution limits and rules that make it a perfect fit for some scenarios. Think about what you are trying to accomplish, as well as what you can afford.
For example, if you’re looking to contribute a fairly significant amount toward retirement and the business has fewer than 100 employees, a SIMPLE 401(k) may be the right fit. While the terms of the plan will determine how much you can contribute, those contributions can be deducted as a business expense when filing that year’s tax return. However, unlike a traditional 401(k), employers are required to contribute to their employees’ SIMPLE 401(k) accounts. So, there’s a delicate balance between the tax savings that you’re going to get and what you must contribute for your employees.
Other options for business owner retirement plans may include a solo 401(k) for solopreneurs without full-time employees, SIMPLE or SEP IRAs, or even cash balance plans which allow for significantly higher contribution amounts. For a small business owner, a SIMPLE IRA or SEP IRA may be sufficient, as they have lower contribution limits and are typically less expensive to manage and administer than other plan options.
Even though it may seem like a big decision, it’s important to remember that the plan can change over time. For example, a new business owner may start out with a SIMPLE IRA because they just want to get started and may not know what profits are going to look like. Over time, they may transition into a different plan that is a better fit for their current needs.
At SYM Financial, we have a qualified plans team that is dedicated to helping business owners navigate all the retirement plan options.
Write Off Bad Debt
If your business has aging accounts receivable and uses accrual accounting, you may be able to write off bad debt. If you’ve made every effort to collect on the owed funds, you may be able to lower the taxable income of your business by writing off this bad debt (rather than waiting for it to be collected at some point in the future). Bad debt can include loans to clients and suppliers, credit sales to customers, and business loan guarantees.
To take advantage of this, you need to prepare an aging report. The report will detail the amount owed to you by all customers and how long it has been outstanding. The total amount of bad debt can potentially be written off. Keep in mind that writing off a bad debt doesn’t mean you have to notify the debtor or cease your collection efforts.
Take a Home Office Deduction
When the IRS created the home office deduction, they probably didn’t expect the entire country to be forced into working from home for a year or more. Lucky for you, if you had to work from home (or choose to work from home), you may have the ability to lower your taxable income.
The IRS provides two options for deducting home office expenses: simplified or regular.
As the name suggests, the simplified option takes a straightforward approach. It allows for a $5/square foot deduction (up to 300 square feet) and the space must be used regularly and exclusively for business purposes to qualify.
The regular approach is slightly more complex as it requires you to determine the actual expenses of your home office. These would include keeping track of expenses such as mortgage interest, depreciation, utilities, and homeowners insurance. This is typically calculated by figuring out what percentage of your home is used exclusively for business purposes and writing off an appropriate percentage of those expenses.
Either option can be an opportunity to reduce your taxable income. Be sure to ask your CPA about which route makes the most sense in your situation.
Tax Planning for Business Owners: Strategies and Tactics
At SYM Financial, we work with business owners to help them effectively manage their business from a financial perspective. Teaming up with a financial advisor can bring clarity to the many decisions business owners are faced with and, ultimately, help make the right decisions for your situation. Additionally, our qualified plans team is available to help answer any questions you may have about choosing (and maintaining) the best retirement savings plan for you and your business.