Year End Tax Tips for Small Business Owners
December is a chaotic month for most people.
The holidays, while joyful, produce their own set of stress and financial burdens.
And for many small businesses, it is the busiest and most important and profitable month of the year.
However, if you run an small business it is also an important month for tax planning.
In December, you can look back on how your business did and make year-end decisions based on this to get your tax bill down.
In this post, I will highlight a few easy ways to pay less taxes by implementing some simple year-end tax planning strategies.
Manage Your Income and Expenses
As the end of the year gets closer, one easy way to reduce your tax bill is to manage any income and expenses you have control over.
- Defer collecting any income you have control over until January.
- Pay any expenses you have control over by December 31.
Controlling your income may be a little harder than controlling your expenses but there are a few ways to do it.
For instance, if you invoice clients for services you provide, hold off on invoicing for December work until the first of the year.
Again, controlling your income is not as easy and may require a little creativity.
On the other hand, managing your expenses as the end of the year approaches is much easier.
Here are a couple ways you can manage your expenses at the end of the year to reduce your tax bill:
- As a small business owner, you likely subscribe to several software services. Prepay for next year for some of them in December. They’ll typically give you a month or two for free and you’ll get a bigger tax deduction this year.
- Signup for any conferences you want to attend next year and book any travel associated with attending.
- Pay any outstanding bills you have.
- If you’ve had your eyes on a new laptop or any other expensive equipment for your business, buy it now.
- If you have employees or contractors you may want to reward some of them for a job well done with a holiday or year-end bonus.
- If you are running your business out of your home or generate business miles otherwise and have been thinking about purchasing a new vehicle, consider doing it by the end of the year to take advantage of really big deductions in the current year (more on auto deductions here).
Make these purchases or pay these bills or bonuses by the end of the year and you will reduce your taxable income for this year.
If you have your eye on a new laptop, tablet or some other equipment, buy it before the end of the year and get the deduction this year.
Keep in mind, a lot of this is all about timing your tax bill.
For instance, deferring some of your income by collecting it next year doesn’t change the fact that you will pay tax on that income.
It simply defers your tax bill on this income for an entire year.
And when it comes to managing your business and personal finances, one of the cardinal rules is that a dollar today is worth more than a dollar tomorrow.
If you can defer some of your tax liability into the next year and invest the current year tax savings back into your business now, you should be better off.
There is one caveat to this advice.
It assumes your business uses the cash method on your tax return, which means you recognize income when it is collected and deduct expenses when they are paid.
Most small businesses do use this method, but if you want to be sure, you can reference your most recently filed tax return.
If you are a sole proprietorship and file a Schedule C for your business, this information is at the top of your Schedule C on line F.
If you are a Partnership and file a Form 1065, it is at the top of page 1 on line H.
And if you are an S-Corp and file a Form 1120S, it is at the top of page 2 on Schedule B, line 1.
If you will be filing your first tax return this year, you can discuss your options with your personal tax advisor, but it is likely that you will elect to use the cash method.
Contribute to a Retirement Plan
Another easy way to reduce your tax bill today when your business is doing well enough is to contribute some money to a retirement plan.
There are several options available to you as a small business owner and many of them will get you a tax deduction.
The easiest option if you are looking for a small tax break this year is to fund an Individual Retirement Account (IRA).
There are some rules and other considerations you must weigh when it comes to contributing to an IRA.
First, you can only deduct IRA contributions to traditional IRAs.
With a traditional IRA, you get a deduction when you contribute your money to the IRA and pay tax on distributions when you take the money out down the road.
There is another option called a ROTH IRA, which allows you to contribute after tax money now but doesn’t tax you when you take distributions down the road.
The ROTH IRA won’t save you any taxes now, so it doesn’t really belong in a discussion on year end tax saving tips, but does make sense for many people.
Contributions to a traditional IRA, SIMPLE IRA, or SEP are deducted on your individual tax return, which reduces your overall tax liability.
There are additional restrictions associated with a traditional IRA.
If your small business is a side hustle and you also have an employer who offers retirement benefits that you are eligible to participate in, your ability to make deductible contributions to a traditional IRA is limited.
If you’re married and your spouse has a job and is eligible to participate in an employer sponsored retirement plan, your ability to contribute to an IRA is also limited.
In 2017, the maximum you can contribute to an IRA and deduct is $5,500 ($6,500 if you’re over 50).
If your business is doing really well and you can afford to contribute more to a retirement plan, you may consider setting up a SEP or SIMPLE IRA.
These retirement plans are relatively easy to set up and offer much higher contribution limits if your business is profitable.
For instance, a SEP lets you contribute and deduct up to $54,000 in 2017.
Of course, navigating all of your retirement plan options and can feel overwhelming.
If you’re interested in pursuing one of these options and need help, you should consider working with a professional advisor.
I recommend finding a Certified Financial Planner (CFP) who works on a fee-only basis, which means they don’t sell high-commission products.
XY Planning Network is an excellent online network of CFPs who focus on working with younger professionals and business owners and many of them understand modern small businesses because many of them operate online and work with clients virtually.
Elect to be an S-Corp
An excellent option that could save you thousands of dollars in taxes if you haven’t already done so is to elect to your have your business treated as an S-Corp by the IRS.
Generally, this must be done by March 15 for the year you want the change to be effective (to be an S-Corp starting Jan 1, 2017 you would file the necessary form by March 15, 2017), but the IRS typically provides late election relief.
Why would you do this as an small business owner?
Any of the other popular forms of small business structure (sole-proprietorship, partnership, LLC) will subject you to self-employment tax on ALL of your taxable business profits.
Self-employment tax equals 15.3%.
And this is on top of your regular income tax.
By electing to be treated as an S-Corp, you can become an employee of your Company and pay yourself a wage (you can’t be an employee in any of the other structures).
So, instead of paying self-employment tax on $100,00 profit, as an S-Corp you can pay yourself a reasonable wage of $30,000-$40,000 (or whatever you deem reasonable) and you will only pay the 15.3% self-employment tax on the wage amount.
An example should help drive this point home:
- You own an small business and your share of taxable profits is $100,000.
- You will pay income tax on the entire $100,000 in both of the scenarios below.
Most Other Popular Structures
- You pay self-employment tax on all $100,000 of the profit.
- This equals approximately $15,300.
As an S-Corp
- As an S-Corp you need to pay yourself a “reasonable wage”.
- There is no concrete definition for what is “reasonable”, but generally you should estimate what you would pay someone else to do your job.
- In this scenario, if you paid yourself a $40,000 annual wage you would only pay about $6,100 in self-employment tax, a savings of over $9,000.
You can elect to be an S-Corp if you are just starting out or if you have been in business for years.
You can even make the election if you are currently an LLC.
In fact, a popular strategy for legal protection and tax savings for many small businesses is to first, create an LLC for legal protection because it is easy to do.
Then, file the appropriate form with the IRS to indicate you want to be treated as an S-Corp for tax purposes.
There are a few things you should consider before becoming an S-Corp.
First, it’s typically not necessary until your small business is making a profit of at least $40,000.
There are additional payroll fees, tax return preparation fees, unemployment insurance costs, professional fees for setting it all up and other expenses associated with making this conversion, so the additional costs will outweigh the tax savings until your business is making a reasonable profit.
Remember, you have to pay yourself a reasonable wage.
So, if your business is only making $30,000 to $40,000 in profit and you pay yourself a reasonable wage, the tax savings won’t be large enough for it to make sense.
It will very well may cost you more than it will save you.
The other consideration is that, if you want to implement this plan at the end of the year, you will need to pay yourself a wage for your entire year’s work in one payroll run.
The IRS typically only grants late election relief if you look and act like an S-Corp for the year you are making the election, which basically means you paid yourself a reasonable wage.
Getting the one-time payroll run taken care of (after which you will pay yourself a wage on a regular schedule), along with filing any other paperwork to make an S-Corp election will likely require the help of a payroll company and/or professional tax advisor, so reach out to your tax advisor sooner than later if you want to consider making this move by the end of the year.
You can read more about the different legal structure options for your small business in this post.
A lot of the information presented in this post can overwhelm a lot of people who aren’t naturally interested in it.
I do my best to break it down in a way that is easily digestible.
Have a question about it?