If you’re like most small business owners, you think about taxes once a year — when they’re due. That could be an expensive mistake.
Small business tax planning is important. Meeting with your CPA isn’t just about filing your taxes, it’s about making sure you’re doing the best for your business all year long.
To get a jump on tax planning, you can start simply by making a few strategic decisions about purchases and benefit contributions. These strategies can then grow in complexity as your business grows.
Ready to plan? This guide will help you get started.
What Is Small Business Tax Planning?
Tax planning means analyzing your business from a tax perspective and making strategic decisions that can help you lower your tax liability. While that sounds complex, most tax planning isn’t difficult. It’s taking the time to think through small changes that can save you money on taxes.
For example, if you’re having an incredibly profitable year, tax planning could help you decide to purchase equipment that you need now (rather than putting it off) to take advantage of first-year bonus depreciation on the purchase.
Or, if you pay estimated taxes quarterly, reviewing your financial situation regularly can help to ensure that you’re not sending the IRS too much or too little money throughout the year.
Tax planning has a simple goal: to help you make the best decisions to enable you to keep more of the money that you earn.
How Do You Begin Tax Planning?
If you want to ensure that you’re making the best decisions with your taxes, you’ll want to begin with these three things:
Keep Accurate Records
Good tax planning begins with accurate record-keeping. So much of making sure you’re not overpaying in taxes is dependent on knowing your income and expenses. Inaccurate or incomplete books can mean that you overpay or don’t make the best decisions.
Up-to-date records help you make decisions quickly throughout the year. If you haven’t yet, invest in a bookkeeper or have your accountant help you set up and organize a bookkeeping system. Using a simple system and keeping it updated regularly can give you the best data to analyze your business.
Assess Profitability and Business Needs Regularly
How your business performs shouldn’t be a surprise saved for the end of the year. Keeping accurate and up-to-date records means that it should be easy to get a measure of your financial performance and profitability regularly.
A lot of the tax planning strategies you can employ relate to changes you can make throughout the year, not just at tax time. For example, investing in expensive equipment or hiring a new employee from a targeted group to take advantage of the work opportunity credit.
When you know how your business is performing and what you’ll need to continue growing in the future, it’s easier to look for tax strategies that can support your goals.
Meet With Your Tax Advisor
Your accountant should be doing more than just filing your taxes. They can be a valuable advisor who can help you ensure that the decisions you make in your business are optimal from both a profitability and tax perspective.
Ask your tax professional if they offer advising and planning services that you could work with them on throughout the year. If this isn’t something they offer, it would be beneficial to find someone who will.
What Are Some Small Business Tax Strategies You Can Use?
There are a number of strategies small business owners can use to reduce their taxes while supporting business growth. These are some that will commonly come up during the course of business.
Maximize Allowable Deductions
There are a lot of deductions a business owner can take. As a reminder, deductions will decrease your taxable income. Most business owners know a fair amount about what expenses are allowable, but there are timing and limit issues that need to be considered.
Here are some that you’ll want to familiarize yourself with:
100% Bonus Depreciation
If you’re considering making new purchases for your business, the Tax Cuts and Jobs Act (TCJA) now lets you take a 100% bonus depreciation in the year of purchase for certain items, rather than depreciating it over its useful life. This means that you can deduct the entire amount of your purchase in the year that it was made, reducing your taxable income.
For example, if you buy a piece of equipment for $100,000, you can claim bonus depreciation for the entire purchase and have a valuable deduction. If your company’s tax rate is 21%, that bonus depreciation could save you $21,000 in taxes that year.
However, there may be some instances where opting to forgo bonus depreciation and instead depreciating the property over a longer period of time might be more advantageous. Your tax pro can help you make the right call.
Car and Truck Expenses
Use a car in your business? You’ll want to keep great records to ensure you’re writing off everything you can. The simplest way to deduct your expenses is by using the IRS standard mileage rate ($0.58 in 2019). You’ll keep track of your miles driven related to your business and claim $0.58 per mile driven. Drive frequently and this can add up to a big deduction at the end of the year.
You may know that utilities to keep your office running are deductible. But don’t forget about your mobile phone that you use for business. If you use your phone 50% of the time for business and 50% of the time for personal uses, you can deduct 50% of the bill.
And if you have a home office you’ll want to make sure you’re clear on what’s allowed to be deducted. You can deduct the portion of your internet bill that is used for your business as well as a second landline (if you only have one landline that expense can’t be deducted).
Head out to a business lunch with your client? The IRS is going to let you deduct 50% of the total cost. The meal must be ordinary—don’t plan something wildly lavish. And take note: Entertainment expenses used to be deductible as well, but the TCJA did away with that deduction.
Any employee contributions to retirement plans or other benefit plans are 100% deductible. If you’re self-employed, making sure you maximize your retirement plan contributions directly reduces your taxable income for the year. For example, with a SEP IRA you’re allowed to contribute 20% of your self-employment income to the retirement plan, up to $55,000. That would give you a significant deduction.
Depending on your business structure, you’ll have different retirement plan options. Your tax professional can help you decide whether a solo 401(k), SEP IRA or SIMPLE IRA will benefit you most.
Qualified Business Income (QBI)
With the TCJA came the Qualified Business Income (QBI) deduction—up to 20% of the business’s income is allowable as a deduction. This can mean big tax savings for some. But the QBI deduction is complex and not available to everyone. Specifically, there are taxable income limitations in place that will phase out this deduction at higher income levels.
To make the most of the QBI it’s important to work with a tax professional who can help you navigate the new rules and figure out how best you can use them in your tax planning.
Timing of Business Income and Deductions
When you get close to the end of the year, timing is everything. If your business uses cash basis accounting, managing when cash is received and spent can have an impact on your taxes.
If you are trying to defer some of your taxable income until next year, you may want to delay sending some invoices or billing customers until the very end of the year, or the beginning of the next. You won’t need to recognize that income until you’ve received the cash or check.
If you’re looking to bump up your expenses in the current year—and decrease your current year taxable income—consider pre-paying some expenses. If the benefit of the expense you’re paying doesn’t extend more than 12 months from when it’s paid, you can deduct the full expense in the year it’s paid.
For example, if on December 1 you prepay the next 12 months of your business insurance policy, you can deduct that entire amount in the year you actually pay for it.
Deferring income or pre-paying expenses can be a helpful strategy if you are currently in a high tax bracket and anticipate that you’ll be in a lower tax bracket in the following year. Knowing your business and how you expect it to perform in the future can help you employ some last-minute strategies to save on taxes.
Ensure You Have the Right Business Structure
As your business grows and changes, your initial business structure may not continue to be the best one to use. Proper tax planning helps you decide when you may benefit from a different structure.
For example, you may have started your business as an LLC, but as your income grows you want to set up a solo 401(k) to put more away for retirement. Depending on your income, switching to an S-Corp may help you contribute more to retirement while reducing your present tax liability.
Your tax advisor can help you understand when and why to switch your business structure and guide you through the process.
The Final Word
Business tax planning isn’t just the strategies you employ at the end of the year—it’s looking at your business holistically at various points in the year and planning how you can make the best decisions to lower your tax liability. Every business owner who wants to keep more of the money that they earn should focus on tax planning year-round.