Avoiding Mistakes with Your Small Business's Tax Planning

Sometimes the Small Business Tax Choices that Seem Obvious are Wrong

What to Bring to a Pre-Tax Season Planning Meeting
••• skynesher/Getty Images

Michael Hanley is a one of the most sought-after small business tax planning-focused CPAs in New York. We asked him for some out-of-the-receipt-box thinking on how small business owners should handle year-end tax filings.

If you want to learn even more beyond these tax planning tips from Hanley, we have an entire library of educational content dedicated to dealing with your business taxes. For now here's Hanley's take...

Decide if aggressive year-end tax strategies are right for you.

Not everyone should be putting an aggressive year-end business tax strategy into place. Here's how to make that decision for your business:

  1. Don't spend money that you wouldn't ordinarily spend just to reduce your tax bill. It may seem obvious, but remember that $1 spent does not equal $1 worth of tax saved: $1 spent creates a $1 deduction, which (depending on your tax bracket, business structure, and state of operation) will only lead to $.00 - $.60 worth of tax saved. So, while tax deductions are great for businesses to fully utilize, they never provide an equal return for the dollars you spend, in order to get that deduction—which means you should never wastefully spend money just to increase your deductions. But if you anticipate a few large purchases that'll need to be made early in the new year, it might be a good idea to buy them ahead of schedule so you can take the deduction for your current tax year.
  2. Don't spend money that you wouldn't ordinarily spend just to reduce your tax bill. It may seem obvious, but remember that $1 spent does not equal $1 worth of tax saved: $1 spent creates a $1 deduction, which (depending on your tax bracket, business structure, and state of operation) will only lead to $.00 - $.60 worth of tax saved. Therefore, although businesses benefit from realizing tax deductions, they do not provide an equal return for the money spent to achieve that deduction—which means you should never wastefully spend money just to increase your deductions. But if you anticipate a few large purchases that'll need to be made early in the new year, it might be a good idea to buy them ahead of schedule so you can take the deduction for your current tax yeer.
  3. You may not want to accelerate expenses into the current year. For example, if you had a pretty bad year with a lower-than-average profit and expect your profit to pick back up in the following year, you may want to defer as many expenses into the following year as possible. If this year, you find yourself in the 20% tax bracket, but you’ll land in the 30% tax bracket the following year, assuming there are $10,000 in expenses in question, you can save $2,000 by deducting those expenses this year, but you can save $3,000 by deducting the expenses next year. Just as in our previous example, it pays to thoughtfully plan out big expenses. The same can be true for deferring expenses—for the right reasons, so that you're offsetting your income as much as possible when the expenses in question are necessary to the operation of your business.

If you do opt for a series of aggressive year-end tax strategies, make sure you are actually spending money and not just moving money around.

The most common misconception surrounding year-end small business tax planning is the old "zero out your business bank account by 12/31" strategy. However, this strategy isn't necessarily the healthiest move for the survival of your business in the event of unexpected losses or falling short on income projections early in the next year.

If done properly, the zero out strategy can be an effective way to defer current year taxes into next year by inflating your perceived losses. However, simply zeroing out your bank account will not necessarily result in any tax deferrals.

Paying yourself a bonus, taking a shareholder distribution, repaying your officer loan, paying down credit card balances, paying down credit lines, or paying off other debt will not create deductions that result in tax deferrals. These strategies are simply re-distributing the money that belongs to your business, into other forms that are still tied to the company in some way, and thus don't qualify as operating expenses.

If you are going to put this plan in place, you must actually be paying expenses or purchasing equipment that goes toward improving or maintaining the operation of your business.