Michael Hanley is 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 their 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 simply to minimize your tax bill.
It is essential to remember that $5 spent does not equal $5 worth of tax savings. Rather, the $5 spent reduces taxable income by $5, which may only result in up to $3 worth of taxes saved. So, while businesses may benefit from tax deductions, they should not recklessly spend cash, simply to amplify their ultimate deductions.
But if you anticipate making a few necessary large purchases in the new year, it might be a good idea to buy them ahead of schedule so you can take the deduction for the present tax year.
2. You may not want to accelerate expenses into the present year.
For example, if you had a rough year, with underwhelming profits, but you anticipate a future uptick in business, it may be shrewd to defer the maximum amount of expenses to the next calendar year.
For example, if you currently sit in the 20% tax bracket, but expect to shift into the 30% tax bracket next year, assuming expenses will be approximately $10,000, you can save $2,000 by deducting those expenses this year, but you can save $3,000 by deducting the expenses next year. It thus pays to thoughtfully defer expenses to offset your income as much as possible when the expenses in question are necessary to the operation of your business.
3. 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 redistributing 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.