Avoiding Mistakes with Your Small Business's Tax Planning
Sometimes the Small Business Tax Choices that Seem Obvious are Wrong
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:
- 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.
- 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 you are in the 20 percent tax bracket this year, but will be in the 30 percent tax bracket next year, and you have $10,000 worth of expenses in question, deducting them this year will save you $2,000, while deducting them next year will save you $3,000. 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.
- Make sure you know whether you file your tax return on the accrual basis or the cash basis. Most year-end tax strategies only work for cash-basis taxpayers. Accrual-basis taxpayers report all income in the year that it is earned and all expenses in the year that they are incurred. So, just because you are paying for a 2011 expense in 2010 doesn't mean you get to deduct that item in 2010. Be aware of your tax reporting designation as this will have a big impact on whether or not it's worth planning and spacing out large purchases for 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.