Tax prep can time-consuming, but if you fall out of compliance with the U.S. tax code, your business could face penalties. Review these common end-of-year practices to develop good tax habits.
- Work with a CPA or certified tax professional to ensure that your business is taking full advantage of deductions, write-offs and other tax advantages. Working with professionals will also ensure you're staying informed about constantly changing tax laws and regulations.
- Besides tax organization, the end of the year is a good time to strategize how you want to prioritize spending and push expenses. For example, by pushing expenses from Dec. 31 to Jan. 1, you can reduce your taxable income for the current year
- Work with your HR department or office manager to ensure your employees, be them full time, part time or contract-based, receive the appropriate tax forms.
- This advice is ideal for small business owners looking to learn more about the tax process before speaking with a CPA or tax professional.
To keep that from happening to your small business, you have to be smart with how you tackle business tax preparation. Even though tax season doesn't officially begin until next year, it's in your best interest to take a few steps today to prepare your next income tax return. If you want to end the year on a tax-based high note, here are some steps you can take to get ahead of the game.
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1. Catch up on your previous quarters' financials.
The third quarter of 2020 ended on Sept. 30, and businesses everywhere are reaching the final stretches of the financial year. As such, now is an excellent time to create an updated projection for the final quarter.
If your small business has been in operation for a while now, you should have a general idea of how it tends to fare during the final few months of the year. A.J. Gross, president at ALG Group, said knowing your business is key to putting together an accurate projection. "You need to be able to see where you think the business is going to end up overall for the fourth quarter of 2019," he said. "If you plan on growing or expect a downturn, it's entirely based on the entire year and your business cycle."
For example, if your business winds down during the summer with sales slowing to a crawl during the holidays, you should already have prepared for that kind of slowdown. Conversely, if you own a retail store, you know just how swamped you and your employees will be once Black Friday rolls around.
Since most small businesses pay estimated taxes based on the previous year's figures, you should try to determine how the past three quarters compare to last year. The estimated tax payment method enables small business owners to keep track of their expenses in the buildup to tax filing in April, and offset any costs that occur between this period and their final submission to the IRS.
If you find that your estimated income taxes were close, you can use that information to determine whether you need to increase your tax payments because of an increase in income or save funds for when you file your tax return.
"You may not necessarily want the government to hold on to your money, so you can pay the minimum amount," Gross said. "However, it may be good to have a certain amount saved in case you know you're going to owe taxes based on a better year in 2019."
Key takeaway: Compare the first three quarters' financials with last year's numbers to get an idea of how your tax situation is shaping up.
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2. Consider making large year-end investments.
When it comes to filing taxes, deductions are your friend. Saving money on taxes always feels good and ensures that you're taking advantage of government-sanctioned exceptions.
One way you can increase your tax deductions is by making upgrades or capital improvements near the end of the year. John J. Petosa – a licensed CPA, attorney and faculty member at the Whitman School of Management at Syracuse University – advises businesses to consider purchasing new equipment or certain other business property that will qualify for a Section 179 deduction. Under that deduction, small business owners can seek out deductions for all or part of the cost of certain qualifying property in the year you put that item into service.
"If you were waiting on that new computer system, you may wish to buy it [now] and put it in service this year [and] write it all off, which reduces your overall taxable income," said Petosa. "Often, I will suggest that my clients create a separate bank account for taxes and [put] a percentage of their receipts … in [that] account to save it so they are not short on tax day."
While Gross agrees with that sentiment, he added one major caveat – it has to make sense in the near or short term. "You only want to make investments that will improve the profitability of the business," he said. "If it doesn't improve your profitability, it doesn't make sense."
For example, if you want to purchase and deduct a $50,000 piece of machinery with a 30% tax rate, you will save $15,000 in tax savings but will still be down that $50,000.
Key takeaway: Consider making upgrades or capital improvements near the end of the year to increase your tax deductions. By spending more on deductible items, you can reduce your overall income.
3. Check your retirement plan.
Perks are incredibly powerful ways to attract and keep new employees. While many small businesses offer offbeat perks to sweeten the deal, the tried-and-true benefit of retirement plans is still a major boon to workers. [Read related article: The Best Retirement Plan Options for Small Business Owners 2019]
As you prepare your taxes, you may want to look at your retirement offerings. Small businesses have access to specially qualified retirement plans outside of the typical 401(k) or IRA. Simplified Employee Pension Plan (SEP) programs can help you put away up to 25% of your income (up to $54,000).
"The nice thing about some of these plans is if you put together a SEP, you don't have to contribute the funds until the due date of the return, and if you file an extension, you can have until the extended due date, even though you will have already taken a deduction on the return," Gross said.
Key takeaway: Review your retirement offerings and consider programs outside of typical 401(k) and IRA programs. Alternative plans may allow you to put away up to 25% of your income.
4. Check for obsolete inventory or uncollectable debts.
There's a certain amount of risk in running a business, and, unfortunately, some items just don't sell, and some debts can't get collected. While neither situation is ideal for any business, they are both deductible.
Old inventory, or inventory that can no longer be sold, is deductible as an expense come tax time. Since inventory only gets expensed when it's sold, Gross said you can get rid of the items that can't be sold and deduct what you originally paid for them.
The same concept applies to uncollected debt, though what constitutes an uncollectable debt depends on your business model. In either instance, you'll need proper records to prove both situations.
Key takeaway: Old inventory is deductible. Analyze what you have on site, and consider more creative deductions, like uncollectable debt, and determine if you can reduce your taxable income.
5. Remember cash-based businesses can be more flexible.
If you run a cash-based business, you may want to consider how you report your income and costs near the end of the year. Cash-based businesses must record their income and costs only when they're received or spent. With that in mind, Gross said you may want to think twice about how you send and receive payments near the end of the year.
"If for any reason you're near the end of December and you have the option to defer receiving a check until the following year, you can potentially do that because you didn't receive the cash until the following year," Gross said. "Same goes for expenses. If you write a check and it doesn't get cashed until 2020, it's still an expense in the current year."
Depending on how you handle your year-end cash flow, Gross said you can essentially accelerate your expenses while deferring your income.
Key takeaway: Cash businesses have more flexibility with how their income and costs are recorded. Review your year-end cash flow, and work with a CPA to understand what expenses can be deferred.
6. Hire a small business tax professional.
As an individual, you may be your own bookkeeper or tax preparer, but it's relatively easy to file your own tax return thanks to accounting software applications and other services willing to provide worthwhile tax advice. For a small business owner, however, it might be better to have a tax expert prepare your taxes.
American tax law is incredibly complex. While failing to properly file your income or payroll taxes as an individual can become an untenable tax situation, it can spell doom for your small business. Falling behind with your business taxes can lead to tax liens or levies, wage garnishment and the end of your company altogether. According to the IRS, if you owe more than $1,000 in taxes, you must make estimated tax payments in the amount of 100% of last year's tax liability, or 90% of the current year's liability, whichever is smaller.
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If you do your business taxes on your own, Gross said the same tax forms apply that were around before the Trump administration's bid at tax reform – the Tax Cuts and Jobs Act of 2016 – passed. Even though that piece of legislation was sold as a way to simplify the entire process, Gross said it made things more difficult. "The latest changes actually made things more complicated for small businesses, since it changed how and what you can deduct."
If you have a pass-through business, such as a sole proprietorship, partnership or S corporation, the law allows for a 20% income tax deduction, though married individuals who own certain businesses like law firms or doctor's offices can only claim it if their yearly income is below $315,000 (or $157,000, if single).
The law also changed what kind of expenses are deductible. While a percentage of business dinners and lunches can be deducted, businesses can no longer expense leisure activities like tickets to concerts or sports events.
If you opt to get tax preparation help, the cost of those services will vary by the size of your business. If your operation has a small number of employees, your costs can be upward of $500, while larger businesses can expect to pay as much as $2,500. Regardless, Gross suggested that you take the potential for catastrophe out of the equation and hire a pro if you rely on your business for income in any way.
"An established business should probably hire a tax professional, just because of the amount of deductions and tax planning necessary," he said. "You're definitely less likely to get in trouble by doing something by mistake if you hire a professional.”
Key takeaway: While these tips are a good starting point, it's not a substitution for working with an experienced tax professional.
7. Donate to charity.
Many businesses donate a portion of their income to charity. Not only is a donation a noble and important act, it can help reduce taxable income. By donating to charity, you can better your small business's finances. While money is always a great donation, items like clothes, shoes and toys can also go a long way. Be sure to keep receipts and other documentation to back up your deductions.
Key takeaway: While donating cash is a good way to earn a deduction, consider donating other items, like toys or clothes.
8. Defer income.
Depending on your income levels during the holiday season, you might consider pushing that income to the following year to save on taxes. Income earned on December 31 counts for the previous year, while income earned on January 1 can be logged for the upcoming year's taxes. Talk with an accountant or tax professional before doing this, as it may not make that much of a difference.
Key takeaway: Review your cash flow with a tax professional and consider deferring certain income to the next year.
9. Accelerate expenses.
Think of accelerating expenses as the reverse of deferring income. Instead of deferring payments, though, you spend money upfront on certain expenses so you can earn a tax deduction in the current tax year, rather than the following tax year. Accelerating expenses only makes sense in certain scenarios. Check with a tax professional to see if this strategy is right for your business.
Key takeaway: Accelerating expenses may make sense for businesses looking to earn deductions on certain payments for the current tax year.
10. File end-of-year tax forms.
While tax forms for your business's income and operation aren't due until mid-April, you likely need to submit important forms related to your business and its employees by the end of the year. These forms include:
- Form W-2: This form reports wages your business has paid to its employees, and the taxes withheld from those wages. While this form has more relevance to the personal income tax levels of your employees, it's still your business’s responsibility to file them with the Social Security Administration.
Form 1096: If your company employed contract workers during the year, you'll have to submit 1096s. These forms function in a similar capacity to W-3s, only they're applicable to independent contractors who receive 1099s.
Form 941: This form is used to account for taxes paid to programs like Social Security, Medicare and income taxes.
Form 940: This form covers Federal Unemployment Tax (FUTA), which accounts for taxes businesses have to pay for unemployment compensation.
- Form 1095c: If your small business provides health insurance to its employees, you'll have to file this form. These forms address which employees received coverage and can be used to determine eligibility for tax credits.
Key takeaway: Your business is responsible for providing certain forms for workers. Review who you employed for the year and ensure you provide the right forms to the right employees.