It’s that time of year again. Summer is over and the kids are back in school. In the midst of homework and after school sports, it’s a good idea to take a little time to do some tax planning. It doesn’t matter if your situation is simple or complicated, almost everyone will benefit from a little analysis before January rolls around.
Procrastination pays, at least in this case. Although it’s too late for things like withholding adjustments to have much affect, there are still a number of areas that can make a big difference at tax time. Because it’s late in the year, your accountant will be able to make an accurate prediction of your financial picture, and knowing your financial picture is the most important part of tax planning.
Small businesses should start with a review of their financial statements. Besides being a good business practice, it also allows for a proactive role in managing taxes. If net taxable income can be managed, the potential tax liability can be estimated, and more importantly, minimized. If the critical step of reviewing financial statements is not completed before the end of the year, many of the tax planning options will no longer be available.
The process starts by completing your monthly accounting. This means making sure the bank accounts are reconciled, accounts receivables reflect what you are owed, balances match the general ledger, and expenses show what you’ve paid. This is the same process that will happen at the end of the year in preparation for filing. Without a solid set of financials, suspect estimates could lead to disastrous results. The end of third quarter is typically a good cut-off. It allows for tax planning to be done in late October or early November with solid estimates based on three quarters worth of data. Any earlier and the projections are less accurate, much later and you’ve shortened your action window.
Estimating revenue and expenses for the fourth quarter will give you a picture of the entire year. Consider potential revenue sources or unusual expenses in the final quarter of the year. Add the quarterly estimates to your third quarter totals to determine your projected yearly net income. Your accountant can assist you in making corrections for those items that are not necessarily cash flow items (e.g. depreciation).
Now the fun begins. Where should your taxable income to be? Too high and an unnecessarily large portion will go to the IRS, too low and some losses may be suspended. Using the estimated income, your accountant will determine which strategies to raise or lower your income are most appropriate. Depending on the size and nature of your business, you may not have much affect on the taxable amount, but you may find that you can use money for your benefit that would have otherwise gone to the government.
Strategize methods to reach your goals. Reducing income will reduce tax liability, however business owners looking for loans or investment may want to sacrifice some tax savings to show higher income levels. Saving deductions may also be a good idea if higher income is expected in the following year. In cases where there is little advantage to affecting overall taxable income, repurposing funds may net an effective immediate gain on retirement investments or result in a net discount on business purchases.
Reduce income by delaying receipt of payment. This can be offered to your customers as a benefit through extended terms or by delaying billing until early January. Remember that it’s not allowable to delay depositing checks that you received. They are taxable on receipt because you have constructively received payment. You have to legitimately delay the revenue before you receive it.
Generating expenses will also have the net effect of reducing income. Invest in capital equipment, buy supplies, or pay for needed services before the end of the year. You can also accelerate paying bills; pay January’s rent in December and ask service providers to bill you for services before the end of the year.
Fund your retirement. The reduced tax liability will result in an effective immediate return on the investment of your tax rate. Likewise, equipment purchased for the business will receive similar savings.
Maximize income by accelerating revenue into the current year. Ensure all billing is up to date and consider offering discounts for early payment. Make sure you have deposited all checks received before the 31st. Consider offering early billing and discounted prepayment rates for services you plan to provide in January.
Postponing expenses will also increase income. Wait to pay any January bills till after the New Year. To avoid late fees, have the bills ready to go with checks dated 1 January, then drop them in the mailbox on the first. You may even consider paying late fees if it won’t jeopardize your business credit and the late fee is less that your tax rate. You can also delay buying equipment or making other smaller purchases until January, which would push the deduction into next year.
The bottom line is that timely information is valuable and puts you in control of your taxes. No one likes to be at the whim of tax law, left with “it is what it is” and “it’s too late now” at tax time. Find a CPA who specializes and works with clients on tax planning. Too much is at stake to take an after the fact approach to taxes. Waiting until tax time will almost certainly leave money on the table. Be proactive and reach out to your CPA now, while you still have time to affect the outcome.
Not all issues can be fixed in the last few months of the year. Sometimes even after you’ve done everything possible, there is still a large tax bill on the horizon. Use the next few months to plan for it and make corrections for next year. Knowing what’s coming will reduce stress at tax time.