Year-End Tax Savings Strategies for Business Owners

There are common complaints I hear from business owners. “Why am I paying so much #$*&!@ taxes!” is one of them. “Because you made so much #$*&!@ money!”, is my usual retort. My cracks at humor and the glass half full thing always fail. It makes me chuckle but doesn’t give them what they want.

Here are 5 strategies that can help them (and us) pay less in taxes.

Strategy 1: Buy things our businesses are going to need anyway, now.

Strategy 2: Pay bills that aren’t due until next month, before the end of the year.

Strategy 3: Prepay certain expenses.  There are a handful of expenses businesses are allowed to prepay and deduct in the current year. This sounds like strategy 2, but it’s not. This strategy takes advantage of the “12-month rule”. The 12 Month Rule allows business owners to prepay certain type of expenses ahead of time and deduct them in the year they are paid. As the name implies, you can’t go out more than 12 months. The big one here is rent payments. In addition, this works with equipment leases, business insurance and licenses.

Strategy 4: Put off some billing for a few weeks.

Strategy 5: Saving the best for last – load up our retirement accounts. Here are five reasons that make this strategy so great:

  1. Contributing money to a “qualified retirement plan” is more of a real tax savings, providing the opportunity to defer taxes for decades.
  2. It creates wealth for business owners and their employees.
  3. It creates wealth that is compounding tax deferred, thus growing faster than an after-tax investment account.
  4. Illinois (and more than a dozen other states) do not tax retirement funds.
  5. For the real estate investor, with the right plan and a little planning, it is possible to hold real estate in a retirement account.

While the retirement plan strategy is the best, it is also the most complicated. There are several types of retirement plans to choose from.

Some types of retirement plans need to be set-up and funded before the end of the year. Others don’t have to be set-up or funded until the tax filing deadline (including extensions). Thus, it is possible for a cash basis taxpayer to take a deduction this year for a retirement plan contribution that won’t be paid until next year.

Another important variable in choosing which type of retirement plan is best for you is whether a plan is mostly employer funded or employee funded. This not only could affect the out of pocket costs to the business owner, but funding employer vs. employee funded plans can have different implications on the Qualified Business Income Deduction (QBID).

It’s important to be aware that there is a liquidity issue with retirement accounts. Funds in a retirement account are not meant to be withdrawn until you’re at least 59 ½. This doesn’t mean we can’t get at the money sooner; it just means in most circumstances a person taking an early distribution out a retirement account will pay both income tax and a 10% penalty when they do. However, the 10% penalty is usually not as bad as it sounds. The extra value created by a couple of years of tax deferred compounding can easily make up for the 10% ding.

Here’s an example using these strategies:

A business owner and spouse have an S corp. The business owner’s salary is 80,000, the spouse’s salary is 50,000 and without using any of the strategies above, the S-corp will net 40,000. The business has some extra cash currently and cash flow for Q1 2020 will be strong. In this scenario, federal and state taxes come out to 30,200. Ouch!

Let’s apply some of these strategies and see what happens.

  • The scanner is slow and the hard drive on the server is making scary sounds. Our business owner buys a fast scanner (adding efficiency) and gets the computer guy in to replace the hard drive and perform some system maintenance. This all costs 2,000 and goes on the company credit card. That bill gets paid in January 2020, but is deducted this year.
  • The 5,000 bill for supplies that just came in isn’t due until 1/10, but the business owner mails the check out right after Christmas.
  • Rent is 2,000 a month. Our business owner gives the landlord a gift and mails a check for January, February and March’s rent before the end of the year.
  • The first week of March 2020, our business owner meets with their financial planner, creates a SEP plan and wisely makes the maximum contribution. That’s a 20,000 tax deferred investment for their future.

Instead of 30,200, taxes are now 22,700. Our business owner knocked down their tax bill 7,500! All by making wise investments, most of which won’t be paid until next year.

As wonderful as this all can be, there may be circumstances when it’s best not to apply these tax savings strategies.  Some things to consider.

  • The strategies will require some cash in the future. Your priority should always be to put profits and cash flow ahead of reducing taxes. If cash is tight – “fugget about it!” If 2019 profits are low, it might also make sense to take a pass.
  • Don’t spend money just to save on taxes. Spending a $1 on something you don’t need to save .37c on taxes is stupid.
  • Making purchases on a credit card before 12/31 can be deductible this year even though you won’t pay the bill until next year. So, if you have a very temporary cash squeeze you’re not out of luck. NOTE: if a business is run as a corporation, partnership, or multi-member LLC, then the credit card should be in the name of the business.
  • The first four strategies involve accelerating expenses and delaying revenues (income). These are strategies that don’t create a permanent tax savings. They can effectively kick the can down the road, putting off taxes for a year, but it will reverse next year. So, we should consider the tax brackets we’re likely going to be in for 2019 vs. 2020. If we’ll likely be in a higher or the same tax bracket this year, then apply the strategies. However, if we think we’ll be in a HIGHER tax bracket in 2020, then we may not want to use these strategies this year.

My cheeky reply, “Because you made so much #$*&!@ money!”, is not nearly as sarcastic as it first sounds. The truth is we pay more in taxes when we make more money. Let’s just not pay any more than we have to.

In a few days, we will post another piece on tax savings strategies for all taxpayers (not just business owners). If you want to be notified when this next piece is posted, you can sign up here.

Adam

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