The annual countdown: 5 year-end tax strategies
End of the Year for businesses refers to the end of the calendar or fiscal year for a business. For calendar businesses, the end of year is December 31, while for businesses on a fiscal year, end of year will typically fall around June 30, but may fall at the end of other months as well.
For businesses, the end of the year (EOY) is an important time to reflect on the past 12 months and plan for the year ahead. Year-end planning helps businesses set goals for the upcoming year, see a compiled view of the progress their business made in the year, and ensure that the business is on track to financially be successful as a business. Additionally, tax planning can give you the best chance to maximize opportunities to claim deductions and credits.
Strategy #1 - Income
It’s more than just what you make. How you make income is the driver of your tax deductions and credits.
When it comes to taxes, income is the hidden culprit. We want to make a ton of money but not pay that much in tax dollars – most of the time, that’s just not how it works. But, if we effectively plan out the year through forecasting and projections, not only will you be prepared for your income tax bill, you can position yourself to develop a plan to minimize your tax bill.
Strategy #2 - Location, location, location
When you start a business, naturally, you may want to form your business in the state you live in – sometimes, this is the right move, but most often, location is an oversight in starting a business, especially an online-based business.
There are so many benefits based on where your business is located. There are things such as opportunity zone credits and even grants in a ton of neighborhoods that you may not know about.
| Sometimes, you should step outside the box and weigh the reasons why you may operate in a different state from where you form your business.
The state you operate your business in does not have to be the state your business is formed in, and vice versa. For instance, say you live in Texas and decide you want to launch a business. You decide that you want your business to be a sole proprietorship. You know the income from your sole proprietorship will be included on your 1040. Up to this point in your life, you have been a W2 employee, and you know that Texas does not have an income tax. You then decide that since Texas doesn’t have an income tax, you wouldn't be liable for income tax, and this sounds awesome to you. So, understandably, Texas, you feel, would be a great place to form and operate your business, but there was one small thing you missed. Even though a business does not “pay income tax in Texas, your still business has to pay taxes in the state of Texas – those taxes are called Franchise Taxes.
Franchise taxes often catch business owners by surprise when they are in states that claim they do not have an income tax. Make sure you don’t get caught by the “no income tax” surprise.
Strategy #3 - Business entity structure
You get this business idea, decide what type of entity structure you want when you first start your business, and most of the time, you never go back and think twice about your entity structure and if you need to change it. Business owners want to get to the fun stuff, and that’s ok. That’s why you should have an accountant or tax attorney there to guide your business strategy.
When you start off your business, it's easy to become a sole proprietor or single-member limited liability company (“SMLLC”). But once your business starts growing and gaining income, you should consider other tax structures.
A business entity such as an S Corporation (“S Corp”) can cause you to greatly save on SE Tax. If you are operating as a sole proprietor or SMLLC, all of your ordinary income is subject to FICA/SE tax, whereas with an S Corp, it is not.
This structure is owned and operated by a single individual. The sole proprietor is exposed to unlimited liability; lawsuits against the business likely put personal assets at risk and vice versa.
All earnings are subject to SE tax.
(GP or LP)
Business owned by 2 or more people. May have general or limited partnerships that may enable full liability or restrict liability.
Earnings are allocated to each owner based on a Partnership Agreement.
Limited Liability Company
LLCs are popular for good reason. LLCs combine the liability protections of corporations with the pass-through taxation available to sole proprietors and partnerships.
Generally, all earnings are subject to SE tax.
(C-Corp or S-Corp)
Businesses that earn large amounts of revenue typically consider a corporation or an LLC taxed as a corporation.
Earnings can be accumulated or current and distributions may receive double taxation.
Strategy #4 - Payroll
Payroll has a dynamic component, and it gets a little more complex when you introduce employees, contractors, and freelancers. If your business has employees, then you are on the hook for taxes such as FICA, whereas, when working with contractors and freelancers, the business owner is not liable for these taxes. Because of not having to pay these taxes, contractors and freelancers may seem like the best route to take, but the IRS has strict guidelines on if someone is an employee, contractor, or freelancer. This is where planning and strategizing for year-end comes in handy. You can plan out if your business needs to call for actual employees or if you only need a couple of projects completed where contracting out assistance will work.
Strategy #5 - Business expenses
Spending money is a necessary part of running your business – like filing taxes. Since you’re going to spend money, even if you don’t want to, you should try to plan ahead on some of those expenditures. For instance, if you have a surplus in cash (leftover cash that you can spare), it would be a great strategy to pay down any payables or notes to increase your expenses and interest paid in the current year. If you have inventory, it may be time to stock up on some of your most frequently purchased products. Buying inventory early may also assist you in saving money. Business Owners such as wholesalers and other merchants typically increase their costs after each fiscal year. If you buy inventory early enough, you may be purchasing at a cost lower than you would buying in the new year.
End-of-year planning is a small investment of time that can lead to major tax benefits. You can find additional strategies for accountants and small business owners in ComplYant’s webinar. Click here to listen.