Tax season is a grueling time of year for many small businesses. It's often associated with the stress of combing through budgets and spreadsheets and working long nights to account for every penny. However, you can prevent tax season headaches by thinking about your taxes year-round and preparing for tax season long before it's time to file.
By folding tax planning into your overall business strategy, you can tackle your taxes far more effectively and may even end up with bigger deductions than you anticipated.
What is strategic tax planning?
Strategic tax planning is when a small business creates a plan to minimize the amount of taxes they pay in a given period. You should start planning formal tax-strategy sessions in the middle of each tax year to give yourself ample time to create and apply your strategies. Every entrepreneur should have a basic understanding of the provisions of the tax code and work with a certified public accountant (CPA) when possible in order to implement a proper and individualized strategy. [Read related article: Is It Time to Hire a CPA?]
There are two basic rules small businesses should follow when making a tax plan. First, you should never incur any additional expenses just for a tax deduction. Second, you should attempt to defer taxes when possible so you can use that money interest-free until the next time taxes are due.
What is the importance of business tax planning?
It is essential for small businesses to create a tax plan to mitigate their liabilities, especially when these transactions are taxed. By giving yourself time to prepare for your taxes, you can avoid common mistakes, maximize tax relief, reduce your payable taxes by deducting your expenses from earned income and have greater control of when you pay your taxes.
One example of poor tax planning, according to Anthony Mezzasalma, a CPA with Mezzasalma Advisors, is taking in a major influx of revenue before the end of the year that could potentially move your business up a tax bracket. Rather than having to pay more taxes as a result of taking in that revenue, good tax planning would see your business receive that money at the start of the new year. If delaying revenue isn't an option, you might consider if there are some larger expenses for the business that you can spend some of the money on.
“If a client comes to me in December and they're like, ‘I landed a big client and it’s looking like I have more income in 2020, what can we do about it?’ If it's December before end of year...maybe you accelerate your expenses and buy that piece of equipment you were thinking about buying or you defer some revenue,” said Mezzasalma. “There’s less you can do after the fact.”
Having a tax plan also means that you stay updated on the changes to the tax laws. Because of the coronavirus pandemic, deadlines and tax requirements for small businesses are constantly changing. Having a tax plan allows you to see what's changed and reassess your strategy accordingly.
Business tax planning strategies
Here are some of the best tips for keeping taxes a priority for your small business 365 days a year, according to QuickBooks:
1. Use the right business tax software.
One of the best ways to stay on top of your business taxes is to use business accounting software. There are many resources and apps you can use to ensure an efficient tax-filing process months before it's time to begin filing.
These tools can help you keep track of everything related to your business expenses, income and taxes. By taking proactive measures to be more organized, you can streamline the tax-filing process.
2. Track your spending, and have regular budget check-ins.
Aim to track all of your spending throughout the year so that none of your expenses are hard to pin down once tax season rolls around. It's incredible how much you forget when it comes time to file. Noting expenses the day or week they happen ensures you don't miss them at the end of the year.
“If you’re staying on top of things during the years, you can more easily identify and act on opportunities that you can’t otherwise act on after the year’s over,” Mezzasalma said. “By keeping your books up to date, you can realize how well you’re doing that year and react accordingly.”
For some, it helps to have monthly expense check-ins. For others, it is best to go through business spending every week. Get on a schedule to consistently keep track of your business's spending habits. You can also use an app to track all of your spending. If you don't keep track of your spending and expenses, you could be hit with fines later on, or you may lose sight of possible deductions when it comes time to file your taxes. [Read related article: The Complete List of Small Business Tax Deductions]
3. Keep your business and personal expenses separate.
Regardless of whether you have been regularly keeping track of your spending, you should ensure that you separate your business expenses from your personal expenses, to avoid confusion. If you haven't done so already, set up a separate bank account for your small business, and only make business purchases using your business's credit card.
4. Keep important deadlines top of mind.
Stay aware of important deadlines throughout the year to hold yourself accountable. Make a note of all of your tax deadlines, and don't be afraid to set up business deadlines for yourself. If you want to have monthly or quarterly expense check-ins, keep those on a calendar, and set deadlines for when you want to keep track of your expenses. Keeping important dates and deadlines organized will help you at tax time.
5. Hire an accountant or business tax professional.
If you find taxes for your small business overwhelming or confusing, or if you just want another resource, consider hiring an accountant or other tax professional to help. Tax professionals are highly knowledgeable in the field and can assist you with as much or as little as you need. They can also help hold you accountable for everything you need to be practicing throughout the year to maintain smart and legal business tax practices and finances. Additionally, a tax professional can help you stay aware of hidden fees and documents.
6. Take advantage of the qualified business income (QBI) deduction.
The qualified business income (QBI) deduction provides pass-through business owners a deduction worth up to 20% of their share of a business's income. However, there are regulations and limitations attached to it.
Pass-through business entities include sole proprietorships, partnerships, limited liability companies (LLCs) and S corporations that are not subject to corporate income tax because their profits flow through to owners, who are then taxed under the individual income tax.
If you own a specified service trade or business (SSTB) and your income exceeds a certain threshold, you'll lose out on this deduction. An SSTB can be any service-based business, such as a law firm, medical facility, accounting firm or investment firm.
7. Consider employee bonuses and retirement benefits.
Awarding bonuses is a great way to motivate and incentivize your employees to work harder, and it's also tax deductible for your business. The IRS requires you to finalize bonuses by the end of the year and pay the bonuses within two and a half months from the end of the year. You also must pay the bonus directly to the employee and not a sole proprietor or LLC, as then the bonus is no longer tax deductible.
Similarly, setting up retirement accounts for your employees can reduce your business's taxable income. If your business sets up a 401(k) plan for an employee before the end of the tax year, you can deduct the contributions made to the plan. When considering your employees’ retirement options, it’s important to remember that timing can be everything when it comes to certain 401k plans.
“Some [401ks] have to be set up during the year, so if you want to create a 401k plan for 2020, you have to adopt that plan before the end of the year in order to get a deduction for 2020,” Mezzasalma said. “Others can be set up after the tax year – like a SEP IRA – where you can actually create, adopt and fund the plan after the tax year is over. Then you can get a tax deduction for the previous tax year.
If you missed the cutoff to set up a 401(k) plan last year, you have until the due date of your tax return to establish a simplified employee pension plan. Employers can contribute up to 25% of an employee's compensation.
Additional reporting by Andrew Martins and Joanna Furlong.