Tax planning strategies for small business owners to consider before the year end
As each year comes to an end, it is prudent for small business owners to consider and implement (if applicable) tax planning strategies, which can minimize their tax liability and free up more cash flow to address other financial planning goals (e.g., retirement, education funding for a child). I list tax planning strategies that can help small business owners with their tax planning before the end of each year. Note that this list is not exhaustive and has general strategies, which means it should not be taken as specific tax advice. My firm, Lasting Wealth Principles, does provide specific tax advice to clients after a full review of their financial and tax situations.
Accelerate expenses to current tax year
The objective of accelerating expenses is to maximize tax deductions in the current tax year. Incurring certain tax-deductible expenses before the end of the year decreases taxable income for the current year, which will lessen the tax liability for a small business owner. I illustrate with a hypothetical example of a small business owner below.
Mark owns a technology consulting firm, which requires him to travel for work. He looked at this travel schedule and realized that his travel expenses will be significantly higher during the following tax year. To accelerate some of these tax-deductible expenses into the current tax year, he decides to purchase some of the airline tickets way in advance (i.e., make these purchases during the current tax year even though he will not be traveling until the following tax year). As a result, Mark reduced his tax liability for the current tax year.
Defer income to following tax year
The objective of deferring income is to move income to the following tax year. Deferring income (e.g., delaying certain invoices) also decreases taxable income for the current year, which will lessen the tax liability for a small business owner. I illustrate with a hypothetical example of a small business owner below.
Jane owns a marketing consulting firm and notices that her projected income for the following tax year will be significantly lower than this current tax year (Jane has had unprecedented sales this year so her projected income for the current tax year will put her in a higher tax bracket). To transfer some of her income into the following tax year, she decides to delay invoicing certain clients until after December 31st. As a result, Jane reduced her tax liability for the current tax year.
Tax loss harvesting
This tax planning strategy does not apply in accounts like a solo 401k or SEP IRA because they are tax deferred (i.e., taxation occurring at distribution of funds from accounts). However, if a small business owner also invests in a taxable account (i.e., brokerage account), then it is prudent to consider tax loss harvesting, which is a strategy of offsetting capital gains with capital losses. With a tax loss harvesting strategy, an individual sells an investment that is not performing well in their brokerage account and then uses that loss to reduce capital gains, which can lower tax liability for that year. I illustrate with a hypothetical example of a small business owner below.
John owns a sales consulting firm and has been steadily saving for retirement by making annual contributions to his SEP IRA. In addition to his SEP IRA, he also has been saving to and investing in a brokerage account because he wants to use it as a supplemental retirement account. As each year ends, he meets with his financial advisor to discuss if tax loss harvesting is an appropriate tax planning strategy to use before the end of the year. Throughout the year during his quarterly reviews, John and his financial advisor have been monitoring a specific investment that has been underperforming. However, there have been other investments in the portfolio that have performed well and generated capital gains, which will result in capital gains tax. As a result, his financial advisor recommended that this could be an optimal time to sell the underperforming investment at a loss and use this loss to offset capital gains to lower John’s tax liability for the year.
How Lasting Wealth Principles helps small business owners with tax planning
I believe in taking a proactive approach with tax planning strategies, which helps small business owners minimize their tax liability and have a plan for their taxes going forward. Note that tax laws are constantly changing so I make sure to stay up to date with any applicable changes that will impact my clients and adjust their tax planning accordingly. Given their many tasks and responsibilities, I understand that small business owners might not have much available time to address their personal finances, so it is my responsibility to make sure they do not miss tax planning opportunities, and these areas get appropriately addressed in a timely manner.