As the end of the year approaches, small business owners have a unique opportunity to minimize federal income tax liabilities with strategic planning. Read on below to make sure you take full advantage of your tax plan.
Maximizing Tax-Deductible Expenses
One of the most effective ways to reduce taxable income is by maximizing deductible expenses. On a cash basis, prepaying expenses like rent, utilities, or insurance premiums before December 31 allows these costs to be recognized within the current tax year. Similarly, stocking up on office supplies or investing in new equipment can yield substantial savings through Section 179 deductions or bonus depreciation rules. Paying outstanding professional fees also ensures these costs contribute to current-year deductions. It is important, however, to ensure all expenses meet the IRS’s criteria for ordinary and necessary business costs.
Additionally maximizing your current year deductions to save money in the current year doesn’t always make sense. Remember that if you’re prepaying everything you can to take the deductions in the current year, you will have potentially less to deduct in the coming year. Trying to shift next years expenses into the current year on a cash basis only makes sense to do in two situations. The first is if you expect meaningful and beneficial tax changes in the following tax year that would make it advantageous to defer taxes to the future.
The second circumstance is if you expect to make less in the following year. In this case, accelerating deductions into the current year can lower your taxable income when you’re in a higher tax bracket, resulting in greater overall savings. However, if you anticipate higher earnings next year or expect to be in a higher tax bracket, deferring deductions may be a better strategy to maximize their value. Always consider the broader context of your income patterns and tax liability projections over multiple years to ensure your approach aligns with long-term financial goals. Consulting a tax professional can help tailor these decisions to your specific situation.
Leveraging Retirement Contributions
Contributing to retirement plans is a powerful strategy for reducing tax burdens while building long-term financial security. For 2024, small business owners can contribute to a Solo 401(k), allowing up to $23,000—or $30,500 for those aged 50 or older—as an employee, with additional employer contributions up to 25% of net earnings. SEP-IRAs also offer considerable opportunities for high-income earners, with contributions capped at $69,000 for 2024. These contributions not only reduce taxable income but also provide significant retirement savings. Although contributions can be made up to the tax filing deadline, establishing a plan by year-end ensures a broader range of options.
Managing Capital Gains and Losses
Tax-loss harvesting is a powerful year-end strategy for small business owners to minimize tax liabilities by offsetting gains with losses. If you’ve sold investments or assets at a profit, these capital gains can be reduced or even eliminated by selling underperforming investments at a loss before year-end. For example, if you’ve realized $20,000 in capital gains but also have $15,000 in unrealized losses, selling the losing assets enables you to offset the gains, reducing your taxable income. Additionally, up to $3,000 in net capital losses can be used to offset ordinary income annually, with any excess losses carried forward to future years. This technique not only reduces your immediate tax burden but also provides the flexibility to optimize your portfolio for long-term financial goals.
Tax-gain harvesting, on the other hand, can be an effective strategy for business owners in lower tax brackets or during years with reduced taxable income. This approach involves intentionally selling investments that have appreciated in value to “realize” the gains at favorable long-term capital gains rates, which may be as low as 0% for taxpayers in the lowest brackets. By harvesting gains during low-income years, you can lock in profits while potentially paying little to no tax. Additionally, this strategy can reset the cost basis of the investment, allowing for a reduced taxable gain on future sales. It’s particularly useful when planning for potential future income spikes or changes in tax laws.
Balancing tax-loss and tax-gain harvesting requires careful consideration of your overall tax picture. Combining these strategies ensures that you capitalize on available deductions while taking advantage of opportunities to minimize long-term tax liabilities. However, it’s critical to be mindful of IRS wash sale rules, which disallow the deduction of a loss if you repurchase the same or a substantially identical investment within 30 days. By carefully timing transactions and coordinating with a tax advisor, you can optimize your tax outcomes while aligning your investment decisions with broader financial goals.
Monitoring Estimated Tax Payments
Monitoring estimated tax payments is critical to avoid penalties. To meet safe harbor rules, small business owners must pay at least 100% of their prior year’s tax liability or 90% of their current year’s projected liability. Adjustments to quarterly payments may be necessary to account for unexpected income or deductions, and Form 2210 can help calculate potential penalties. Conducting a year-end financial review is also invaluable. By analyzing financial performance, business owners can identify opportunities to defer income into the next year or accelerate deductions into the current one.
Take Charge of Your Year-End Tax Planning
Year-end tax planning is essential for managing a successful small business. Implementing these strategies can significantly reduce federal tax liabilities, enhance cash flow, and position businesses for sustained growth. However, given the complexities of the tax code, partnering with a skilled tax advisor ensures compliance and maximizes benefits. Taking these steps now can pave the way for a financially secure and prosperous future.