Updated December 2022
It’s a common misconception that the tax code is rigged so the rich benefit and the poor are penalized. While the uber wealthy can definitely afford shrewd accountants and savvy tax attorneys to help, there’s another perspective to consider. The tax code favors employers versus employees. As a small business owner, you’re an employer. Employers have considerable more strategies available that can help you save money.
Here are some things to consider as we wind down the year.
Small businesses: Consider the S-corp
Even though S-corps have a stupid name, they’re awesome for small, domestic businesses. If you already have an LLC set up, you might still be able to either convert your LLC to an S-corp or possibly be elected to be taxed as an S-corp. Technically, S-corps are a tax designation you make with the IRS and not an actual entity. You’ll have to ask your accountant to help you figure out which option you can do to make your S-corp election.
S-corps are awesome because they may be able to reduce the amount of self-employment taxes you might pay and you might be eligible for some new deductions with the recent tax reform. Remember: you should only register for S-corp status if you will save on taxes. The quick and dirty way to figure that out is to identify what a reasonable salary would be for someone with your job description and if your business still has profits after paying you that salary, then an S-corp designation is at least worth looking into. You can and should definitely talk this through with your accountant to make sure it’s right for your specific tax situation (because this is not tax advice and I’m not an accountant).
Fair warning: there is more complication with an S-corp. An S-corp has more restrictions than an LLC with regards to ownership. One big caveat that you should be aware of with an S-corp is that you’re legally required to run payroll. Payroll involves getting set up with your state’s employment department, doing all the paperwork so you can pay into state taxes, finding a payroll service provider (I love Gusto), and understanding who will be in charge of filing payroll taxes (usually the payroll service provider) and then you’re off to the races.
Make a plan for your retirement contribution
As a small business owner, you have cornucopia of options for retirement. From the IRA to the 401k to a SEP IRA or even Cash Balance Pension, talk to your accountant about what your options are and when your contribution deadline is. For some retirement plans, like the IRA, you have until you file your taxes for this year to make your retirement contribution. For other plans, like a 401k, you’ll need to make your contributions by the last day of the year.
Either way, it’s a good idea to talk to your accountant about different retirement scenarios because your contribution amounts will impact your tax situation. Lastly, all retirement accounts have tax breaks to incentivize you to save for your adorable, old self. The nuances of how much you’ll save in taxes and what year you’ll get the tax break are all things you should go over with your accountant.
Don’t let the tail wag the dog
Don’t spend money you wouldn’t ordinarily spend to try to reduce your tax bill. It’s important to remember that expenses are not a dollar-for-dollar savings. In other words, $1 spent does not save you $1 in taxes. In most cases, spending $1 will often save you $0-$0.60 in taxes. While spending money can reduce your tax bill, it’s never an equal return. So remember kids, wastefully spending to bump up your deductions is not cool.
Know your basis: cash or accrual?
A lot of year-end tax strategies can only work for cash-basis taxpayers. If you’re an accrual-basis taxpayer, you have to report all your income when you earn it (not when you get paid or deposit the check) and report all your expenses when you incur them (not when you pay them). So if your business is on an accrual-basis and you send out invoices in December, but don’t get paid until the end of January, you’ll still report the December income in the prior tax year. The same goes for expenses. If you get an insurance bill on December 1, but it’s not due, and you don’t pay it until January, you’ll still report the expense in December.
Understand the implications of deferring or accelerating income and expenses
Deferring income or expenses means waiting until the next tax year to get paid/deposit income or waiting until the next year to pay for business expenses. Accelerating is the opposite of that. It’s realizing income in the current year and increasing expenses in the current year.
When you push income off or increase expenses to decrease your tax liability this year, it’s important to consider what that might do for next year. If this year your tax bracket is 20% and next year you think you’ll be in the 30% tax bracket, then it actually might make sense to shift expenses next year because you’ll have more tax savings. The other side of the same coin is if you’ve had a slower year this year, and you expect next year to bounce back, you could also consider deferring expenses next year to help offset that increase.
Make sure to look at the bigger picture when you're offsetting your income. Minimizing large expenses has more layers when you take the time to strategize the tax implications.