6 Year-End Tax Planning Moves For Small Business Owners

While tax season 2022 may be months away, New Year’s Eve will be here before you know it. The fourth quarter is the time for some proactive tax planning to lower your 2021 tax bill. For business owners, tax planning shouldn’t be a once-per-year exercise when filing your taxes. With extensions, you may be able to delay filing your 2021 taxes until late 2022. However, many tax planning moves that can help lower your total taxes owed may need to be made before the end of the current year.

Review How Your Business Is Set Up

What is the corporate structure of your business? Are you a sole proprietor, S-Corp, LLC, Partnership or C-Corp? As your business and income grows, the best structure for your business may change. This is something you should review with your CPA and certified financial planner every few years (more often if your business is growing rapidly or if there have been changes to the ownership).

Review Your Business Retirement Plan

One of the best ways for small business owners to slash their taxes is to establish a retirement plan. This could be anything from a SEP IRA to a Solo 401(k), up to the combination of a 401(k) with a defined-benefit pension plan. Would you rather write a big check to the IRS or to your own retirement account? The choice is obvious to me. In case you were wondering, high-income small businesses can potentially defer income taxes on hundreds of thousands of dollars per year.

Here are a few of the most common retirement plans for high-income small business owners.

SEP IRA – If you are self-employed, you can contribute 20% of your self-employment earnings into a SEP IRA, per year, with a maximum contribution of $58,000 for 2021. There are no catch-up contributions for SEP IRAs. With no year-end deadline, a SEP IRA can be set up just before filing your taxes for the previous year.

Solo 401(k) – Typically, a Solo 401(k) will allow for the largest pre-tax contributions, which should translate into fewer taxes being owed. Business employees are allowed to contribute up to $19,500 for 2021 plus a $6,500 catch-up contribution if they are at least 50 years old. Additionally, the business will be able to make a profit-sharing contribution, up to 25% of payroll. That means a grand total of $58,000 (or $64,500 for those over 50) could be saved provided the individual contributes the maximum amount allowed by the IRS ($19,500 for 2021) and the business contributed the maximum allowable amount for payroll.

You can also benefit from a Roth Solo 401(k) for the employee portion of your contributions, $19,500 plus a $6,500 catch-up contribution for business owners over the age of 50. If your spouse also works with you in the business, he or she can be included in the plan, essentially doubling the amount you can contribute and the tax savings.

Defined-Benefit Pension Plan – For those needing huge tax savings, the defined-benefit pension plan is king. Combine it with a 401(k) profit-sharing plan, and your business could sock away a few hundred thousand dollars per year. You may also hear this called a cash-balance plan.

Defined benefit pension plans are the most complicated of the small business retirement plans to set up because the plan design is complex and time-consuming. If you think this may help your business keep more of its hard-earned money, talk to your trusted fiduciary financial planner ASAP. The extra work is more than worth it for high-income small-business owners willing and able to max out contributions to their 401(k) and defined benefit plans. Contribution limits will depend on age and income, but they can often run north of $150,000 per business owner per year. The tax savings can be huge, especially for those in high-tax states like California and New York.

Are You Eligible for The Home Office Deduction?

During the COVID pandemic, more and more small business owners have begun working from home full-time. Business owners reading this who work from home may be eligible to take the home office deduction. Here is what you need to know to determine if you qualify and get a better understanding of how this often-scary home office deduction works.

This valuable tax break can save hundreds, or even thousands, of dollars in taxes each year. The best part is that you are already incurring these expenses for housing regardless of your business use. Take the time and discuss the home office deduction with your tax preparer to make sure you qualify.

Don’t Ignore Your Bookkeeping

Filing taxes are a stressful process for even the most organized business owner. Please don’t try and file your taxes from a shoebox full of receipts. Break up your accounting and bookkeeping throughout the year. This can be easily done with software like QuickBooks. For a more complicated business with many invoices and expenses, consider hiring a bookkeeper. At a bare minimum, avoid procrastinating until tax time to get your books in order.  Missed tax deductions increase your taxable income and are essentially like throwing money away.

Claim First-Year Bonus Depreciation

One of the positive changes from the Tax Cuts and Jobs Act (TCJA) is that you can now get a 100% first-year bonus depreciation for qualified used and new property that was acquired and placed in service during your 2021 business year. To put this more plainly, you may be able to get a tax break for the entire cost of assets purchased in 2021. If you are having a big income year, you may want to consider moving up some planned purchases into 2021.

Proactive Tax Planning for Potential 2022 Tax Changes

When planning for 2021 and 2022, there are proposals from the Biden Administration to increase taxes on those making more than $400,00 per year as single filers and $450,000 for those who are married, filing jointly. Many business owners find themselves with incomes above these levels. While you shouldn’t make major tax planning decisions based on government proposals, you should be prepared for potential changes to the taxation of your income. The higher your tax bracket, the more valuable tax planning will be for you and your business.

Even without any changes to the tax law by the Biden Administration, many of the current changes from the TCJA (Trump tax plan) are only expected to last through 2025. While the TCJA was supposed to be a huge win for all taxpayers, many have complained that it only benefits the super-rich and has shafted many in the middle class. Now, Trump is talking about a new tax cut for the middle class; how that would be paid for is anyone’s guess.

Be Proactive with Your Tax Planning

With proper timing (from proactive tax planning), your income and deductions could become even more valuable. For those who use pass-through entities (Sole Proprietor, S Corp, LLC, or Partnership), your portion of the business profit and deductions are passed through to you and eventually taxed on your own personal tax returns. Taxes are based on your overall household income and filing status.

As it stands now, the 2021 federal income tax brackets are like the 2020 brackets, with a few small adjustments for inflation. If you expect to be in a similar or lower tax bracket next year, you may want to try and defer some income into 2022. Likewise, you may also want to move some tax deductions up into 2021. At the very least, these tax-saving strategies can help defer some of your taxes from 2021 to 2022, which will give you a little more time to pay Uncle Sam. 

You will want to take the opposite tax planning approach if you are expecting to be in a higher tax bracket in 2022. In this case, you would want to accelerate income where possible into 2021. Or you may want to delay some deductions until 2022. Doing so would mean that you would have more income taxed this year (2021) but end up with an overall lower net tax rate for the two years combined.

For the self-employed, minimizing taxation is one of the best ways to increase the net profitability of your small business. Be proactive and work with your certified financial planner and CPA to develop a strategy to make proactive tax planning choices that will help you keep more of your hard-earned money. In the case of retirement accounts, would you rather write a check to yourself or the IRS? The choice is yours.