Small business owners often overpay their taxes. It’s not surprising. After all, U.S. tax law is incredibly complex. And the IRS estimates that business taxpayers spend, on average, around 21 hours dealing with taxes, including recordkeeping, planning, and completing and submitting tax forms.
That complexity leads to missing out on year-end tax planning strategies that can reduce a business owner’s taxable income and allow them to keep more of their hard-earned profits.
To help make next tax season a little less, well, taxing, here are a few year-end tax planning strategies to consider.
1. Claim Bonus Depreciation
Chances are, you purchase computers, equipment, furniture, and other assets for your business that you use over the course of several years.
Typically, the tax code requires you to depreciate those items over their useful life. But bonus depreciation allows you to write off 100 percent of those costs on your 2021 income tax return.
If you’re considering buying a new piece of equipment, upgrading your technology, or making some tenant improvements, consider pulling the trigger before December 31.
One word of caution — not all assets qualify for bonus depreciation. Buildings and their structural components aren’t eligible. Also, the property must be “placed in service” in 2021, meaning you need to actually start using it. So, ordering a laptop on December 30 that won’t be delivered until January 2022 won’t lower your tax liability this year.
2. Postpone Income and Accelerate Expenses
Using cash basis accounting for tax purposes (as most small business owners do) creates some valuable tax planning opportunities. Under the cash method, you recognize income when it’s received and expenses when they’re paid. So, if you want to lower this year’s tax bill, consider whether you can push this year’s income to next year or accelerate next year’s expenses to this year.
For example, say you finished a client project in December of 2021 but haven’t yet billed your client for the work. If you wait until January of 2022 to send your client an invoice, they won’t pay you until 2022, meaning you don’t have to claim the income on your 2021 tax return.
Likewise, say you’re planning on sending several members of your team to a conference next year. You weren’t planning on paying those registration fees until March of 2022, but if you pay them in December of 2021 instead, you can claim the deduction this year.
Postponing business income and accelerating expenses can lower your tax bill in a few ways. First, if you can lower your taxable income enough, you may be in a lower tax bracket, so you’ll pay a lower overall tax rate this year.
Second, by lowering your business income, you reduce the amount of income subject to self-employment tax. Self-employment tax is the self-employed version of Social Security and Medicare, and as a business owner, you pay the whole 15.3 percent tax rate yourself — employees only pay half. So, lowering your self-employment tax burden can save you a pretty significant amount.
Second, if your adjusted gross income (AGI) is lower, you may qualify for other tax deductions and tax credits that have income limits. For example, you might be able to deduct more of your traditional IRA contributions, contribute to a Roth IRA, pay a lower rate on long-term capital gains, claim tax credits for education, or be able to itemize medical expenses.
3. Establish a Retirement Plan
The Setting Every Community Up for Retirement Enhancement (SECURE) Act provided some pretty good incentives for small businesses that set up workplace retirement accounts.
Small businesses can claim a tax credit worth up to $5,000 per year for three years to help offset the costs of setting up the plan. Those costs include fees to set up and administer the plan and educate employees about their retirement savings options.
To qualify for the credit, your business must have:
- 100 or fewer employees who received at least $5,000 in compensation during the prior year,
- At least one plan participant who isn’t a highly-compensated employee, and
- A roster of employees who didn’t participate in a prior retirement plan offered by your business in the past three years
There’s an additional credit designed to increase employee participation in retirement plans. The Small Employer Automatic Enrollment Credit provides a tax credit of $500 per year for three years for small businesses that include an auto-enrollment feature in their retirement plans.
Together, the two credits could reduce your tax bill by up to $5,500 in the first year alone.
4. Give to Charity
Charitable contributions aren’t typically deductible on small business tax returns — only on the returns of C corporations. But the tax benefit of those contributions doesn’t disappear. Instead, they pass through to the business owner’s individual tax return.
To benefit from the deduction, you normally have to claim itemized deductions rather than the standard deduction. However, the Coronavirus Aid, Relief and Economic Security (CARES) Act now allows non-itemizers to deduct up to $300 in charitable donations as an “adjustment to income” on Schedule 1.
Just keep in mind that the $300 deduction for non-itemizers applies only to cash donations made to qualifying charitable organizations. Donating non-cash items, such as vehicles, clothing, or household goods, doesn’t qualify for non-itemizers. However, people who itemize can still claim non-cash donations on Schedule A.
Also, you have to donate by the end of the year. Donations made after December 31 can’t be deducted until the following year.
5. Contribute To an HSA
Health savings accounts (HSAs) are accounts that let people with high-deductible health plans (HDHPs) save on out-of-pocket medical expenses in a tax-advantaged account.
Contributions to an HSA are tax-deductible, the money grows tax-free while in the account, and withdrawals are also tax-free as long as you use them to pay for qualifying health care expenses.
For 2021, you can contribute up to $3,600 for an individual HDHP or up to $7,200 for family coverage. And even if you miss the December 31 year-end, you can still contribute to an HSA in 2022 and claim it on your 2021 tax return. The deadline to make contributions for 2021 is April 15, 2022.
6. Claim the Employee Retention Credit
The Employee Retention Credit (ERC) is another tax credit created by the CARES Act. It incentives businesses to keep employees on the payroll during the pandemic by providing a credit against the employer’s portion of payroll taxes. Because it’s a refundable credit, if the calculated credit is greater than your payroll tax liability for the quarter, the excess amount can come back to the business as a tax refund.
The ERC expires at the end of 2021, but businesses can still claim the credit for the third and fourth quarters of 2021.
It’s worth up to 70 percent of the first $10,000 of qualified wages per employee per quarter. To qualify for the credit, your business must:
- Have fully or partially suspended operations due to a governmental order during the pandemic,
- Experienced a decline in gross receipts of 50 percent or more compared to the same quarter in 2019, or
- Be a “recovery startup” business launched after February 15, 2020, and have annual gross receipts of $1 million or less.
Unlike some of the other tax credits mentioned above, the ERC is a credit against payroll taxes. If you qualify for the credit, you don’t have to wait until you file Form 941 to get the benefit. You’re allowed to reduce the employer share of Medicare tax payments in anticipation of claiming the credit or request an advance using Form 7200.
Maximize Your Tax Savings
Every business and individual tax situation is unique, and deciding whether these tax strategies are right for you can be confusing. If you need help, be sure to reach out to a CPA or another qualified tax professional. They can help you with your year-end tax planning and identify other ways to maximize your tax savings.