As a small business, you’re always looking for ways to maximize the bottom line. But come tax time, it’s best to minimize that income, so you can hold on to more of it. This requires budgeting and planning well before Dec. 31, as you need to have enough money to take advantage of the many tax deductions and credits available to small businesses. And for those businesses worried about the fiscal cliff, it may make sense to do the opposite this year if on the brink of jumping into a higher tax bracket.
However your business is structured, any income that remains after all your bills have been paid is taxable. “Every dollar you can defer is a dollar worth deferring,” notes Arthur Cooper, President and CEO of Optimum 7, an internet marketing company based in Morristown, N.J. with offices in Miami, Fla. Cooper recommends pre-paying fixed monthly expenses (e.g. rent/mortgage, utilities, monthly subscriptions, insurance) for early 2013 to reduce taxable income for 2012. “Business expenses are counted on an accrual basis [when they occur], while income is counted on a cash basis,” notes Cooper. “So, it makes sense to delay accounts receivables and any bank deposits until the first week of January.”
Despite or because of the uncertainty of what tax rates may look like next year, Cooper is sticking with what’s worked best for his business, minimizing income and maximizing expenses. “This is the choice every business has to make,” says Cooper. “For those businesses sure to face higher taxes next year, an argument could be made to generate as much income as possible this year, as you’ll pay more in taxes but at a lower rate.” Collect on all those unpaid bills and deposit very check before year end while waiting until after Jan. 1 to pay your bills and accrue any business or capital expenses. Cooper, who's had the same accountant for 25 years, advises consulting a CPA well versed in all the deductions/credits available to small businesses. “The fact is nobody knows what will happen. Congress could kick the can down the road again,” notes Cooper. “But in terms of tax planning, you can’t wait until they’ all go home for the holiday recess. It will be too late.”
While virtually any expense related to the cost of running your business can be deducted, there are also many credits available to small businesses. While deductions are subtracted from income, on which your tax liability is based, tax credits are deducted directly from your tax bill, essentially reducing your tax liability dollar for dollar. Rachel Scott, MBA, EA and Principal at Canoga Park, California based
VSA Accounting Services, encourages businesses take advantage of those deductions set to expire or change in 2013. Sections 179, which allows businesses to deduct up to a maximum of $139,000 on equipment and software purchased and put into use in 2012, is due to drop to $25,000 in 2013. And bonus depreciation of 50% on equipment purchases over the $560,000 threshold for capital investment writeoffs is to be phased out. “If you have profits and can declare dividends,” notes Scott. “Qualified dividends are still being taxed at 15%, but that’s due to rise next year.” Scott recommends declaring dividends and reducing profits now to take advantage of that lower rate. Another overlooked deduction is for startup costs, up to $10,000 for 2012. This shrinks to $5,000 for 2013. Small businesses can also claim a tax credit for up to 50% of the costs to set up a retirement plan.
Christopher Tasik, founder and managing director of Stamford, Connecticut based Tasik Financial Strategies, LLC, recommends small business owners max out their 401k contributions ($17,000, if under 50; $22,500, if over 50). “If the amount you’re putting in every pay period doesn’t hurt a little bit, you’re probably not putting enough in,” says Tasik. For 2012, businesses with only one employee-owner can contribute up to $50,000 ($55,000 if over 50). Tasik suggests looking into multiple employer plans to help scale the costs. “The real value of a 401k to a business is employee loyalty,” notes Tasik. “It’s really not that huge of a cost for the value.”
The Affordable Care Act (often referred to as ObamaCare) provides tax credits for up to 35 percent of premium costs for certain small businesses starting or continuing to provide health insurance coverage to employees through 2013. In 2014, the maximum credit increases to up to 50 percent. Health savings accounts (HSAs) allow employers and employees to make tax-free contributions to the account for medical expenses. For 2012, the maximum contribution for individual coverage is $3,100 and $6,250 for family coverage (with $1,000 additional catch-up contributions for people age 55 or older). Some state even offer writeoffs for HSAs.
Another way to build goodwill among your employees and reduce your tax liability is by giving bonuses. Gifts or $25 or less are also tax deductible. You can also take a federal deduction if you pay state and local taxes before Dec. 31.
Don’t forget to hold onto those receipts for smaller expenses. While the IRS only needs receipts for business expense over $75, you need some form of documentation to claim the deduction. “You could be losing out on potential writeoffs,” warns Greg Jones, CEO of Tysons Corner, Virginia based Bookkeeping Express and co-owner of two Five Guys Burgers and Fries franchises. “Having organized records makes it easier to deduct those expenses.” Jones recommends categorizing receipts and outsourcing part of internal systems (e.g. payroll, bookkeeping) as a way to self audit your business. Such best practices should be implemented throughout the year. “You have to take care of the basics,” notes Jones. “You need to know what deductions are available and what you need to prove them.”
Budgeting is a key part of keeping that financial house in order. “Every small business needs to have a budget,” Tasik points out. “You can’t do any tax planning without money in the bank.” Small businesses should already have a budget in place for next year and be measuring that budget against actuals throughout the year. Jones recommends getting bringing in your CPA twice a year for a “temperature check” to make sure you’re maximizing all the deductions and credits available to your business, particularly those specific to your business’s industry.
Jones and his partners in the limited liability company that operates their Five Guys restaurants keep reinvesting their profits into growing the franchises rather than taking distributions. They are set to open a third next month. As long as the money stays within the LLC, it’s not taxed. “If want distributions throughout the year, be prepared to pay come tax season,” says Jones. “For us, we’d rather grow the business now. We look at it as more of an annuity for when we don’t want to work anymore.”
It’s not that you won’t have to pay, it’s just a matter of when. “The more you can defer your tax burden, the better financial shape you’ll be in,” explains Cooper. “Especially when you compound that activity year over year.” All that income deferred into January becomes taxable the next year or when you sell your business or retire. “It’s far better to show as little income as possible in any given tax year, as it lowers your business’s tax burden,” advises Tasik.