Year End Tax Tips
Posted by: Joseph Kuo | December 12, 2018
Before we get started, let me clarify that most of these options provide more benefits to businesses on cash basis accounting, rather than accrual method accounting. If you are not familiar with accrual method accounting, think of it as having to record revenue when you’ve delivered value and to record expenses when you’ve received value. This means that once you’ve delivered your product/service, you record revenue even if the customer hasn’t actually paid you. It also means that you only get to record insurance premium monthly, even if you’d prepaid for 6 months. Alternatively, with cash basis accounting, you recognize revenue and expense when you receive or make payment – even if it is for future delivery/services. Note that, if you use a credit card, spending happens when you swipe the card, not when you have to pay the statement. With that said, let’s get into these year end tax tips.
You can delay year-end revenue by waiting to send out invoices until late December. While businesses typically want to receive payments as soon as possible, cash based businesses can reduce current year taxes by taking payments after the New Year. Note that you would only do this with reliable customers who pay on time. For customers with poor payment history, you’d still want to collect as quickly as possible.
Add to savings
You can take advantage of qualified and personal retirement savings accounts. If you have a qualified retirement plan at your business, you can max out your retirement plan. Even without a qualified plan at work, you may still have access to individual retirement accounts. The great thing about retirement accounts is that each dollar you save can lower your tax for this year. Therefore, it costs you less than $1 for each $1 worth of savings. In other words, even if you don’t have much cash, you can still put some money aside since you get some back in the form of lower tax payment. Do be aware that, once money goes into the retirement plan, there are rules for when you can take it out without penalty. The most common plans/accounts are 1) 401k with profit sharing, 2) SEPs, 3) SIMPLE, and 4) IRA.
Loss and gain harvesting
Another way to manage revenue is via tax loss or gain harvesting. This means that you sell investments at a loss or a gain to offset some other parts of your income. Loss harvesting is when you specifically sell investments at a loss to offset the gains you’ve recognized throughout the year. Loss harvesting is a more common topic but there is also a case to practice gain harvesting. If you are experiencing a temporary income reduction for one year or you’ve realized a significant loss with another investment, you can take the opportunity to sell something at a gain and pay lower tax. Watch out for the “wash sale” rule if you are doing this with securities (i.e. stocks, bonds, options); don’t trade the security 30 days before and after you plan to sell that security at a loss.
One way to manage expenses for your taxes is to hire your kids (or some other family member) to work for you. While you’ll incur payroll tax, you also get to reduce your income for tax purposes, plus your kids now have income to put money in IRA or Roth IRA. The earlier they start savings, the greater the benefit they will receive from compounding.
Another way to increase expenses for cash basis businesses is to prepay as many expenses as possible. You can even put it on credit cards. Some examples include contractors, utilities, insurance premiums, office supplies, etc. As a rule of thumb, there is a 12-month limit to how far ahead you can prepay; the specific limit may depend on contract and when you start receiving benefits. Note that there are different rules for “assets”, which is equipment you will use for many years, such as car, heavy machinery, and building.
Purchase of expensive equipment that lasts a while doesn’t usually get counted as expense since there is real value to that equipment’s useful life. Instead, you get to take depreciation, simulating the reduction in the equipment’s useful life. However, there are ways of increasing the rate of depreciation or even taking the whole depreciation in 1 year. Therefore, you may be able to make qualified purchases that can significant increase your expenses for this year and, thus, reduce your income. Please work with a tax professional on this. The applicable IRA rules are Section 168(k) and Section 179.
Other Tax Opportunity
Along with lowering corporate taxes, the new tax law also provided some relief to other types of businesses. There is now a Qualified Business Income deduction for pass-thru income. In other words, income that is taxed via the owners’ tax returns as opposed to the business’s tax return. If the owners’ total taxable income is below the threshold ($315k for married filing jointly or $175.5k for single), there’s a 20% deduction for the pass-thru business income. Above the threshold, there is a complicated phase-out calculation so you will want to consult a tax professional.