The end of the calendar year is a busy time for most entrepreneurs and small business owners. By now, you’re probably already wrapping up your strategic plans for 2022 — but it’s not too late to think about ways you could also boost your 2021 profits if deferring taxes until 2022 makes sense. Here, we discuss five, year-end tax planning tips for small business owners to help increase the bottom line and start the new year off on the best financial footing.
Defer Operating Income and Accelerate Tax Deductions
You already know that income received during this calendar year will count as income in 2021, but there are still ways you can defer income into 2022. The simplest way is to delay sending invoices in December, pushing receipt of payments into 2022. This tactic is best employed for customers with solid payment histories. If you use accrual based accounting instead of cash based accounting, talk to your accountant professional to ensure that you’re not altering your billing process but receiving no tax benefit in return!
The flip-side of the accounting coin is to prepay January bills during December. This reduces taxable income during 2021 and lowers this year’s tax burden. The tax rules in most states allow you to count checks mailed in December as paid, even if they don’t hit the books until January. Alternatively, owners can prepay recurring expenses on credit cards during December to take advantage of the same tax benefits, knowing that you won’t need to pay the credit card statement until January.
Maximize Retirement Contributions
If you are self-employed, you can contribute as high as 20% to 25% of your annual compensation into a SEP IRA, up to $58,000, annually. Similarly, a small business owner has the option of a solo 401k which allows more flexibility to minimize taxes owed.
For those seeking substantial potential tax savings, few options beat a defined-benefit pension plan. A defined benefit plan is typically combined with a 401k profit-sharing plan to allow a maximum contribution into qualified plans, annually. Typically, these plans work best for family-owned firms with large free cash flow and the ability to direct $100,000+ to retirement savings. The underutilization of these plans may stem from the set-up complexity, but a seasoned accountant can help file the paperwork to get one in place.
Consider Large End-of-Year Investments
If you have been considering making a sizable equipment purchase for your small business, now is the time to pull the trigger. In all probability, bonus depreciation rules may allow owners to deduct the entire amount paid for a company car, new equipment, computer hardware, etc. from 2021 profits. Owners can often deduct the entire amount paid for the investment this year instead of depreciating the amount over several years (check with your tax professional).
Alternatively, another way to increase deductions (and lower taxes owed) is by making capital improvements or purchasing new equipment that will qualify for a Section 179 deduction. Via this underutilized deduction, entrepreneurs and business owners can deduct the cost of qualifying property as an expense. By spending more on qualifying items, you can reduce your net profits, and in turn, your taxes owed. However, make sure your purchase is a true investment: you don’t want to increase expenses that do not directly contribute to productivity gains.
Claim First-Year Bonus Depreciation
One major, potential tax benefit stemming from the Tax Cuts and Jobs Act is that business owners can now take a 100% bonus depreciation amount in the first year for qualified property acquired and put into service during 2021. (Note: this benefit can also be claimed in 2022). This is an increase form 50%.
Qualified property includes upgrades to your place of business, although there are some exclusions. If it’s too late in the game to claim this deduction in 2021 but you’ve been putting off workplace property improvements for too long, read up on the specifics on the IRS website and then talk to your contractor and tax professional about taking advantage of this temporary benefit before it expires at the end of next year.
Be Proactive With Your Company Tax Planning
We rarely recommend making changes based simply on rumors swirling around Washington, but business owners should keep an eye on recent proposals from the Biden Administration to increase taxes on high income taxpayers starting at $400,000 depending on filing status. Depending on your business structure and profitability, many small business owners may find themselves at or above these income thresholds, meaning that higher taxes could be in store in the years ahead.
You should be prepared for possible tax changes that could impact your business, pass-thru, and personal take home pay. This means speaking with a wealth management professional who will incorporate contingency planning into your holistic financial plan. The higher your potential tax bracket in 2022 (and beyond), the more valuable proper tax and wealth planning can be for you, your family, and your business.
Conclusion
2021 was another tumultuous year for many entrepreneurs and small business owners. Remember, even as you are finalizing your strategic planning for 2022, it’s not too late to consider ways to reduce your tax liability for 2021. By making timely capital investments, optimizing retirement contributions, and being proactive with tax planning, you can potentially decrease how much of your hard-earned revenues end up in government hands.
At Magellan, we believe it’s our job to match your vision of retirement with a plan to pursue it. For small business owners and entrepreneurs, that means aligning personal and professional financial goals. Together, we will create diversified income sources, a dynamic spending strategy, a cash cushion, a written retirement strategy, and a thoughtful transition plan. That approach will include ways to ensure that your chosen profession is carried out via a legacy, as appropriate.
For More Information About Our Business Financial Services for Entrepreneurs, Contact Our Team Of Financial Advisors Today!
Sources:
1. https://www.wellsfargo.com/biz/retirement/401k-plan/
2.https://www.forbes.com/sites/davidrae/2021/04/15/4-ways-for-the-self-employed-to-save-for-retirement-and-minimize-taxes/?sh=19256c513e82
3. https://www.irs.gov/publications/p946
4.https://www.irs.gov/newsroom/new-rules-and-limitations-for-depreciation-and-expensing-under-the-tax-cuts-and-jobs-act
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Wells Fargo Advisors Financial Network and its affiliates do not provide legal or tax advice. Transactions requiring tax consideration should be reviewed carefully with your accountant or tax advisor. Any estate plan should be reviewed by an attorney who specializes in estate planning and is licensed to practice law in your state.