This is a guest post contributed by Mario Lucibello, CPA, MST at Greenhaus Riordan & Co LLP in the US to help our American readers be prepared for their US end of financial year planning.
As 2016 draws to a close it is time to start preparing for your 2016 taxes as well as plan ahead for your 2017 tax year. Getting your taxes right is critical to the health of your business (and to your personal finances).
Not only does putting off your taxes create a major source of stress that hangs over you, if you don’t file on time, you can face interest charges, a failure to file penalty, and a failure to pay penalty. These fines are cumulative, so they add up over time and end up costing you far more than you would have paid otherwise.
Interest is calculated on what you owe, while the failure to pay is calculated from April 15th — you’ll be charged for whatever amount you still owe. If you haven’t filed by April 15th (or filed an extension) then you get charged a pretty steep monthly fee of 5% per month, up to 25% of what you owe! If you really can’t manage to get organised on time, then file for an extension before April 15th — this gives you an extension until October, so there’s no reason you should be dealing with this penalties.
Here are a few things to be aware in order to minimize your tax liability and to make the process go as smoothly as possible this year.
1. Know Your AGI & Tax Projections
When planning for your taxes, it’s important that you have two numbers fixed firmly in mind: your adjusted gross income (AGI) and your tax bracket.
AGI is your gross income less any ‘above the line’ deductions (such as retirement plans and self-employed health insurance, and your tax bracket, of course, is the class of tax liability you fall into according to your AGI. The higher your AGI and tax bracket, the more taxes you will be liable to pay.
Ideally, you want to keep your AGI as low as possible. Many tax benefits begin to be phased out once you pass a certain AGI (such as the exemption for interest paid on student loans, exemptions for dependents, and Schedule A deductions like your mortgage interest and real estate taxes).
Preparing a tax projection for this year and next year will allow you to decide how to handle this year’s liabilities.
Sit down and look at your planning opportunities as soon as possible — many of them must be handled before year end. For example, state taxes are not due until April, but if you pay this year, you can get a deduction. The other big planning opportunity is accelerating or deferring your income and deductions.
2. Accelerating or Deferring Income and Deductions
Now that you know your numbers, do you anticipate being in a higher or lower tax bracket next year (compared to the bracket you will fall into for this year)?
Small business owners who use the cash method of accounting will generally be afforded a deduction when a business expense is paid, and income is recognized when the cash is received from their customers. This gives you the flexibility to either accelerate or defer your income or deductions that are close to year-end to the financial year that is most advantageous for you.
For example, if you had a really successful year thanks to a big outlier deal, but expect next year to be business as usual, then you should pre-pay as many deductions this year as possible. This will minimize what you have to pay next year when you will feel it more.
If you had a lean year and your AGI is lower than normal, then plan not to overpay anything. Pay some of the bills due this month in January, so you take the deductions next year. Or you can have your customers hold onto payments until January so that that additional income is taxed next year when things will be a bit more comfortable.
3. Fund a Retirement Account
There are many different tax deductible retirement plan options out there. SEP, IRA, 401k, Cash Balance, Pension, Profit Sharing… the possibilities are endless but the concept is the same.
Whatever you contribute to these plans will give you a tax deduction that will reduce your taxable income.
A few plans allow for up to $100,000 of contributions to your own account annually, which can create a huge reduction in your AGI (and can positively affect your tax bracket too). While many plans don’t allow for such big contributions, many allow for up to $50,000, which can still have a sizable impact on your tax responsibilities.
4. Roth Conversions
If you’ve had a slow year and fall into a lower tax bracket, don’t forget about Roth Conversions. If you’re in a position where you’re liable for a large tax loss but have but little to no income, don’t forget about Roth conversions. While these won’t lighten the load right now, it will provide you will more tax-free income when you retire.
Here’s what RothIRA.com has to say about it:
“With a Traditional IRA you receive a tax break today, but pay income taxes in retirement. This is opposite of what happens with a Roth IRA… When you convert from a Traditional IRA to a Roth IRA you pay income tax on the contributions. The taxable amount that is converted is added to your income taxes and your regular income rate is applied to your total income…
If you anticipate your income dropping significantly in a certain year (and increasing in following years) then a conversion could be done in the low income year. Since your income is lower you may be in a lower tax bracket when you convert.” 1
5. Keep Your Books In Order
We constantly get asked what the best tax trick is for the small businesses, and my response every single time is to have a good system for tracking expenses and STICK TO IT.
Deductions are constantly lost due to sloppy bookkeeping and poor systems around small business finances.
For example, people miss out on home office deductions every year. Even though your home is a personal expense, if you use a room as an office, you can claim that portion of your rent or mortgage as a business expense.
The IRS allows you to deduct a portion of your household expenses if an area of your home or apartment is exclusively used to operate your business.
The deduction is based on square footage of your home office in comparison to your entire residence. Deductible expenses include the pro rata percentage of rent, utilities, mortgage interest, real estate taxes, insurance, maintenance, cleaning and even yard maintenance.
This is an often overlooked deduction since the expenses are typically personal in nature and must be provided separately to your accountant outside of your bookkeeping system.
Make sure you keep a record of what you’ve paid so that you can clearly indicate to your bookkeeper the amount that should be deducted.
Another key deduction for small business owners is the Auto Mileage Deduction.
Many people drive extensively for their business, and in 2016 the IRS allows a deduction of 54 cents per mile driven for business purposes.
If you drive 10,000 miles, that is a $5,400 business deduction! You must maintain a contemporaneous log with relevant information such as the date of your trip, the starting point, the destination and the purpose of the trip or the IRS has the authority to disallow your entire mileage deduction. Keep good records and you can really cash in on this deduction.
If tax deductible expenses (like home office space and auto mileage) are being charged on personal credit cards or paid from personal bank accounts, tax deductions will inevitably slip through the cracks if you are not very proactive about record keeping, and the IRS will reap the benefits of you not claiming them.
My recommendation, at a minimum, is to have one business bank account and one business credit card that are used for business only, and to keep an exact record of anything that has to go through personal accounts.
Keeping all your bookkeeping in order has a dual benefit: It allows you to keep a close eye on the financial health of your business, and it will mean a cheaper, easier process at tax time.
If you have all the information on hand and in good order, your accountant and bookkeeper will have to spend a lot less time preparing your tax file. This means less hours charged and often a better tax return, since nothing is missed in the fray.
6. Qualified Small Business Stock
If you sold your business this year, you might be eligible for a tax exclusion on the proceeds of the sale.
There is a code section that allows for a 100% exclusion from gain on the sale of “qualified small business stock” up to $10 million. This topic could be a whole blog post in itself, but if you have recently sold, or are thinking about selling, you should investigate this option.
Unsurprisingly, there are a lot of boxes you have to check to be eligible for this exemption, including…
- It has to be a share sale
- The business has to be a C-Corp
- You need have to have held the shares for 5 years or more prior to the sale
- The business can’t be capitalized for more than $20 million
- It can’t be a service business or an investment business that just holds assets — it has to be a real business that trades in products.
Not all businesses will qualify for this, but ask your CPA if your sale could be exempt this year.
And if you are planning to start a new business in 2017, ask your CPA how to make sure you will qualify for this exemption if you wanted to sell it in the future.
It takes a lot of planning at the start of the business to get everything set up correctly, but if you know that you are building the business to sell, then this is absolutely worth investigating.
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Tax time doesn’t have to be painful if you take a little time to plan things out carefully and are proactive about minimizing your liability.
If you have questions about how to manage your bookkeeping in order to take as much advantage of tax season as possible, contact Bean Ninjas. They specialize in helping online businesses with their bookkeeping, and help you to take the stress and uncertainty out of handling your finances.
Note from Meryl – Thank you Mario for putting together this informative post! Here are Mario’s contact details.
This advice is of a general nature only and before implementing this make sure to discuss your specific circumstances with your tax advisor.
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