3 ways business owners can save on taxes at the end of the year
The end of the year always seems to sneak up faster than expected. No one knows this more than accountants and CPAs who are already looking ahead to their busiest time of the year—tax return season—and doing their best to get ahead of the rush.
As an entrepreneur, your number one business to-do is going to be working with your CPA, accountant, or bookkeeper to close your books for that year and review your annual financial position. But what if your bottom line puts you in over your head with a higher tax liability than expected?
In addition to credits and deductions you may qualify for based on your business activities, you can also work acts of generosity into your tax saving strategy. In this two-part post, we’ll cover how businesses and their owners can use a bit of good will and forward thinking to get extra tax savings as well as the best practices for executing these strategies in the most compliant of manners.
Part I: Three last minute ways to spend and save on your tax return
Giving back to your community
Whether you’re supporting local organizations in your community or nationwide non-profits, having a giving strategy can help lower your business’s taxable income even as late as the last few weeks before December 31. The additional boost of good will around the office or throughout your company culture makes this one of the most popular ways businesses save by spending.
You can determine how much you can save using your entity type:
- C Corporations can deduct 10% of their taxable income in donations each year. (However, they should still claim anything that goes over 10%, as it can be carried into next year’s deductions as well.)
- Pass-through entities (Sole Proprietorships, Partnerships, and S Corporations), pass all charitable contributions through to their owners, partners, or shareholders who can each claim up to 50% of their adjusted gross income in cash deductions on their individual returns.
Charitable giving has become such a popular tax saving activity for businesses and individuals alike that it now has it’s own holiday à la Black Friday or Cyber Tuesday. Since 2012, Giving Tuesday has been the official worldwide day dedicated to giving back, with more and more involvement each year. (Mark your calendar for Monday, November 16, 2016, this year and follow along on Twitter using #GivingTuesday.)
Giving back to employees
When it comes to tax-deductible spending, very few activities improve workplace morale quite like employee bonuses. Many businesses pay bonuses based on individual performance or results but are also known to distribute purely holiday themed bonuses throughout the company.
Similar to performance commission, giving holiday gifts in the form of cash, check, or even goods are typically based on overall company performance, which makes sense. When a company performs better than expected, employee raises and one-time bonuses can offload extra cash and offset tax liabilities.
Giving forward to your future self
Most of us have the same attitude about saving for retirement as we do about flossing—we know we should do it but are maybe not as diligent about always getting it done. Those of us who own a small business have an extra incentive pushing us to put away, in the form of tax deductions.
Because business owners are usually self-employed, they are responsible for paying estimated taxes. Setting aside for retirement is a great way to offset some of that tax responsibility while setting your future self up with a nice nest egg. Retirement plans in the form of IRAs or 401(k)s also come with added tax savings for the current filing year and even long-term tax-free interest savings. The IRS has summaries of various plans available here (pages 2 and 3).
Part II: Making sure those activities can help you save
Giving back may have you feeling as holly jolly as Saint Nicholas himself. Before you let those philanthropic feelings carry you into early holiday glee, remember: For each giving strategy, be sure you follow the best practices, so your charitable giving, employee rewards, and retirement planning all comply with tax regulations and help you save.
Know what types of charitable contributions count
Not all nonprofit organizations are created equal, so make sure the one you plan on donating to qualifies you for tax deductions. While donations to all 501(c)(3) qualified charities are deductible, certain groups, including lobbying groups, labor unions, chambers of commerce, civic or social clubs, homeowners’ associations, and political candidates or organizations are not. (To be safe, check with the IRS before you decide on a cause to donate to.)
As always, be sure to keep records of what you give back. Documenting is important in the case of an IRS audit. This is also one reason why donating cash or funds can simplify things. It’s easier to record the value of a donation when it shows up on your bank statement versus giving supplies or other physical goods and estimating the value. It may go without saying, but you cannot deduct the value of the time or blood you donate.
Keep diligent records of employee bonuses
Be sure to record employee bonuses—whether they be performance or holiday based—on your income statement. Like a paycheck, bonuses are seen as compensation by the IRS and other tax authorities, so they are always subject to payroll taxes.
While giving cash can be a fun, tangible experience, it also means more planning ahead with your payroll provider to have withholdings taken out in advance. If you pay these bonuses directly through your payroll like you would a paycheck, those tax withholdings will be deducted when processed. From there, your bookkeeping software or service provider should also recognize those transactions automatically.
Special note about retrospective rewarding: Depending on your accounting method, you may be able to pay bonuses out to certain employees within 2 ½ months after the year ends and claim a deduction for the current year. These are known as “accrued bonuses” and only apply to accrual-basis taxpayers. Talk to a CPA, about your accounting method while you prepare for taxes.
Take advantage of tax-saving strategies for entrepreneurs
While an employee can look to their employer to offer a retirement plan, as an entrepreneur you’ll need to be more proactive and decisive when it comes to choosing and setting up the right plan.
Your primary options to choose from are a SEP IRA (Simplified Employee Pension Individual Retirement Account), SIMPLE IRA, and Single Participant 401 k. Each one has different pros and cons so be sure to do your research. This article outlines the differences between these three options and also spells out your steps for getting started such as how to set goals, define milestones, automate savings, and locate helpful resources.
Additional tax saving strategies for business owners
In addition to these last-minute ideas, there are many options business owners should be aware of when planning throughout the year. Consult this guide to find the right strategies for your business.