As many businesses recover from the recession and their profits escalate, they may find Uncle Sam’s tax bite painful without a carefully considered tax strategy.
Proactive business owners can make perfectly legal strategic moves to significantly reduce the amount of taxes they’ll owe, such as deferring taxes, moving income into the following year and taking advantage of the deductions allowed by the federal tax code.
To develop a responsible and thoughtful tax strategy, consult a certified public accountant with tax and audit accounting experience. Additionally, consider the following tips:
- Juggle your income based on revenues. Let's say you’re looking at higher revenue and salaries next year – enough of an increase that you and your partners (if you have any) could be pushed into the 35 percent tax bracket. In that case, you may want absorb as much of your income as possible this year. That way, the income will be taxed at the lower 25 percent rate instead of next year's 35 percent. Invoice early and stay on top of billings.
- Defer income. If you’ve had an outstanding year and have no idea what next year will bring, wait a bit on invoicing. Checks collected after the first of the year, even if they were written the year before, will be taxed in the year they are deposited, if you are on the cash basis.
- Give yourself a bonus or take a dividend next year. You can avoid paying too much in taxes by taking your bonus or dividend in January, which will push the taxes on that money into the next year.
- Take advantage of miscellaneous expenses. These include advisory fees, custodial fees, publications, professional fees, tax planning and preparation costs, certain accounting and legal fees, and unreimbursed employee business expenses. Keep in mind, these expenses must meet certain thresholds before they can be taken as deductions.
- Pay enough taxes and withholding. With revenue spinning upward, it's easy to forget the tax you owe this year will be higher than last year. You may want to increase your withholding or quarterly tax payments. Using an annualized income installment method offers a more accurate appraisal of your financial picture because it incorporates gains, losses, deductions and income for each tax period.
- Consider increasing contributions to 401(k) and similar plans. Self-employed individuals and small businesses without a huge number of deductions could stash gains away in 401(k) and SEP retirement plans. These investments reduce your income taxes now and allow you to pack away $17,500 or more annually.
- Don’t make decisions based only on tax implications. If you are succeeding in business, don’t allow tax deferral to dominate your decision-making. Just because something can’t be deducted doesn’t mean you should live without it. Invest wisely in assets – from technology to employees – that will allow you to continue on your upward trajectory.
If your business is growing, consider yourself both lucky and talented. It's fine to use the tax code to push money into different years when you can, or to save more for retirement. Just don’t abuse it. Being too “clever” will attract unwanted attention from the Internal Revenue Service.