10 Year-End Smart Tax Strategies for Business Owners
A ROTH conversion and putting your spouse on the payroll should both be on your 'to-do' list.
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The end of year is quickly approaching, and it's time for taxes. Hundreds of business owners will turn to their advisors for tips and strategies on how to save money and they'll all get the same time-worn response: Sell under-performing stocks to harvest losses or make sure you have spent the money in your flexible spending account.
Don't fall into that trap. As a business owner you have at your disposal several money-saving strategies to consider before the year ends. Here are those top 10 strategies that can save your bottom line:
1. Make an S-election on an LLC you set up this year and use it for operations.
We implement this election for clients every year in December. If you've previously paid a lot in self-employment tax and had an LLC (sometimes a major mistake by other planners), you can easily still elect to be taxed as an S-corporation, retroactively, to January 1, 2015. It's simple and affordable to file the proper paperwork. There are new IRS regulations that allow for this retroactive classification at year's end. However, don't forget to do your payroll. You are required to take some payroll for yourself out of the company if you make the election.
2. Set your payroll amount.
S-Corporation owners or newly elected LLC S-Corps must complete their payroll before year's end. Many business owners tend to wait until the fourth quarter to do this, which is not a good idea and can be a flag for a potential IRS audit. If you've already done your quarterly payroll throughout the year, this can be a great time to adjust it to the proper amount . . . maybe increase it or lower it, based on your net-income.
3. Put your kids on the payroll.
Surprisingly, this is an often overlooked or under-utilized strategy. Paying your children for bona-fide services they provide in your business can be a powerful tax-saving tool. First, an incredible benefit is that if you pay your children through a sole-proprietorship or single member LLC, and the child is less than 18 years of age, the business is not required to withhold FICA or payroll taxes. Second, the child can use his or her standard deduction of $6,300 in 2015 against any income you pay, as that sum is earned income and thus entails no income taxes. However, if you have an S or C-corporation, the Internal Revenue Code requires that you withhold FICA from all employees on the payroll.
So, use a separate business account for these payments that complies with regulations. For any naysayers out there, keep in mind that the "kiddie tax" does not apply in this situation, as it only applies to passive income. It's also critical to follow the proper procedures and have bank accounts for the children, to follow through with the payments and to document bona-fide services. Cleaning the office, filing, shredding paper and working on the rental property are all great jobs for the kids.
4. Put your spouse on the payroll.
As a business owner, you should consider this strategy only if your spouse wants to contribute money to your company 401(k) for tax-planning purposes. Otherwise, generating earned income for your spouse and subjecting it to payroll taxes would be careless. Moreover, that move really doesn't make sense, to get a deduction for a salary that will end up on your joint return anyway.
5. Implement a 401(k) before year's end.
A properly designed 401(k) can be self directed and utilized in real estate transactions, hard-money lending and small business investments. This year, small business owners can deduct up to $51,000 with matching: That's $18,000 as your deferral before matching, with an additional $5,500 for those 50 and older. However, the payroll level you choose for yourself needs to be carefully considered in this process.
6. Start establishing your entity now.
January 1 is a perfect time to set up your books and a bank account. A number of states impose franchise taxes and fees that make it most economical and logical to file articles in and around the first of the year. That could mean an LLC for that new rental property and getting the title transferred into your LLC, or an S-corporation, because you paid far too much in self-employment tax during 2015. Just make sure you don't file too early and create a short-year tax return. Timing is everything.
7. Close on that rental property.
Cost segregation is one of the fastest growing areas in tax planning and has been used only by owners of large commercial projects. Essentially, cost segregation is the process of reclassifying the assets of a rental property into real and personal property, thus moving certain assets into an accelerated depreciation class. This allows property owners to defer thousands of tax dollars. That said, it's critical that you consider the real estate professional classification and other passive income you may be able to deduct this segregated depreciation against. You could end up with a write-off that falls into a carry-forward status if you aren't careful.
8. Purchase a vehicle.
More than 90 percent of our clients use the mileage deduction strategy. However, businesses that could use a large truck or SUV should consider the purchase of a vehicle weighing more than 6,000 pounds. The current deduction for depreciation can be up to $25,000, depending on the cost of the vehicle and your business-use percentage. Congress is expected to expand this deduction to $500,000 at the last minute, just as it did last year, in December 2014. With this increase, the deduction can vary dramatically among an SUV, RV or truck with a 6-foot bed. Discuss your options with your tax advisor.
9. Make a ROTH conversion.
I cannot emphasize this strategy enough! Consider converting your traditional IRA or 401(k) to a Roth IRA, and start paying taxes at a lower rate without paying taxes on your withdrawals in the future. Regardless of your income, you can convert as many dollars as you want. However, you should carefully consider your tax bracket and how much is in your IRA before switching over. You'll want to keep your marginal tax bracket in check. And as long as you make the election before December 31, you can reverse the election by April 15. So, if you get gunshy later or can't pay the tax you were expecting, check the reset button.
10. Push income or expenses to the proper year.
This is a standard strategy, but a tricky one, with higher tax rates. Typically, you want to push income to the next year and accelerate expenses to the present year. However, when you're spreading out income between this year and the next, try to stay under certain higher marginal tax brackets.
Should you consider any or all of these strategies, it is imperative to have a decent set of books so you can make informed and accurate decisions. One of the best year-end strategies you can implement is just getting your bookkeeping in order to start the year off making better management and economic decisions for your business.
As you can see, there are plenty of options for the small business owner, and unique ones at that. Make sure you consult with your tax advisor and don't be satisfied with the standard answer that you can simply sell some under-performing stocks to save taxes. A small business owner's tax return offers a lot of potential to keep the tax man at bay.