Tax Planning Tips for Small Business Owners
6 min. Read
Last Updated: 02/01/2019
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Tax season can sneak up on small business owners, and advanced planning helps to limit the stress of dealing with complications when deadlines loom.
Rather than letting receipts and financial paperwork build throughout the year, you can find better ways to manage tax reporting. For most business owners, the tax planning process involves gaining an understanding of federal, state and local liabilities, and ensuring the funds are available to meet those obligations. Business tax planning strategies often include taking steps to maximize available tax credits and ensuring deadlines are met to avoid penalties.
Here are some tips to help you stay on track:
1. It's never too early to start thinking about taxes
Start the year off right by adding process improvements to make your recordkeeping system more efficient. The goal is to have a system that provides a high level of accuracy with complete data right at your fingertips.
Create a list of the documentation you needed last year at tax time. Use it as a checklist when you begin to pull together the documents for the upcoming filing season. For example, if you purchase a piece of equipment for your business during the year, you will need the sales receipt for tax support. Make a file for the current year to retain these documents. Searching for the receipt months later will be much more difficult than saving documents in a designated file as they are received throughout the year.
Additional areas of consideration:
Prior year adjustments: At the end of last year, did your accountant or tax preparer give you a list of adjustments? If so, make sure those adjustments have been recorded in your bookkeeping system.
Tax reform: Look for ways to improve your tax position by reviewing pending tax law changes and current tax reduction opportunities. If legislation is pending, you may need to use the best information available to plan for tax reform and its potential impacts on your business. You can also subscribe to IRS Tax Tips, where you will receive emails throughout the year.
Tax strategies based on corporate structure: Due to changes in operations, size, and other factors businesses may benefit from a change in their type of entity. For example:
- If a sole proprietorship has grown, it may be time to incorporate or form a limited liability company (LLC). An existing C corporation may want to become an S corporation, or vice versa.
- Profitable corporations may want to distribute earnings to shareholders. While dividends are not deductible, shareholders who receive them pay tax on them at favorable capital gain rates (zero, 15 percent, or 20 percent, depending on the individual's tax bracket).
- A business may begin to sell across borders into other states and/or other countries. This raises a host of issues, including taxation, international intellectual property protection, and personnel.
- Deliberate actions may optimize business results. Major equipment purchases, hiring additional employees, making improvements to business properties, and adding benefits for current employees are all areas to consider.
Use calendar entries, alarms, and scheduling tools to ensure you don't let deadlines slide. There are many options available on your computer or phone. Or you could use a paper calendar to help you form habits that become part of your routine.
Putting off entering transactions will likely only lead to year-end frustration, a greater possibility of errors, and possibly missed expenses not taken as deductions. In your overall tax preparation checklist, categorize tasks by frequency such as daily, weekly, and monthly. For example:
- Enter all open invoices
- Record daily deposits
- File receipts and other documentation
- Issue sales invoices
- Review tax updates
- Generate and send customer statements
- Reconcile business accounts
- Review past due accounts
2. Select an accounting method
Before filing tax returns, many small businesses must choose between the cash or accrual methods of accounting. Businesses preparing their own tax forms may prefer the cash method of accounting because it's often easiest. However, there are advantages to using the accrual method of accounting in that it matches expenses and revenues. The accrual method focuses on reporting earned income, not just cash received.
Although tax law may dictate accounting methods that must be used in certain situations, there is also room for choice in some areas. Making changes can have long-term consequences and trigger income, so a discussion at a year-end meeting with your tax advisor is advisable. If you intend to engage tax-preparation assistance, don't forget to inquire about the benefits of accrual accounting for tax purposes.
3. Find out which forms to file
Tax filing requirements depend on a small business's legal structure. Sole proprietors can report income or loss from a business on Schedule C of their personal tax return. For example, LLCs, which are often formed to separate business from personal assets, require separate tax returns. The forms vary based on the LLC structure, such as a partnership or corporation. State and local tax requirements should also be researched during the small business tax planning stage to ensure the proper data is compiled before filing deadlines.
In particular, be sure to look into the following form requirements:
Accelerated W-2 Form filing: 2018 was the third tax year that the IRS has moved up the due date for federal W-2 filing to Jan. 31. The Social Security Administration indicated that the number of late W-2s filed in 2017 almost doubled compared with 2016, and the number of corrections filed on Form W-2C increased more than 30 percent from the previous year. Ensure that you submit all W-2s on time to avoid late or non-filing penalties assessed by the IRS.
Affordable Care Act filing: For tax year 2018, businesses defined as applicable large employers (ALEs) under the employer shared responsibility provision of the ACA are required to provide the Internal Revenue Service (IRS) with detailed reports of the healthcare coverage they offer. Unlike the previous two years, the IRS provided no transition relief in 2018 for how employers filed or how they offered coverage. To avoid the risk of substantial penalties, perform your due diligence so that the information on Forms 1094-C/1095-C is accurate and submitted on time.
Additionally, the IRS will now enforce the assessment for the ACA shared responsibility provisions. Questions about this part of the law are answered online, where the agency provides:
- More specifics on how employers will know that they may owe a shared responsibility payment;
- Instructions on steps you should take in response to the payment notices; and
- Information that employers will begin to receive notices of a potential assessment for 2016 as of late 2018, meaning some businesses will need to research these notices, correct any errors in previous filings, and communicate with the IRS while also preparing for current-year obligations.
4. Research possible tax credits
Business tax credits and deductions should be taken advantage of when profit levels are increasing in order to minimize tax liabilities. Many small businesses qualify for tax credits and these change from year to year. There are thousands of federal, state, and local credits, all with unique requirements, so it can be helpful to work with a tax professional or tax credit service provider who can identify the credits you qualify for and assist you in complying with the requirements of the program.
5. Set aside time at year-end to prepare for the upcoming filing season
Even if you manage to stay on task with your tax reporting throughout the year, you can also benefit from spending time at year-end to make sure you're in compliance and have capitalized on your tax planning strategies. The time you invest in these tasks during the last several weeks of the year may help you take advantage of last-minute opportunities to lower your tax liability, and may ensure a smoother tax filing season.
Create a checklist to help make sure all of your transactions are up-to-date and recorded in your accounting system including:
- Vendor invoices: All invoices need to be entered at year-end, and any invoices you receive in the beginning of January that are dated in December should be recorded as well.
- Customer billing: All invoices for products sold or services provided as of year-end should be billed in the system.
- Prepaid expenses: Any prepaid expenses, such as prepaid insurance for the following year, should be recorded as an asset.
- Depreciation: Depreciation for the current year should be recorded and up-to-date.
- Fixed assets: Any new assets purchased during the year should be recorded.
- Inventory: Whether you take a physical inventory at year-end, maintain a perpetual inventory system, or perform periodic cycle counts, ensure now that your inventory records are accurate and any adjustments for damaged, obsolete, and lost or stolen inventory are recorded. You should also have a record of any inventory removed for personal use.
On the payroll side, you'll want to check the following items:
- Ensure W-2 and W-4 forms are current. If you purchase hard copies of your W-2 forms from a third-party supplier, confirm that you have updated forms. If employees have had a life change over the course of the year (such as getting married or divorced, or having a child), remind them to submit a new Form W-4 if the event will impact their withholding allowances for the next year.
- Confirm payroll bank reconciliations. Identify any checks that may remain outstanding.
- Make a list of special wage payments. Special wages like employee parking, athletic club memberships, employee stock options, disability pay (in certain states), relocation assistance, or employee loans or scholarships may require you as the employer to provide additional information based on tax reporting requirements. Once you've determined which special wage payments apply to your business, review accounts payable and general ledger records to ensure your records are accurate.
- Confirm whether employees will receive a year-end bonus and how you'll issue them. If employees will receive additional compensation as a holiday bonus, it is subject to applicable payroll taxes and should be reported on a W-2. You'll also need to include holiday bonuses on your income statement to claim the additional pay, under most circumstances, as tax-deductible. If you'll pay employees a flat sum for a bonus, you can gross-up the amount when you input it into payroll so employees receive the funds less applicable taxes.
Organize all supporting documentation so that you can gain quick access as you prepare your taxes or respond to requests from your tax preparer. Often requested support includes:
- Expense receipts
- Mileage logs and vehicle odometer readings
- Customer invoices
- Bank statements
- Credit card statements
- Employee records and tax filings
- Estimated tax payments
And finally, review guidance from the IRS on recordkeeping requirements for small businesses.
6. Consider implementing an online accounting system
As your business grows and becomes more complex, you may want to re-evaluate your recordkeeping system and replace manual processes with automated tools. To help with bookkeeping in advance of tax season, consider using online accounting software. This helps you stay on top of data entry because you can access the system from any location where internet access is available. Online software also tracks applicable sales taxes. At year-end, you can use accounting software to generate financial statements and other reports that tax professionals will need to prepare business returns. Further, online accounting systems offer the capability to grant access to external accounting and tax professionals, avoiding the need for small companies to manually compile data for filing purposes.
In addition to accounting software, consider other enhanced services that can support business growth. Engaging a professional tax service firm can help you get organized and be well-prepared for the upcoming tax season.
Some examples of administrative and professional services you may want to look into include:
- Payroll and payroll taxes
- Sales tax services
- Tax credit services
- Time and attendance
- Human resources
- Employee benefits
- Online payment services
- Inventory control
Preparing for taxes can be overwhelming. Advanced planning, research, and the use of an online accounting system help increase both the accuracy of small business tax returns and the efficiency of the filing process. An experienced tax credit service can help you prepare.