Year-End Tax Tips for Entrepreneurs
Although, the most productive tax planning should be performed routinely and often pays large dividends; it’s not too late to minimize your tax exposure for the current year. Schedule an appointment with your tax advisor before year-end to discuss strategies to minimize your tax exposure.
To get you started, we have assembled the following list of tax saving strategies:
Rent Your Home to Your Business
Known as the “Augusta” rule, Internal Revenue Code 280(a) allows taxpayers to rent their personal home (or a room) for 14 days (or fewer) each year tax-free.
The Augusta rule was lobbied for by residents of Augusta, Georgia, in the 1970s. Each year, the Masters golf tournament is held at the Augusta National Golf Club, and residents of the city wanted to rent their home to attendees of the tournament without becoming full-fledged rental businesses. Their efforts paid off, and Section 280(a) was added to the tax code. Fortunately, today, the IRS Augusta Rule extends to all homeowners in the US, not just those in Augusta, Georgia.
Using this code section, business owners may consider renting their personal home to their business for a holiday party, management meeting, etc. and taking a business deduction for the expense while excluding the income on their personal income tax return.
Donor-Advised Charitable Funds
A donor-advised fund is like a charitable investment account, for the sole purpose of supporting charitable organizations you care about. When you contribute cash, securities, or other assets to a donor-advised fund, you are generally eligible to take an immediate tax deduction. Then those funds can be invested for tax-free growth, and you can recommend grants to virtually any IRS-qualified public charity.
When you give, you want your charitable donations to be as effective as possible. Donor-advised funds are the fastest-growing charitable giving vehicle in the United States because they are one of the easiest and most tax-advantageous ways to give to charity.
Home Office Deduction
If you’re self-employed and find yourself working from home more these days, consider taking the home office deduction. The home office deduction is available to business owners who use part of their home for business purposes. Your home can be a house, apartment, condo, or similar property. It can also include an unattached garage, studio, barn, or greenhouse. The deduction is available for both renters and homeowners.
Hire Your Kids (Income Shifting)
If you are paying income taxes at a high tax bracket, consider hiring your kids or another family member to perform legitimate work for your business and shift income to a lower tax bracket. Each kid can be paid up to approximately $12,000.00 creating a business write-off for your business and without any income tax being assessed to the individual because the amount is less than the standard deduction allowed by the IRS for individual taxpayers.
Furthermore, this strategy will generate “Earned Income” for the individual which is required for individuals to be allowed to contribute to most retirement plans. Consult with your investment advisor, but you may consider a Roth IRA for younger individuals.
Avoid the State and Local Tax (SALT) Cap
An individual taxpayer’s tax deduction for State and Local Taxes (SALT) paid is currently capped at $10,000.00. However, several states have enacted SALT cap workaround laws, and several others are working towards enactment. Generally, the workaround laws in conforming states consist of organizing an entity (LLC, partnership, etc.) for your business and converting non-deductible SALT expenses into deductible business expenses.
Evaluate Your Business Structure
Is the structure (sole proprietorship, LLC, corporation, etc.) of your business appropriate or has your business outgrown its original structure? If your business is not structured properly, you may be over-paying income taxes. Consult with your tax advisor to create an entity structure that is appropriate for your unique circumstances.
Cash vs. Accrual Methods
The 2017 Tax Cuts and Jobs Act allowed for a change in the option to select cash accounting instead of accrual. More small businesses can elect to use cash accounting, beginning in 2018. You can use the cash method if you had average annual gross receipts of $25 million for the preceding three years. Some small businesses may also be exempt from certain accounting rules for inventories, cost capitalization, and long-term contracts.
If your business currently uses accrual accounting, you'll need to use IRS Form 3115 to apply for a change in accounting method. Qualifying for these changes may be complicated; get help from your tax advisor before you make the change.
Explore Available Tax Credits
There are a slew of tax credits and deductions available for small businesses. For example, there are tax credits for starting a small employer pension plan, making handicap accessible improvements to your facility, and the list goes on and on.
Consider Accelerating Depreciation
When considering larger purchases (i.e. equipment) for your business, consider alternatives to depreciating the assets over multiple years such as bonus depreciation and Sec. 179 which allow for much larger write-off’s in the year the asset is acquired. Limitations may apply so be sure to discuss this with your tax advisor.
Accelerate Year-End Expenses
Now is the time to spend money on items your business requires while maximizing tax deductions for the current year. Pay bonuses to your employees, pay current invoices and stock up on supplies. This maneuver may not be appropriate for all taxpayers so visit with your accountant to discuss whether it makes sense to accelerate expenses to decrease your tax bill.
Defer Year-End Revenue
Any income received by December 31st counts as revenue for the current year. Deferring income to January 1st delays it from being considered taxable income until the following year, and this could save you a significant amount of money in the current tax year. This maneuver may not be appropriate for all taxpayers so ask your accountant if it makes sense to defer revenue until January to decrease your tax bill.
Reducing inventory could reduce your businesses taxable income. This may depend on the accounting method you choose report taxes on, so visit with your tax advisor to see if this makes sense for your business.
Contribute to a Retirement Plan
Contribute to your retirement plan or set one up before December 31st to reduce your taxable income this year. If you haven't yet set up a retirement account, talk to your financial advisor to determine which plan is best for your business.
Contribute to a Health Savings Account
An HSA is a medical savings account that’s available to you when you’re enrolled in a qualified high-deductible health plan (HDHP). Perhaps the biggest benefit of an HSA is the triple tax advantages it offers: 1) contributions are pretax and reduce your taxable income; 2) your HSA funds grow tax-free; and 3) when used to pay for eligible medical expenses, HSA withdrawals are tax-free.
HSA contribution amounts are capped each year by the IRS. For 2021, the HSA contribution limits are $3,600 for individuals and $7,200 for family coverage. Individuals who are 55 and older are eligible for an additional $1,000 catch-up contribution.
Take Advantage of Long-Term Capital Gains Tax Rates
When selling investments or other assets, remember to consider potential tax liabilities. With tax rates on long-term gains more favorable than short-term gains, monitoring how long you’ve held a position in an asset could be beneficial as it will likely lower your tax bill.
Holding securities for a minimum of 12 months generally ensures that related gains receive the more favorable long-term rates. On the contrary, short-term capital gains are taxed at ordinary income tax rates which are often-times higher than the long-term capital gains tax rates. Depending on your tax bracket, any significant profits from short-term gains could bump you to a higher bracket.
Consider Cost Segregation for Real Estate Investments
Cost segregation is a tax deferral strategy that frontloads depreciation deductions for real estate assets in the initial years of ownership.
A cost segregation study segregates the individual cost components of a building into the proper asset classifications and recovery periods for federal and state income tax purposes. This generally results in significantly shorter tax lives for these components—typically five-, seven-, and 15-years—rather than the standard depreciation periods of 27.5 years for residential rental property or 39 years for nonresidential real property.
Any tax advice in this email reflects our professional judgment based on our understanding of the facts provided to us and on current tax law. Tax law is subject to change. Subsequent changes in the facts provided to us, the law, or its interpretation may affect this advice. We are not responsible for updating our advice for subsequent changes in law or its interpretation.