While tax season 2022 might be a few months away, the new year will be here before you know it. The fourth quarter is the time to do proactive tax planning to lower the 2021 tax bill. For entrepreneurs, tax planning shouldn't be an annual tax filing year. With the extensions, you may be able to defer your tax return from 2021 until the end of 2022. However, you may need more tax planning measures that can help you reduce your total tax owing before the end of this year.
Review your business structure.
What is the corporate structure of your business? Are you the sole owner, LLC, Partnership, S-Corp, or C-Corp? As your company and income grow, the best structure for your company may change. This should be reviewed with your accountant and financial planner every few years (more often if your business is growing rapidly or there are changes in ownership).
Review your corporate retirement plan
One of the ways for small business owners to cut taxes is to establish a retirement plan. This can range from a Solo 401(K) plan to a SEP IRA to a combination of a 401(k) with a defined benefit pension plan. Do you prefer to write a big check to the IRS or your retirement account? If you're wondering, small, high-income businesses can defer income tax by hundreds of thousands of dollars a year.
These are some of the most common retirement plans for small business owners to save taxes on:
1) SEP-IRA
If you are an entrepreneur, you can contribute 20% of your self-employment income to a SEP IRA, per year, with a max contribution of $58,000 for 2021. There are no clawback contributions for SEP IRA. With no year-end deadline, you can set up a SEP IRA before filing taxes for the previous year.
2) Solo 401(k)
As a general rule, a Solo 401(k) will allow higher pre-tax contributions, which should result in lower taxes owed. Company employees can contribute up to $19,500 by 2021, plus a recovery grant of $6,500 if they are at least 50 years old. In addition, the company can contribute to profit-sharing, up to 25% of the salary. This means that a total of $58,000 (or $64,500 for those over 50) can be saved as long as the person contributes the maximum amount allowed by the IRS ($19,500 by 2021) and the company contributes the maximum amount.
You can also claim a Roth Solo 401(k) for the dependent portion of your contributions, $19,500 plus a recovery contribution of $6,500 for entrepreneurs over 50. If your spouse is also working with you in business, they can be included in the plan, virtually doubling the amount you can contribute and saving taxes.
3) Defined Benefit Pension Plan
The defined benefit pension plan is the most important for those who need high tax savings. Combine that with a 401(k) profit-sharing plan, and your business could save you hundreds of thousands of dollars a year. You may also hear that this is called a cash balance plan.
Defined benefit pension plans are more complicated than small business pension plans because the design of the plans is complex and takes time. If you think it can help your business save more on your hard-earned money, talk to your trusted financial planner as soon as possible. The extra work is worth it for high-income small business owners who are willing and able to define benefit plans and maximize contributions to their 401(k). Contribution limits will depend on income and age but can generally exceed $150,000 per entrepreneur per year. The tax savings can be immense, especially for those who live in high-tax states like California and New York.
4) Do you qualify for the Home Office Deduction?
During the COVID-19 pandemic, more and more small business owners started working from home full time. Entrepreneurs who worked from home may be eligible for the Home Office deduction.
Here's what you need to know to determine if you qualify and to better understand how this often daunting deduction works at your home office.
This valuable tax cut can save you hundreds, if not thousands, in taxes each year. The best part is that you already bear these housing costs regardless of your business use; take your time and discuss the Home Office deduction with your tax preparer to make sure you qualify.
5) Don't Ignore Accounting
Filing income tax is a stressful process, even for the most organized businessman. Don't try to save your taxes in a shoebox full of receipts. Divide your accounting and bookkeeping throughout the year. This can be easily done with software such as QuickBooks. For a more complicated business with lots of bills and expenses, consider hiring an accountant. At the very least, avoid postponing working on your books until tax time. Lost tax deductions increase taxable income and are essentially like throwing money away.
6) Claim First-Year Bonus Depreciation
One of the positive changes in the Tax Cuts and Jobs Act (TCJA) is that you can now receive a 100% depreciation premium for the first year to qualify new and used properties that were purchased and put into use in the fiscal year 2021. You can get a tax exemption for the full cost of goods purchased in 2021. If you have a high-income year, you may want to consider postponing some planned purchases until 2021.
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