Tax planning is an essential part of growing a business. After all, the more tax you pay, the less money you have to invest back into your business to hire employees, launch new marketing campaigns, or develop new products and services.
One common mistake many new entrepreneurs make is treating tax planning as a post-year-end activity. But when you wait until after the end of the tax year to review your revenues and expenses through a tax planning lens, you miss out on opportunities that could lower your taxable income.
There are many steps you can take throughout the year to ensure you're in good shape when it's time to file your tax return.
Keep Good Financial Records
Good tax planning starts with sound financial data, so keep track of all revenues and expenses and reconcile your business bank and credit card statements monthly. When you have complete and accurate records, you have a reliable snapshot of your financial position to use for tax planning strategies and decisions. Using cloud accounting software like QuickBooks Online makes this process simple.
Approach Business Expenses with an Investment Mindset
Another common mistake new business owners make is making big purchases of equipment, vehicles, and other business expenses for the sole purpose of reducing their tax bills. While accelerating expenses into the current tax year can be an effective way to reduce your taxable income, it's a waste of money if you don't really need the item.
Before incurring any business expense, consider whether it will improve your processes or impact your efficiency or profitability. If it doesn't, you're better off paying taxes on that revenue than making nonessential purchases.
Most small businesses are cash-basis taxpayers, meaning they recognize revenues when money changes hands, regardless of when they deliver a service. If you're a cash-basis taxpayer, you can leverage this system to defer income—meaning you delay claiming revenues until next year—if you believe your tax rate will be lower the following year.
For example, say you complete a big project for a client on December 15. You had a big year this year and anticipate being in a high tax bracket, but plan to scale back next year and be in a lower tax bracket. Instead of invoicing your client immediately and having your client pay right away, you wait until December 31 to send your invoice, knowing you won't receive payment until January. That way, you pay a lower tax rate on that revenue.
This strategy also works in reverse—you can ask a client to pre-pay next year's invoice to count the revenue in the current tax year if you think your tax rate will be higher next year.
Set Aside Money for Taxes
As a self-employed person, you likely need to pay estimated taxes four times per year. But when April 15, June 15, September 15, and January 15 come around, are you scrambling to come up with cash to make those payments?
Consider opening up a business savings account in addition to your business checking account and transfer 35% of your net profits to the account each month. That way, you won't have to scramble to come up with the cash when your estimated payments are due.
Setting aside 35% of your profits might seem like overkill, but for most entrepreneurs, it's a good ballpark for covering self-employment taxes as well as federal and state income taxes. Once you've been in business for a while, if you that 35% is too high or too low, you can adjust as needed.
Get Help from a Qualified Tax Professional
A good tax professional doesn't just prepare your tax return once a year. They can address tax questions and concerns throughout the year and help uncover effective tax-planning strategies for your business.
Planning and preparing for taxes doesn't have to be overwhelming. With a little advanced planning and the help of an experienced tax professional, you won't have to spend your free time worrying about taxes. Instead, you can spend your time focused on growing your business and generating profits, knowing the tax bite is being handled accurately and efficiently.