This is a challenge, as something as big as your taxes should not be left for last minute for planning. My take on the end of the year is that you should be planning now for how you can do better next year and putting the actions into place to achieve better results. However, there are some things to be aware of as the year comes to a close that will impact the current year’s taxes. The key concept to each of these ideas is timing. Timing really is everything!
- Capital Gains can be a big issue that is deferred by timing. If you have sold assets for a gain already this year, you may want to find any losing assets that you should be selling and dispose of them now to wipe out at least part of your gains. If you have losses already this year, then you can review your portfolio to see if there are any gainers that you feel have topped out. You can sell them and reallocate those funds, using the losses from the other assets to offset these gains.
- Timing is also a factor in deciding on when to make a purchase. Assess your business for assets that you know you will need to purchase in the next 3- 6 months. If you have a bigger profit this year than you expect next year, of if you just want to follow the theory that the longer you can defer taxes the better, you may want to purchase those assets now. Ordinary expenses can also be made this year instead of next year – for example, you can pay the rent for January at the end of December if you are a cash basis business. This also applies to your personal expenses. If you are itemizing deductions, you can pay the January Mortgage payment in December, though you will want to find out what the cut off is for your lender for it to post for this year. Property taxes follow this same concept, though if you are subject to the Alternative Minimum Tax (AMT) this may actually work against you…
- Bunching of deductions is also a helpful way to manage taxes with timing. This is applies to your personal taxes more than business taxes. If you are just on the cusp of itemizing, you plan to make deductible purchases or payments in January and December of the same year, so you effectively get 14 months worth of expenses this year. The next year, you put off deductible December purchases or payments to the following January. The idea is that you will itemize every other year. This concept also works for medical expenses, which are only deductible to the extent that they exceed 7.5% of your income. Every other year, you will cross that threshold following this logic. Similarly, this applies to miscellaneous expenses, which are largely unreimbursed employee expenses. This category only kicks in as deductible when it exceeds 2% of your adjusted gross income. CAUTION: do not buy something just to get a tax deduction. If you spend $100 on something you do not need just to save $28 in taxes, you actually wasted $72. ONLY BUY WHAT YOU NEED.
- Inventory levels are critical to monitor as becomes close to the end of the year. Small business owners often overlook this concept, as they often believe that the inventory they buy is deductible in the year they pay for it. THIS IS COMPLETELY OPPOSITE. Inventory is not a deduction until you sell it! Think of it this way, if you move money from one business bank account to another business bank account, you did not spend any money, and you do not have an expense. This is concept is what buying inventory is doing. You are trading one asset for another. At the beginning of each year, you have a certain amount of inventory on hand. You add to this your purchases for the year and then you subtract your ending inventory. If you ending inventory is larger than your beginning inventory, you actually spent more money than you are able to deduct. This is why it is important to manage your inventory levels to be at or below the prior year if you are wanting to cut this year’s tax bill. Do conduct some sort of count that can be verified in an audit. Do not just pick a number that suits your purpose. That can turn around and bite you back big!
- Consider next year, will it be at a bigger income year or a lesser income year than the current one? If this year is more profitable or has higher earnings than you expect next year, you certainly do want to move as many expenses into this year and as much income into next year as you possibly legally can. However, if this year has a lower tax rate than next year, say it is your first year in business and you expect to have a loss, you do not need a tax deduction as much this year, and could be wasting tax dollars by employing these techniques. As an example, if this year you have a profits that would be taxed at the 15% tax rate, but next year you expect to be taxed at the 28% tax rate. If you have $100 to deduct in either 2012 or 2013 based on when you spend it, you will save $15 in taxes in 2012 and $28 in 2013. I would push the expense to 2013.
- The timing of a vehicle purchase may prove to be quite valuable. Let’s say you buy a business truck for $25,000 on December 31, 20XX. Your drive it from the lot, to the business and leave it there, or use it for other business purposes that day. The point is, you do NOTHING personal with it. Document exactly what you did, where you went and how many miles you put on the vehicle. In 20XX, it is possible that you will be able to write off 100% of the truck, assuming all the other criteria for a 100% section 179 deduction are met. Now, starting January 1, 20XY, you use the truck 51% for business and 49% for personal (such as commuting to work…remember, that is not ordinarily deductible!) As long as the business use does not fall below 50% in the remaining recovery period (that is the time the vehicle should have been depreciated), you will have successfully received an “extra” tax deduction. CAUTION: Just because you CAN deduct something 100% does not mean you SHOULD. If you have payments that you are making on this truck for the next 5 years, you now have roughly $5000 cash going out the door each year with out any write off (the principal payments on any loan are not deductible, but the interest portion would still be deductible for the percentage of business use of the vehicle.) A tax savings today may have cost you significant taxes in the future. Also, to use this tactic, you are committing yourself to actual expenses. That is the business percentage of all the costs related to the car such as fuel, repairs, maintenance and insurance. This is more recordkeeping and receipt tracking, and may not yield the best deduction overall. Consider using the standard mileage rate, which is $0.555 per mile in 2012 and $0.565 in 2013.. This means you only track the mileage as to whether it is business or personal, and you always have a deduction, assuming you always have mileage. If you buy an economical vehicle, you may very well be deducting more than your actual expense!
- If you can in anyway control how much is withheld from you check in taxes, and you think you may owe more than $1,000 this year to the IRS, it may be advisable to increase your withholdings for the remainder of the year to keep you safe from penalties. I particularly like this technique with S-Corp shareholders. If it looks like their taxes will exceed what was withheld from their paychecks, I will calculate a bonus check with the entire check being allocated to taxes. I have now accomplished two things: I have covered the tax liability without penalty as taxes withheld from payroll are treated as being paid evenly over the year, and second, I just helped my S-Corp Shareholders further justify their salaries under the concept of reasonable compensation as their wages will now reflect a higher figure in concert with the increased earnings of the business.
- If you are about to buy your first home, delay closing until after January 1. The seller, especially if it is new construction, may not be very agreeable to this idea, but if you are paying out of pocket loan origination fees, discount points, yield spread premiums or any other fee that qualifies as points, and you were not able to itemize this year because you did not have enough to cross over the standard deduction, you will now be able to realize a tax savings from paying these in the next year. If escrow closes 12-31, you will have to take these costs in equal amounts over the life of the loan…if you paid $3600 in points, that means you will deduct $120 per year for the next 30 years instead of deduction the full $3600 in the next year.