Lower Your Tax Bill by Timing
Many businesses have found that they can minimize business taxes year-to-year by considering carefully when to make payments to increase expenses and tax deductions and push receipts to create income at the end of the tax year. In general, you want to move income into a year of lower taxes and expenses into a year of higher taxes, although your situation may vary.
Cash Accounting and Year-End Timing
The first thing to check before you move payments and income between two years is what accounting method you are using. The accounting method you use for your business (cash or accrual) makes a difference in the timing of payments and income and in the determination of constructive receipt. Constructive receipt refers to when you effectively receive, or gain control over, certain income. Since most small businesses use cash accounting, the timing examples will focus on this method. In an interview between The Balance and CPA Gail Rosen, Rosen explained that if your business is on a cash basis, you can consider delaying sending late-in-the-year invoices, so payment is not received until the following year. Your business can also purchase items you want this year, instead of waiting.
Timing Income
In cash accounting, you count business income when you actually (or constructively) receive it during the tax year. For example, let’s say you do $1,000 in web design work, and you send the customer a bill in December. You receive the payment in January. Under cash accounting, you count it as income in January, when you receive the payment.
Timing Expenses
It’s the same for expenses. If you receive a bill for $800 in December and you pay it in January, it counts as an expense in January. For example, if your bank credits your business bank account with interest in December, you must count that as income in December, because it’s available to you. It’s considered income even if you didn’t withdraw it or enter it into your books until January.
Timing Payments at Year-End
Before you start to think about timing income and expenses, you also have to determine when you want to lower your business income for tax purposes: the current year or the next year. The usual strategy of small businesses is to lower your current year’s taxes by prepaying expenses and deferring income. However, as Rosen explained, the tax strategy of deferring income or prepaying expenses is not for everyone. If you are going to be in a higher tax bracket next year, you may consider doing the opposite in your tax planning. This is especially true for growing businesses.
Some Ways To Lower Your Tax Bill This Year
There are several steps you can take near year’s end to minimize your tax bill.
Make Deductible Gifts and Donations
As Rosen explains, a charitable gift is deductible in the year it is made. If the check is mailed unconditionally and clears in due course, the contribution is considered paid when mailed. A contribution charged on a credit card is deductible in the year the charge is made, not in any later year when the credit card company is paid. When making business tax deductions for charitable gifts, be sure the gift or donation is deductible to your business.
Prepay Expenses
if you are prepaying your business insurance or loan, send the payment by credit card or make sure you mail the check by year-end. The recipient does not have to receive the payment by year-end.
Buy Assets
When you buy an asset, you can take depreciation expense on that asset. This expense lowers your tax bill. The Internal Revenue Service (IRS) considers an asset to be owned by a business when it is “placed in service”—that is, when it is ready and available for a specific use.
Delay Income
Delaying income doesn’t mean not cashing a check you received as payment, because you have still received it even if you didn’t cash it. Rather, you can delay sending out bills until after the first of the year to make sure you receive the money next year.
Timing Employee Pay and W-2 Income
Employee wages at year-end are sometimes tricky because of constructive receipt. Employee wages must be recorded in the correct year, and the date of the paycheck is controlling. If a paycheck is dated in December, that is the year the employee is considered to have received the pay, even if the paycheck hasn’t been picked up yet. Sometimes, paychecks reflect income from two years; the last week in December and the first week in January, for example. If the paycheck is dated in January, all of the income is considered to have been received in the second year, because the employee did not have receipt of the money in the first year. But, if the employee had access to the wages in the first year without “substantial limitations or restrictions,” all of the money is considered to have been received in the same year. This might be the case if the money is deposited using direct deposit in December, for a pay period ending in January. Some years have more pay periods, which might also affect the amount of an employee’s paycheck between two years.
Using a Credit Card for End-of-Year Payments
It’s certainly appropriate to use a credit card to make those end-of-year payments. You don’t have to pay off the balance now, but the expense can be recorded this year. For example, if you buy a laptop for your business before the end of the year, using your business credit card, you can get the tax deduction this year and pay off the credit card next year.
1099 Reporting for Independent Contractors at Year-End
An independent contractor that performed work for your company may have received payment in early January, but you might have mailed (and recorded) the payment in December and recorded the payment as part of the contractor’s Form 1099-NEC for this year. The independent contractor should include the payment as it is reported on this year’s Form 1099-NEC, but subtract the payment and attach an explanation with the return. The independent contractor must then include the payment on next year’s return, even though no 1099 may be issued for next year.
Accrual Accounting and Year-End Timing
In accrual accounting, you generally report income in the year it is earned and deduct or capitalize expenses (by recording them as an asset and taking depreciation on them) in the year incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year. Expenses are recorded when (a) the liability amount is set and recorded, and (b) the property or services are provided or the property is used. Some recurring items used during the year can be treated as incurred during the tax year, even if some events haven’t occurred. This might be the case if you buy a supply of copy paper and use it during the year. Income is recorded in the year when your right to receive the income has occurred and you can determine the amount. If you are using the accrual method, you include an amount in gross income at the earliest date:
When you receive paymentWhen the income amount is due to youWhen you earn the incomeWhen the title (ownership document) passes
You can record advance payments by customers. If you use the accrual method, you can postpone including the advance payment in your business income until the next year, but not beyond that tax year. For example, let’s say you did $1,000 of web design, and you sent the customer a bill in December. If you are using the accrual method:
The $1,000 bill for your services must be included in your business income in December because that’s when you “incurred” the incomeThe $180 expense for office supplies is included in your December expenses because the amount is fixed and you are using the office supplies
