By: Frank Calabrese
Taxes are a necessary part of running a business, but with thoughtful planning, you can minimize the burden and maximize your profits. For small business owners, family-owned enterprises, CFOs, controllers, and entrepreneurs, understanding year-end tax planning is crucial. These strategies provide opportunities to reduce taxable income and increase savings, ensuring that your business remains financially healthy.
In this comprehensive guide, we’ll explore various year-end tax planning strategies based on the current tax law to help optimize your tax situation for 2024 and 2025.
Selecting the Right Accounting Method
One of the first steps in year-end tax planning involves choosing the appropriate accounting method. Small businesses often have the option to use the cash basis method instead of the accrual basis. The cash method can be particularly advantageous, offering flexibility in income and expense recognition.
Understanding Cash Basis Accounting
Cash basis accounting recognizes revenue and expenses when actual payments are made or received. This provides an opportunity for businesses to manage their taxable income more effectively.
For instance, if you anticipate higher income next year, you might delay invoicing clients until January, pushing revenue into the following tax year. Conversely, you can accelerate expenses by paying bills early, allowing you to deduct them in the current year.
Qualifying as a Small Business
To utilize the cash method, businesses must meet the IRS’s definition of a small business. This typically involves a gross receipts test, where your average annual gross receipts over the past three years do not exceed $30 million. This threshold ensures that only eligible businesses can take advantage of the cash method’s benefits.
Benefits of Income Shifting
Shifting income timing can be a powerful tool. By controlling when income is recognized, businesses can strategically lower their taxable income within a particular year, resulting in significant tax savings.
Qualified Business Income (QBI) Deduction
The Qualified Business Income (QBI) deduction allows many owners of pass-through businesses to deduct up to 20% of their qualified business income, reducing taxable income and thus lowering tax liabilities.
Eligibility for QBI Deduction
Businesses structured as sole proprietorships, partnerships, S corporations, and certain trusts and estates may qualify its owners for the QBI deduction. However, eligibility is subject to income limitations and other criteria.
For a specified service trade or business (in specific fields such as health, law, accounting, consulting, financial services), the deduction for 2024 begins to phase out for married couples filing jointly with taxable income exceeding $383,900. In 2025, this threshold rises to $394,600. For single filers, the limits are approximately half those amounts.
For other qualified businesses, there may be limitations to the owner’s QBI deduction based on the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business, if the owner’s taxable income is in excess of the above thresholds.
Strategic Planning to Maximize Benefits
Effective planning can ensure that your business remains eligible for the full QBI deduction. Regularly reviewing your income and expenses, adjusting payroll, and managing cash flow are essential tactics.
IRC Section 179 Expensing and Bonus Depreciation
Utilizing IRC Section 179 Expensing
IRC Section 179 allows businesses to deduct the full purchase price of qualifying equipment and software purchased or financed during the tax year. It is also available for interior improvements to a building, elevators, escalators, or internal structural framework, for roofs, and for HVAC, fire protection, alarm, and security systems. This can significantly reduce your taxable income.
Qualifying Property and Limits
For 2024, the expensing limit is set at $1,220,000, with an investment ceiling of $3,050,000. These limits increase slightly in 2025. Most depreciable property, including machinery, equipment, and off-the-shelf software, is eligible.
Keep in mind that Section 179 expensing cannot create a net taxable loss.
Claiming Bonus Depreciation
In addition to Section 179 expensing, businesses can benefit from bonus depreciation, which allows for an additional deduction on new and used property.
Current Bonus Depreciation Rates
For property placed in service in 2024, businesses can claim a 60% bonus depreciation. This percentage will decrease to 40% in 2025 and 20% in 2026 before being phased out entirely after 2026.
Unlike Section 179 expensing, bonus depreciation can create a net taxable loss.
Maximizing First-Year Deductions
Bonus depreciation applies to both new and used property, providing flexibility for businesses investing in capital assets.
Timing is Key
To take full advantage of Section 179 expensing and/or bonus depreciation, ensure that your assets are acquired and placed into service by the end of the year. Even assets purchased on December 31 can qualify for a full deduction.
Impact on State Taxes
Be aware that not all states conform to federal Section 179 limits and bonus depreciation. Consulting with a Wiss tax advisor familiar with state income tax conformity with the Internal Revenue Code can help you avoid unexpected state tax liabilities.
Considerations for Long-Term Planning
While Section 179 expensing and bonus depreciation offer substantial short-term benefits, it’s wise to also consider long-term implications. Balancing immediate deductions with future tax liabilities can help maintain financial stability.
Exploring the De Minimis Safe Harbor Election
The De Minimis Safe Harbor Election enables businesses to deduct lower-cost assets and materials immediately rather than capitalizing them.
Qualifying for the Election
To qualify, the cost of a unit of property cannot exceed $5,000 if the taxpayer possesses an applicable financial statement (AFS). Without an AFS, the limit is $2,500.
Benefits of Immediate Deductions
This election simplifies record-keeping and provides immediate tax relief for smaller expenses. It’s particularly beneficial for businesses with numerous low-cost purchases.
Planning Estimated Taxes for Corporations
Corporations, particularly those anticipating net operating losses (NOLs), can strategically plan estimated taxes.
Managing Net Operating Losses
A corporation expecting an NOL can accelerate income or defer deductions to report a modest profit. This allows estimated taxes for the following year to be based on lower income levels, conserving cash flow.
Leveraging Tax Planning to Optimize Cash Flow
Careful management of estimated taxes can improve liquidity, freeing up resources for reinvestment in the business.
Exploring Additional Year-End Opportunities
Year-end provides unique opportunities to fine-tune your financial strategy. Consider these additional tactics:
Timing Year-End Bonuses
Timing the payment of bonuses can influence current-year deductions. Cash-basis employers deduct bonuses when paid, while accrual-basis employers must meet specific conditions to claim deductions in the accrual year (generally paid within 2.5 months after year-end).
Harnessing the 12-Month Rule for Prepaid Expenses
Certain prepaid expenses can be deducted in the year paid, provided the associated benefits don’t extend beyond 12 months. This rule applies to items like insurance, software maintenance contracts, and licensing fees.
Writing Off Obsolete Inventory
Disposing of unsalable or obsolete inventory by year-end can accelerate loss recognition, reducing taxable income.
Postponing Cancellation of Debt Income
If a debt cancellation event is imminent, consider delaying it to the following year, reducing current-year taxable income. Evaluate the timing carefully to align with your broader tax strategy.
Strategic Deferral of Income
Strategically deferring income can smooth cash flow and reduce tax burdens during profitable periods.
Managing Passive Activity Losses
Selling a profitable passive activity before year-end can allow suspended passive losses to offset current income, optimizing tax outcomes.
Conclusion
Strategic year-end tax planning is essential for small business owners, family-owned enterprises, CFOs, controllers, and entrepreneurs. By leveraging available deductions, credits, and accounting methods, you can optimize your tax situation and enhance financial well-being.
The strategies outlined in this guide provide a comprehensive framework for managing taxes effectively. The tax team at Wiss can tailor these strategies to your specific circumstances. Equipped with the right knowledge and tools, your business can confidently approach the new year, ready to capitalize on opportunities and achieve greater success.
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