Small Business Year-End Tax Planning Strategies
Effective year-end tax planning goes beyond compliance. Learn how the timing of key financial decisions can strategically reduce your small business's tax liability.
Year-end tax planning involves implementing financial strategies before a business’s fiscal year closes to legally reduce its tax liability. For most businesses, these steps must be taken before December 31st, as many strategies cannot be applied retroactively after the year has concluded. This approach allows a business to manage its financial position in a way that aligns with tax regulations to optimize its financial outcome.
Core Principles of Year-End Tax Planning
The foundation of tax planning rests on the strategic timing of income and expenses. One method involves deferring taxable income into the next year, which postpones the tax liability. For businesses using the cash method of accounting, this can mean delaying late-year invoices so payment arrives after January 1st.
Conversely, accelerating deductible expenses into the current year increases deductions and reduces the current net profit. This involves paying for expenses before the year’s end, even if they are not due until the following year. The goal is to lower the current year’s tax bill by managing the timing of cash outflows.
A business’s accounting method affects these strategies. For an accrual-basis business to defer income, it might postpone a project’s completion or the delivery of goods until the next year. To accelerate expenses under the accrual method, the liability for the expense must be fixed by year-end, meaning the business has a clear obligation for goods or services it has received.
Accelerating Deductible Expenses
A primary strategy for reducing current-year taxable income is to accelerate deductible expenses through various methods.
- Utilize the Section 179 deduction, which allows a business to expense the full purchase price of qualifying new or used equipment and software. For 2024, the maximum deduction is $1.22 million, with a phase-out threshold of $3.05 million. The asset must be placed in service by the end of the tax year.
- Claim bonus depreciation, which for 2024 is 60% on the cost of qualifying business property with a recovery period of 20 years or less. There is no annual dollar limit on the total amount claimed. This percentage is scheduled to decrease to 40% in 2025.
- Prepay certain operational expenses under the “12-month rule,” which permits a current-year deduction if the benefit does not extend beyond the end of the following tax year. Examples include prepaying rent, insurance premiums, or business license renewals.
- Pay employee bonuses by December 31st to be deductible in the current tax year for cash-method businesses. Accrual-method businesses can deduct bonuses in the current year if the liability is fixed and the bonuses are paid to non-owner employees within the first 2.5 months of the next year.
- Stock up on necessary business supplies, from office materials to operational items. The cost can be deducted in the year of purchase as long as the supplies are reasonably expected to be used within the next year.
Optimizing Retirement Contributions
Retirement plans provide a vehicle for personal savings while creating a business tax deduction. The contributions a business makes on behalf of its employees, including the owner, are deductible business expenses.
The Simplified Employee Pension (SEP) IRA allows a business to contribute up to 25% of an employee’s compensation, not to exceed $69,000 per participant for 2024. The plan can be established and funded up to the business’s tax filing deadline, including extensions.
The Solo 401(k) is for self-employed individuals or owners with no employees other than a spouse. It allows an “employee” contribution up to $23,000 in 2024 ($30,500 if age 50 or over) and an “employer” contribution up to 25% of compensation, with a combined limit of $69,000. The plan must be established by December 31, but employer contributions can be made until the tax filing deadline.
The SIMPLE IRA requires an employer to make either a matching contribution of up to 3% of compensation or a non-elective contribution of 2% for all eligible employees. For 2024, employees can contribute up to $16,000, plus a $3,500 catch-up if age 50 or over. The deadline to establish a new SIMPLE IRA for the current year is October 1.
Key Accounting and Record-Keeping Adjustments
For businesses using the accrual method, a year-end review of accounts receivable for bad debts is important. When a customer’s account is deemed uncollectible, the business can write it off and claim a bad debt deduction. This requires showing that reasonable steps were taken to collect the debt.
Businesses should also review their inventory for obsolete, damaged, or unsellable items. Tax regulations permit writing down the value of this inventory to its net realizable value. This write-down increases the cost of goods sold, which lowers gross profit and taxable income.
Owners of S-Corporations who are active in the business must ensure they are paid a “reasonable salary” before receiving other non-wage distributions. An end-of-year analysis confirms this requirement is met. If the salary is insufficient, a final payroll run or bonus can bring compensation to a defensible level.
Leveraging Available Tax Credits
Tax credits provide a dollar-for-dollar reduction of a business’s final tax liability, making them more impactful than deductions. Reviewing eligibility for various credits can result in significant tax savings.
The Work Opportunity Tax Credit (WOTC) incentivizes hiring individuals from targeted groups facing employment barriers. The credit amount depends on the employee’s group, wages, and hours worked. Businesses must obtain certification that an individual is a member of a targeted group.
Businesses that invest in improving products or processes may be eligible for the Research and Development (R&D) Tax Credit. This applies to qualified research activities aimed at creating new or improved functionalities, performance, or quality. Activities like developing new software or engineering improved processes can qualify.
Other credits may be available depending on a business’s activities, such as the Commercial Clean Vehicle Credit for purchasing qualified new electric or fuel cell vehicles. Reviewing the specific requirements for these and other credits before year-end allows a business to take necessary actions to secure them.