Your Year-End Tax Strategy Checklist: A Guide for Owner-Operated Small Businesses
As the year comes to a close, many small business owners shift their focus to year-end tax planning. This time of year provides an opportunity to reflect on your financial performance and develop strategies to minimize your upcoming tax bill before the deadline.
At traditional CPA practices, it’s not uncommon for businesses to rush into December scrambling for last-minute tax deductions. While reactive tax planning can sometimes provide immediate relief, a proactive approach ensures better long-term results. For those playing catch-up this year, I’ve compiled a year-end tax strategy checklist of common tactics that can be implemented before December 31st to help reduce your tax burden.
1. Accelerated Depreciation
One of the most frequent questions I get toward year-end is: “Can I buy something before the New Year and write it off completely?” This refers to accelerated depreciation. Under tools like Section 179 and Bonus Depreciation, businesses can deduct the full cost of qualifying equipment purchases in the year of purchase, rather than spreading out the deduction over time. While this can provide immediate tax relief, it’s important to evaluate both the timing and eligibility of assets to avoid cash flow issues.
2. Retirement Contributions
Another highly effective strategy for small business owners is maximizing contributions to a qualified retirement plan, such as a SEP IRA or 401(k). This not only reduces taxable income but offers flexibility—particularly for business owners who can defer the employer portion of contributions until after tax season. This allows businesses to optimize contributions while keeping cash on hand during critical periods. Be sure to verify you’re meeting the necessary contribution requirements to fully benefit from this tax-saving opportunity.
3. Defer Income/Accelerate Expenses
For cash-basis businesses, deferring income and accelerating expenses can be a powerful method to manage taxable income. If you’re expecting a large invoice in December, you might consider delaying its issuance until the New Year, allowing you to push that income into the next tax year. Similarly, paying expenses in advance before December 31st lets you deduct them for the current year. This strategy can help smooth out tax liabilities, but be cautious to follow IRS guidelines to ensure compliance.
4. Capital Gain/Loss Recognition
When it comes to investment-related tax planning, there are several end-of-year opportunities to manage gains and losses. One of the most effective is capital loss harvesting, where you sell underperforming assets to offset gains elsewhere in your portfolio. If you have substantial investment income, this can help reduce your overall tax liability. On the flip side, recognizing capital gains in years when you’re in a lower tax bracket can also be a smart long-term move. A proactive financial planner can help you make the most of these opportunities and ensure you’re following tax regulations.
5. Maximize Payroll Withholding
As the year wraps up, ensuring accurate forecasting of your tax liability is essential. If you’ve missed estimated tax payments earlier in the year, adjusting payroll withholding on your final paychecks can help mitigate potential penalties. By increasing your withholding, the IRS will treat those taxes as if they were paid evenly throughout the year, helping you avoid underpayment penalties. This strategy allows for last-minute adjustments and ensures compliance, even if some earlier payments were missed.
6. Pass-Through Entity (PTE) Tax Payments
For business owners in high-tax states, the Pass-Through Entity (PTE) Tax offers a unique opportunity to bypass the $10,000 SALT deduction cap imposed by the Tax Cuts and Jobs Act. By electing to pay state taxes at the entity level instead of the individual level, you can deduct the full amount as a business expense, rather than being capped at the personal deduction limit. To benefit from this, however, payments must be made by December 31st to secure the deduction for the current year.
Creative Year-End Tax Strategies: Thinking Outside the Box
In addition to the more common strategies outlined above, creative tax planning can yield significant benefits when implemented thoughtfully. Below are six creative strategies that, while effective, come with specific requirements and risks. Be sure to consult a qualified tax professional to determine if these strategies apply to your unique situation.
1. EV Charger Credit
For businesses undergoing capital improvements, the EV Charger Credit from the Inflation Reduction Act can provide a substantial tax credit. This applies to the installation of EV charging stations—especially if you’re already making high-voltage electrical upgrades to your facility. While the credit won’t cover the entire project, adding an EV charger to your plans can yield significant tax savings when combined with other capital investments.
2. QBID Insurance Entity
The Qualified Business Income Deduction (QBID) can be a powerful tool, but businesses classified as Specified Service Trades or Businesses (SSTBs), such as financial advisors, often face limitations. However, by creating a separate entity to handle insurance sales or annuity income, you may be able to qualify for QBID on those specific income streams, even if your advisory income is excluded. This requires careful planning but can be highly beneficial if structured correctly.
3. Expense Classification
Carefully managing your expense classifications can unlock additional deductions. For example, charitable contributions are typically deducted as personal itemized deductions, which may not benefit businesses under the higher standard deduction. However, if your contribution is tied to promotional activities or public recognition, it can often be classified as a marketing expense, which is fully deductible. Similarly, business meals may be 50% deductible, but in certain cases—such as snacks for employees or client events—they can be classified as office expenses, making them fully deductible.
4. Down Year Strategies
In years when business is slower, there are unique opportunities to optimize tax planning. One of the most overlooked is capital gain recognition. By selling appreciated assets during a low-income year, you can recognize those gains at a lower tax rate, or possibly at a 0% federal capital gains tax rate. This strategy allows you to control your taxable income more effectively over multiple years. Additionally, Roth IRA conversions can be an excellent long-term strategy during down years, allowing you to optimize your retirement contributions while minimizing tax impacts.
5. Equipment Leasing Entity
For businesses with substantial equipment investments—such as those in the medical or service industries—consider setting up an equipment leasing entity. This strategy involves creating a separate entity to purchase and lease back your equipment. Not only do you benefit from deductible lease payments, but the leasing entity may also qualify for QBID, even if your primary business is excluded. This complex strategy requires careful structuring but can provide significant tax savings for capital-intensive service businesses.
6. Late S-Corp Election
The S-Corp election is a well-known tax-saving tool for small businesses, but not every owner acts on it in time. Fortunately, the IRS allows for a late S-Corp election, which can be filed retroactively for the previous year. This enables small businesses to take advantage of reduced self-employment taxes even if the election wasn’t made during the initial filing period. It’s an excellent option for businesses looking to optimize their tax strategy for the current year.
The Importance of Proactive Tax Planning
While these year-end strategies can be effective, many of them are short-term solutions—often deferring taxes rather than eliminating them. For example, accelerated depreciation might lower your tax bill now but can lead to recaptured income when you sell the asset. Similarly, deferring income can cause a cash flow mismatch, where tax liabilities do not align with reduced cash flow.
The key to optimizing your tax strategy is proactive planning throughout the year. By aligning your tax strategy with your capital allocation and cash flow management plans, you can make smarter decisions about equipment purchases, revenue timing, and investment management. This minimizes the likelihood of overspending or locking up capital in low-performing assets just to secure a deduction.
It’s also important to note that many of the creative strategies I’ve mentioned are not universally applicable and may come with specific requirements or risks. Consult with a qualified tax professional to ensure these strategies are appropriate for your business and that you remain compliant with the tax code.
Conclusion
Year-end tax planning is a critical part of small business financial management, but it’s not a substitute for holistic, long-term tax planning. Short-term fixes can sometimes create future liabilities if not properly managed. The best strategies are those implemented proactively and aligned with your overall business goals.
If you’re ready to take your tax planning beyond year-end scrambling and start thinking long-term, let’s discuss how we can develop a strategy that saves you money now and strengthens your business for the future.