Tax Planning is, among many things, about strategically changing your income level to improve your tax situation. After nearly a full year of work, there are typically some good year-end tax strategies to optimize your taxes before the end of the year. While not all strategies apply to everyone, taking advantage of opportunities could mean saving thousands of dollars in taxes. Here are 9 year-end tax strategies to consider this month:
- Retirement Contributions
Maxing out your retirement account on both the employee and employer side (if possible) is one of the easiest ways to lower taxable income. Business owners with a 401k or Solo 401k plan can contribute up to $69,000 and therefore take a $69,000 tax deduction. Certain SEP IRA plans could allow you to get to similar numbers, depending on your income for the year. Take the time to review your current retirement plan (or start one) to see how much you could save.
- HSA Contributions
HSA contributions are another great year-end move. If you have access to an HSA through your health insurance plan, think about maxing out the contributions to take advantage of the triple tax benefits. Owners with family coverage on their health insurance plan could contribute up to $8,300 ($4,150 for self-only coverage) this year. That contribution is deductible this year, will grow tax-free, and can even be distributed tax-free if you ever have medical expenses in the future.
- Roth Contributions & Conversions
After your tax-deductible contributions are met, you may also want to look into funding or maxing out your Roth accounts as well. As long as you are under the income limits, contributing $7,000 or $8,000 each year to a Roth IRA will add up over time. If you are over the limit, think about a Backdoor Roth IRA. If you had a lower income year, it may be a perfect time to purposely convert your existing IRA/401k money to Roth and pay the taxes this year.
- Optimize your Qualified Business Income Deduction
In certain businesses, owners can use up to 20% of this year’s profits as a deduction. To maximize your QBI deduction, paying close attention to your total taxable income for the year is very important. Depending on your income for the year, it may be wise to increase or decrease your taxable income to maximize your 20% deduction. This is one strategy to get your advisor and CPA involved since 20% of a 6-figure annual income could be a large swing in your tax bill.
- Bonus Depreciation (buying more cars or equipment)
This one is pretty common for business owners, but purchasing more vehicles or equipment for the business and writing them off could help reduce your taxes. Be sure that your investments are still working towards the growth of your company. Buying another company car just to get the deduction is not going to help you as much as you’d like. You could make a new investment and deduct up to 60% of the cost this year.
- Year-End Employee Bonuses
Similar to the QBI discussion in #4, a large year-end bonus for employees (and employers who are also employees) could help reduce taxable income and therefore the tax bill. Increasing W2 wages paid out is considered a deductible expense to the business. As long as you are optimizing the QBI deduction in the process, a year-end bonus could be a well-rounded way to accomplish that. Then both employers and employees are happy.
- Using the Business to Pay Your State Taxes
This strategy may not be as relevant to us in Kentucky, as opposed to other states with a much higher income tax rate. Regardless, with the right business structure, it can be possible for the business to pre-pay state and local income taxes that the business “created” for the business owner. It may be proportional to the equity of the owner if multiple owners are involved. Since TCJA was passed in 2017, there has been a $10,000 SALT (state and local tax) cap. This strategy could help you deduct more than that if your situation applies to it.
- Give Money to Charity
You are not going to be here forever, and certainly will not be a business owner forever. Setting aside money now to give to charity could be a great way to benefit from a tax deduction as well as support a good cause. A lot of people struggle with the “who” in giving, but that doesn’t have to be the case. Contributing to a Donor Advised Fund can allow you access to the deduction but doesn’t have to be paid out immediately. You can choose over time who your charitable distributions go to when you are ready.
- Deferring Income for a Month
If you have already had a higher income year, see if your business can defer some of the income scheduled for this month until next month (in the new year). Deferring upcoming income and accelerating upcoming expenses may not have a radical effect on your tax bill but it could help smooth the taxes between this year and next. If you are planning on selling real estate this month, for example, it may be helpful to wait a month or two and plan accordingly next year.
There Are Always Ideas
There are always more ideas depending on the specific situation, but the goal is to focus on what you can control. Tax planning is part art and part science. One of the reasons why tax planning is so important at the end of the year is because it should come second to the growth of your business. Once you have had another successful year, then advisors can come in to optimize your situation with a few strategic tax moves. If any of these sound like they work for you, I’d encourage you to reach out to your advisor and tax professional to get solid advice on reducing your tax bill.
TC Falkner 