With the tax year almost over, and hopefully it has been a good one, there are some last-minute year-end tax tips you can take to ease any tax burden that might befall you for doing so well.
It is my view that any action taken should not be done solely for tax reduction reasons. It’s like when grocery stores offer a two for one bargain.
Well, it isn’t really a bargain because more money is coming out of your pocket and into the pocket of the grocery store. Yes, the item you
buy might be something you will use in the future but it is the present-day cash flow that can be critical to your budget.
In tax terms, the meaning of this analogy is don’t go out and spend money on stuff you don’t need, may not use or that doesn’t give you some benefit just because you think you want to reduce the tax cost.
Here is a simple example:
Let’s say your tax rate is 30% Federal. You decide you want to reduce your taxes by $3,000 dollars. This means you have to go and spend $10,000 (at 30%) just to get a $3,000 tax deduction.
The question you should ask of course is what are you going to spend $10,000 on?
This course of action has resulted in a cash outlay out of your pocket of $10,000 minus the tax benefit of $3,000 for a net reduction to your net wealth of $7,000. This is crazy and what is meant by don’t let the tax tail wag the dog.
Now, if you need equipment for your business, you need supplies, you might want to pre-pay some other expenses (there are rules around this so you have to be careful) if you want to give a bonus to an employee, do other promotion or advertising, all of these are valid expenses let’s call
it investments into your business that can produce longer-term benefits and would be worthwhile doing.
Making sound year-end choices can help you ease the burden of taxes without negatively impacting your business.
Here are 5 year-end tax tips to consider:
Tip #1. Maximize your tax bracket.
The 24% income tax bracket (tax on taxable income) for a
married couple in 2019 ranges from $165,000 to $315,000. Look at your revenues and expenses.
If your net revenues are under $315,000, you could accelerate income from services or receivables before the year-end up to $315,000 before being kicked into a 32% tax bracket (income over $315,000). Similarly, if you think your taxable income will exceed this amount then wait to collect the money until January 1 of 2020.
Money not received by you is not taxable.
By waiting 1 day, whatever money you do receive on January 1 will be taxable in 2020, but your cash flow won’t suffer because it is only 1 day.
Tip #2. Maximize (or minimize) Expenses.
If your business needs upgrades, conference room chairs, software, desks, supplies and the like, these are good items to buy before the end of the year as they are tax-deductible, lower your profit and reduce tax. These are items you would purchase anyway. Now the dog is wagging the tax tail.
Similarly, should you think 2020 is going to be a plentiful year you may want to wait to take the expenses until 2020 to help offset the income you expect to make.
Are you doing your 2020 planning and budgeting?
If not, how else are you going to know how to approach your business in 2020 to be efficient, effective, create predictable revenue, lower costs and increase savings?
I work with business owners to help them grow their business and swing their net worth by a quarter of a million dollars or more over a number of years based on business, legal, short and long term tax strategies.
Tip #3. Harvest Losses.
This is a time-honored idea and one of the smartest year-end tax tips you can take advantage of. When it comes to your stock investments (not in IRAs or 401(k’s) of course. Some investments you own have done well. Others, not so much.
Get together with your financial planner and take a look at your winners and losers. You might want to sell some of the losers (assuming they won’t turn into winners) and the losses from the sale can offset the gains from the winners.
This is one of the most simple and effective year-end tax tips and will put you in a tax neutral position.
The alternative would have been to sell the winners and pay tax on the gains and still carry around the losers all the while wondering what you were thinking and why you pay so much. Simple idea but oftentimes gets lost when not brought to a conscious level.
Another benefit of looking at your investments is that not all taxes are created equal.
Taxes on gains from your investments most likely will be taxed at a lower rate than the income from your services. Another angle to consider is that if you have substantial capital gains that you could sell and generate income then you can reduce the income from your services.
This will allow you to take advantage of the lower capital gain rate on your investment income and defer tax or your ordinary income.
Tip #4. Entity Structure.
Operating as a sole proprietorship is costing you tens of thousands of dollars every single year. Stop it. I want you to keep more of what you make and forming an entity for the new year can be a great way to do that.
When you form an entity by year-end (later part of December) the State of California gives you a little break from the minimum tax you have to pay every year.
Talk with your friendly neighborhood tax man (me) for good advice in this area.
There are many planning possibilities and pitfalls and sometimes your tax preparer doesn’t have the experience and tax knowledge to address the tax law considerations.
Tip #5. IRA to ROTH IRA.
This is one of my favorite year-end tax tips. Whether you should or shouldn’t involves a lot of factors but the benefit of making this conversion is that you are taking what will become taxable income when you have to start taking money out your IRA and making it into tax-free forever.
And that means when your kids withdraw the money if there is money left after you have faded into the black.
While tax planning should be done throughout the year, the 5 year-end tax tips above may give you a little bit of breathing room so that you can have a little more for yourself and your family to enjoy whatever you have planned during the holiday season or beyond.