Our blog spends a lot of time hashing out business cash flow management and cash flow improvement. We’ve also discussed how a key to solid cash flow management is planning and projections. Well, unfortunately, income taxes can take a big bite out of cash flow and planning for that bite is essential. It’s that time of year when a lot of CPAs talk to their clients about year-end tax planning so as not to miss out on year-end tax moves that could benefit cash flow. Of course, before we go into any detail, we have to state the obvious; You should (really, you should) consult with your own tax advisor on what year-end tax planning ideas make the most sense for your business.
Before we get started, lets put out another warning that so many CPA firms gloss over… tax planning is only one aspect of overall business financial planning. You should never make decisions based on the income tax impacts only, and all tax planning decisions should be made in terms of the overall positive impact on the business.
So here we go, here are some of the tried and true year-end tax reduction strategies – **We will also provide some commonsense counterpoints on when the ideas may not be best for you.
1. Deferring income into 2014 – If you are a “cash basis method of accounting” taxpayer that means you do not claim taxable income until the actual payment is received. Consider delaying some invoicing until the last day of the year, in effect delaying payment and income recognition until January 2014. If you are an “accrual basis of accounting” taxpayer there is not a whole lot of room for maneuver here since you are supposed to recognize income as it is earned, regardless of when it is paid. However, if you consistently invoice once projects are completed, then simply do not rush to wrap up projects before year end, thereby delaying invoicing and revenue recognition into 2014 once projects are completed.
2. Deferring income into 2014, Common Sense Considerations – Of course, if your cash flow is already tight you do not want to jeopardize your business any further by delaying cash inflow. If cash flow is tight by all means continue to invoice and apply collection strategies to keep the money coming in. Do not send your cash flow stream into roller coaster strategies just to try to reduce your tax bill a little. Also, by now you should have done some annual planning and have some idea of what you expect 2014 to look like. If you are in an obvious growth pattern then there is a good chance you will be in a higher tax bracket for 2014. If that’s true, does it make any sense to defer income into next year? Perhaps the better strategy could be to accelerate income into the current tax year, bite the bullet and pay the taxes now when you may well be in a lower bracket.
3. Accelerating Expenses into 2013 – Again, if you are a “cash basis tax payer” you have some room to work here. As a cash basis taxpayer you are allowed to pre-pay expenses up to one year into the future and take the deduction now. So, if you are cash flush at year end and trying to reduce taxable income pick some fixed monthly expenses that you know you will absolutely have to pay next year, and make the payment before year end (monthly rent might be a good candidate). If you are an “accrual based taxpayer”, sorry, you have to have actually incurred the expense and have a bill as evidence to take the deduction. One thing accrual based taxpayers can do is analyze your accounts receivable and taking bad debt expense deductions on any accounts that are uncollectible. Also, if you carry inventory, and have some old inventory on hand that is become obsolete, consider disposing of it or donating it to charity and taking the deduction on it this year.
From a planning standpoint, if you know for sure you have some equipment needs now or within the next few months, accelerate the purchases into 2013. You can then take advantage of first year expensing (foregoing long term depreciation) by taking advantage of special Section 179 and Bonus depreciation rules. Just make sure the equipment is in place and functional before year end, and ask you tax advisor if these special deprecation rules will help you.
4. Accelerating Expenses into 2013, Common Sense Considerations – Please, do not spend money you may not ordinarily spend just to reduce your tax bill. Remember, $1 spent on a deductible expense does not equal $1 dollar in tax savings. It only equals tax savings at whatever your tax rate is. What would you rather have, $100 in your pocket, or $100 dollars spent and only $35 dollars of tax savings. Also, same as above, if you are anticipating a great year in 2014 and the possibility of a higher tax bracket, does is make any sense to accelerate expenses into the current year? On the equipment purchases point, make sure the purchases are made with a Return On Investment plan in place, don’t just buy the shiny new equipment for the tax deduction. And remember that debt reduction payments will have no tax benefit for you, so consult with your tax advisor to ensure that your cash disbursements with have the desired tax impact.
Best of luck with your 2013 tax bill. Year-end tax is only one small aspect of an overall business financial strategy, something we help many businesses to develop.