If you run your own business, you probably grumble about your taxes from time to time. Does the grumbling get worse when your CPA starts working on your tax return and you realize it is too late to do anything to reduce your tax bill? If this sounds all too familiar, it’s time to take a year-round approach to minimize your business and personal income taxes. Here are three tips to get you started.
Plan Ahead for Tax-Deferred Retirement Savings
Many business people discover two things at the end of the year:
- They have more taxable income from their non-retirement investment accounts—typically used to hold emergency funds or to save for big expenditures—than they expected. Because they didn’t plan for this income, they now owe taxes on it.
- At the end of the year, their CPA suggests making a tax-deductible IRA contribution to reduce their taxes, but they don’t have the cash available to do it.
Why not connect these two dots and use some of those investment earnings to fund an IRA contribution throughout the year? Just check the earnings on your investment accounts each quarter and transfer those dollars into your IRA. By the time the next tax season rolls around, you should have accumulated a nice addition to your IRA—and a nice tax reduction.
Reduce Self-Employment Taxes by Incorporating
If you are self-employed, you have to pay Social Security and Medicare taxes equal to 15.3% of your earnings each year, assuming your 2019 earnings are below the Social Security tax limit of $132,900. If your business generates income above a reasonable salary for yourself, you could reduce your self-employment tax by forming an S corporation or an LLC taxed as an S corporation.
This allows you to divide your income into two components, classifying part of it as salary and part as a distribution of corporate earnings. You only have to pay self-employment tax on the salary portion. Shifting $10,000 from salary to distribution will reduce your self-employment tax by over $1,400 per year, allowing for IRS rules that let you deduct half of the self-employment tax as a business expense.
While you may think of your salary and earnings distribution as strictly annual decisions, you can adjust these figures over the course of the year, depending on how the business is doing. You will have some additional expenses if you incorporate, though, so talk to your lawyer and CPA to determine if this move is right for you.
Track Investment Gains and Losses Accurately
Throughout the year, when you buy an investment security, save the trade confirmation document and record any brokerage or transaction fee you paid. While investment transaction fees are generally not tax-deductible expenses, you can add a purchase fee to your cost basis and subtract a selling fee from the proceeds of a sale, thereby reducing capital gains taxes. When you later sell a security, file the original purchase record showing your cost basis with the record of the sale.
At the end of each year, check your 1099-B forms against your saved records. You may find that the 1099-B shows the wrong amount of capital gain/loss due to:
- Incorrect cost basis and/or
- Failure to account for transaction fees.
Such errors can happen when you transfer assets from one financial advisor to another, that is, buy a security through one firm and sell it through a second firm. The second firm may assign a “default” cost basis equal to a security’s market value on the transfer date, which can result in your capital gains/losses being misstated by thousands of dollars. Unless you have the purchase records as proof of your true cost basis, you generally have to pay taxes based on the 1099-B figures.
Minimize Taxes with a Year-Round Approach
Other tax mitigation strategies include maximizing your home office deduction, choosing a health insurance plan that lets you contribute to a Health Savings Account, and choosing the most beneficial method for recognizing asset depreciation.
Are you ready to talk to a tax accountant in DuPage County who will help you take a year-round approach to minimize your taxes? Call the financial futurists at Klein Hall CPAs at 630-898-5578. We are conveniently located on 75th Street, west of Route 59 and east of 34/Ogden Avenue.