Income tax season is an annual ritual with potentially serious consequences for small business owners. Pay too little and the IRS could be breathing down your neck; pay too much and you could jeopardize your company's financial standing in 2017 and beyond.
But tax season doesn't have to bring bad news. With a few simple tips, you can make your small business more tax efficient and lay the groundwork for your future exit from the company.
Tax efficiency begins with good recordkeeping.
Sloppy recordkeeping is one of the surest ways to mismanage your tax liability. If you wait to organize your company's receipts and financial documents until a month before your return is due, it's all but guaranteed that you will overlook expenses and neglect other opportunities to reduce your tax burden.
For sole proprietorships and other pass-through organizations, it's essential to keep business and personal records (and funds) separate - even though they will be reported on the same tax return. In addition to clear lines of division for tax purposes, the distinction between personal and business records demonstrates the company's actual income potential when you enter the business-for-sale marketplace.
And if you're still preparing your tax returns manually, stop what you're doing and install tax preparation software today. There are plenty of affordable tax preparation solutions for small businesses out there - nearly all of which integrate with popular accounting software and improve visibility to tax reduction strategies.
Know which credits and deductions apply to your business.
It's your responsibility to stay informed about available tax credits and deductions - the IRS won't identify these opportunities for you. In fact, the government will happily take your money if you fail to take advantage of credits or deductions and pay more than your required share.
As the filing deadline approaches, there are several important credits and deductions to consider:
Section 179 Expense
The Section 179 expense allows you to deduct the cost of equipment purchases in the year of purchase rather than depreciating the asset over multiple years. Section 179 can be a significant deduction - for 2016, you can expense up to $500,000 ($510,000 next year). Other limits apply, but Section 179 is a great way for current owners to realize tax savings now instead of waiting to recover the cost of investments in subsequent tax years, when a new owner may receive the benefit.
Bonus depreciation also allows business owners to expense a larger share of the cost of qualifying tangible personal property in the current tax year. For eligible property purchases, you are entitled to deduct 50 percent of the cost in the first year. However, the bonus depreciation deduction is scheduled to be reduced over the next several years. So, by investing in certain types of equipment and other assets sooner rather than later, you can receive a tax advantage and increase the value of your assets, making your business more attractive to buyers.
Work Opportunity Tax Credit
The Work Opportunity Tax Credit was extended through 2019. It gives small business owners tax incentives to hire veterans and other qualified individuals who have been unemployed for more than 27 weeks. Owners who take advantage of this credit can deduct 40 percent of first-year wages, up to $6,000. As a future seller, hiring veterans can be a smart move. In many cases, veterans are superb hires who help grow the business through teamwork and dedication.
Small business owners can often deduct the cost of operating a motor vehicle for business purposes. The easiest way to calculate this deduction is to keep track of your business mileage and multiply it by the IRS' standard mileage rate, which was $0.54 per mile in 2016. Alternatively, you could track the actual costs of operating your vehicle (e.g., fuel, repairs, etc.) and calculate the deduction based on the percentage of miles used for business. With good recordkeeping, you can calculate it both ways and opt for the method that results in the most tax savings.
One last tip: Remember to file your tax return on time, even if you can't pay the amount of tax you owe by the filing deadline. You will still be penalized for failing to pay on time, but you can avoid the additional penalty for failure to file.
By proactively managing and reducing your tax liability, you get to keep more of the money you earned through your business. But just as importantly, effective tax management improves profitability and cash flow - and ultimately, the value of your company to potential buyers.