Avoiding Mistakes with Your Small Business's Tax Planning

Michael Hanley is a one of the most sought-after small business-focused CPAs in New York. We asked him for some out-of-the-receipt-box thinking on year-end tax strategies. Here's his take.

Decide if aggressive year-end tax strategies are right for you.

Not everyone should be putting an aggressive year-end tax strategy in place. For example:

1. Don't spend money that you wouldn't ordinarily spend just to reduce your tax bill. Remember, $1 spent does not equal $1 worth of tax saved: $1 spent creates a $1 deduction, which (depending on your tax bracket, business structure, and state of operation) will only lead to $.00 - $.60 worth of tax saved.
2. You may not want to accelerate expenses into the current year. For example, if you had a pretty bad year with a lower than average profit and expect your profit to pick back up in the following year, you may want to defer as many expenses into the following year as possible. If you are in the 20% tax bracket this year, but will be in the 30% tax bracket next year and you have $10,000 worth of expenses in question, deducting them this year will save you $2,000, while deducting them next year will save you $3,000.
3. Make sure you know whether you file your tax return on the accrual basis or the cash basis. Most year-end tax strategies only work for cash-basis taxpayers. Accrual-basis taxpayers report all income in the year that it is earned and all expenses in the year that they are incurred. So, just because you are paying for a 2011 expense in 2010 doesn't mean you get to deduct that item in 2010.

If you do opt for a series of aggressive year-end tax strategies, make sure you are actually spending money and not just moving money around.

The most common misconception surrounding year-end tax planning is the old "zero out your business bank account by 12/31" strategy. If done properly, this is an effective way to defer current year taxes into next year. However, simply zeroing out your bank account will not necessarily result in any tax deferrals. Paying yourself a bonus, taking a shareholder distribution/dividend/draw, repaying your officer loan, paying down credit card balances, paying down credit lines, or paying off other debt will not create deductions that will result in tax deferrals. If you are going to put this plan in place, you must actually be paying expenses or purchasing equipment.