For a closely held business, the company’s tax return and the owner’s tax return are really one planning exercise. Pass-through profits land on the owner’s personal return, and even in a C corporation, salary and distribution decisions do too. The last weeks of the year are when you can still change the outcome. Here is what we review with clients before December 31.
Start with a projection
Good planning starts with numbers, not guesses. Take results through the most recent month-end, estimate the rest of the year, and project both the business and the owners’ personal returns. A projection shows where you stand before you act, and whether estimated tax payments are on track.
Timing income and deductions
The basic levers depend on your accounting method. Cash-basis businesses can often defer income by billing later in December and accelerate deductions by paying expenses before year-end. Accrual-basis businesses can review accruals, write off uncollectible receivables and dispose of obsolete inventory. Keep in mind:
- Prepaying expenses only works within limits. Paying several years of rent or insurance in advance generally does not produce a current deduction.
- Bonuses to unrelated employees can sometimes be accrued at year-end and paid early the next year, but bonuses to owners and related family members are generally not deductible until they are paid.
- Deferring income is not always the right answer. If a sale of the business is planned, for example, it may be better to recognize income now.
Equipment and other purchases
Equipment, vehicles and other business assets may qualify for immediate expensing under Section 179 or bonus depreciation rather than being depreciated over several years. To count for this year, the asset generally must be placed in service by year-end; ordering it or paying a deposit is not enough. Two cautions: New York does not follow the federal bonus depreciation rules for most property, so the state deduction may be smaller, and a large deduction now means smaller deductions later. Buy what the business needs.
Owner compensation and distributions
S corporation owners who work in the business must take reasonable compensation through payroll before taking distributions. Confirm salaries fit the work performed and that health insurance for more-than-2% shareholders is reported correctly on W-2s. Partners should review guaranteed payments and draws the same way. C corporation owners should weigh salary against dividends, and avoid leaving large loans from the company outstanding without proper documentation.
Retirement plans
A retirement plan is one of the most reliable ways for an owner to reduce taxes while building savings. The deadlines differ by plan type: some plans must be in place before year-end for certain contributions to count, while others can be adopted or funded after year-end, up to the return due date. If you are considering a 401(k), profit-sharing, cash balance or SEP plan, review it now.
Pass-through issues to check
- Basis. If the business has a loss, owners can deduct it only to the extent of their basis and amount at risk. A shortfall can sometimes be addressed before year-end with a capital contribution or properly structured loan.
- Qualified business income deduction. Many owners of pass-through businesses can deduct a portion of their business income. Limits based on W-2 wages, property and the type of business can apply, and salary and timing decisions affect the result.
- New York pass-through entity tax. Electing partnerships and S corporations can pay New York tax at the entity level, which may let owners work around the federal cap on state and local tax deductions. The election for a year must be made early in that year, so year-end is the time to decide about next year and confirm this year’s estimated payments.
The owner’s personal return
- Charitable giving. Giving appreciated stock instead of cash avoids tax on the gain. Concentrating several years of gifts into one year, sometimes through a donor-advised fund, can make itemizing worthwhile.
- Investment gains and losses. Review your portfolio for losses that can offset gains realized during the year.
- Estimated taxes. A large bonus, distribution or sale can create an underpayment. Increasing withholding before year-end can help, because withholding is treated as paid evenly throughout the year.
- Gifting and estate planning. Annual exclusion gifts must be made by December 31. Owners planning to transfer shares in the business to family members should coordinate the timing with a valuation and their estate plan.
Practical steps before December 31
- Prepare a year-end projection from current books.
- Decide on equipment purchases and confirm they can be placed in service in time.
- Set owner pay and distributions, and review retirement plans.
- Check basis, estimated payments and the pass-through entity tax election.
- Make charitable and family gifts.
How we help
We prepare year-end projections for closely held businesses and their owners, and coordinate the business and personal returns so decisions in one don’t create problems in the other. The earlier we meet, the more options are still open. Learn more about our tax planning services.
This article is general information, not accounting, tax or legal advice. Tax rules change, and the right approach depends on your business and personal situation. Consult your advisor before acting.