As a CPA who works almost exclusively with small business owners, one of the most common misunderstandings I see is that many people think tax planning and tax filing are the same thing. They are not. In fact, confusing the two could be costing you thousands of dollars every year! In today’s post, I’ll explain why tax planning is one of the most powerful financial tools you have as a small business owner.

What’s the difference between tax filing and tax planning?

You probably already know the answer to this question if you really think about it. Tax filing is just complying with tax laws by reporting your income and deductions to the IRS. This is the part that everyone dreads because the focus is on gathering paperwork, plugging in numbers, and submitting forms on time. It’s boring.

On the other hand, tax planning is coming up with a strategy to use before the year ends and reviewing that strategy throughout the year with the end goal of reducing your tax bill. This is much more exciting and often overlooked by overworked small business owners who only have time to do what they must (the filing part).

I work with my clients to really get them thinking about making time for tax planning in addition to tax filing because being proactive with a solid strategy can save them thousands of dollars in taxes every year! I encourage them to look at tax planning as something that also must be done, and I hope you start looking at it that way too!

Which tax planning strategies can I use as a small business owner?

I would definitely recommend you speak to an accountant about any big tax changes you’re going to make as a small business owner. Just like you do with other areas of your business, it’s important to research and take advice from experts in the field.

However, to get the conversation started and to get your brain churning, I’ve picked out the 7 most effective and easiest-to-implement tax planning strategies for you:

• Choose the right business entity.
  • Since your business structure (aka business entity) impacts how you pay taxes, this is an important tax planning decision. For example, many LLCs elect to be taxed as an S-Corporation to reduce self-employment taxes. This setup can save thousands each year, but it’s only effective if it’s planned and implemented correctly.
• Maximize your business deductions.
  • Tax planning helps you identify and track all eligible business expenses for things like a home office deduction, mileage and vehicle expenses, education, retirement plan contributions, and the list goes on! Knowing what counts ahead of time can really help you save big bucks at tax time.
• Time your income and expenses.
  • In some cases, it might make sense to defer income to the next year or to accelerate expenses into the current year, especially if your income fluctuates. For example, you might prepay for software, insurance, or equipment before December 31st to reduce your current tax year’s taxable income.
• Set up a retirement plan.
  • Business owners can take advantage of tax-advantaged retirement plans like SEP IRA, Simple IRA, and Solo 401(k)s. Not only can a retirement plan help you build long-term wealth, but your contributions are deductible, which means you’ll lower your taxable income.
• Hire your kid.
  • Your business can hire your child as long as they actually perform work for the business and are paid wages. This tax planning strategy shifts income to your child, who is likely in a lower tax bracket, while also reducing your taxable income. Your child can even contribute earnings to a Roth IRA to kickstart their savings for their own future!
• Take advantage of Section 179 and bonus depreciation.
  • If you need to make a big purchase like equipment or a vehicle, then tax planning can help you decide when and how to write off those expenses. Section 179 and bonus depreciation rules can allow you to deduct the full cost of these types of purchases in the tax year of purchase (up to certain limits), but you’ll need to make sure your timing is right.
• Estimate and pay your quarterly taxes.
  • You can and should estimate what you’ll owe in taxes each quarter and make sure you’re paying the right amount to avoid penalties and to keep your cash flow predictable.

Abridged by Amy

Hopefully I’ve convinced you that tax planning is an important part of becoming a savvy business owner. I wish everyone would understand that tax savings don’t come by finding an obscure loophole or some fancy tax trick but in good planning, done consistently. 

If you’re only talking to your accountant in March or April, it’s often too late to make changes. Instead, I encourage you to rethink your approach and schedule a mid-year review, ask questions, and create a plan that works for you and helps you meet your goals.