Preparing for 2021: Tax Planning Strategies for Small Business Owners

If you are a small business owner, every penny of your income counts. This means that you want to optimize your revenue and minimize your expenses and your tax liability. Unfortunately, far too many entrepreneurs are not well-versed in the tricks and tools available to them and end up paying far more than they need to. You don’t need an accounting degree to take advantage of tax-cutting tips. Here are a few of our favorites. 

Think About Changing to a Different Type of Tax Structure 

When you started your business, one of the first decisions you needed to make was whether you wanted to operate as a sole proprietor, partnership, LLC, S corporation, or C corporation. But as more time goes by, the initial reasons for structuring your business the way that you did may no longer be applicable or in your best interest from a tax perspective. There is no requirement that you stick with the business structure you initially chose. 

Ever since the Tax Cuts and Jobs Act of 2017 (TCJA) changed the highest corporate income tax rate from 35% to 21%, sole proprietorships, LLCs, partnerships, and S corporations can realize significant tax savings by electing to be taxed as a C corporation. This simple change can make sense if these pass-through businesses’ owner is taxed at a high tax bracket. If so, all you need to do is fill out and file Form 8832. Before doing so, make sure that the tax savings you can realize are a reasonable tradeoff for the other reasons that you may have initially selected the structure you are currently in. 

Pass-Through Businesses Can Get a 20% 

One of the most impactful changes that the TCJA made for pass-through businesses whose income is passed-through for taxation as their owners’ income is a valuable tax break known as the qualified business income (QBI) deduction. For eligible recipients, this deduction is worth a maximum 20% tax break on the income they receive from the business – but determining whether or not you qualify can be a challenge. 

There are several restrictions on taking advantage of the deduction, particularly regarding specified service trade or businesses (SSTBs) whose owners either earn too much income or rely specifically on their employees’ or owners’ reputation or skill. Though architecture and engineering firms escape this limitation, other business models – including medical practices, law firms, professional athletes and performing artists, financial advisors, investment managers, consulting firms, and accountants – fall into the category that loses out of their income is too high. In 2019 single business owners of SSTBs began phasing out at $160,700 and are excluded once their income exceeds $210,700, while those who are married filing a joint return phase out at $321,400 and are excluded at $421,400. To calculate the deduction, use Part II of Form 8995-A

Businesses that are not SSTBs are eligible to take the deduction even when they pass the upper limits of the thresholds, but only for either half of the business owners’ share of the W-2 wages paid by the business or a quarter of those wages plus 2.5% of their share of qualified property. 

These limitations and specifications for what type of business is and is not eligible are head-spinning. Though it is tempting to take the deduction simply, it’s a good idea to confirm whether you qualify and how to claim it with our office before moving forward. 

Know How You’re Going to Pay Your Taxes

It is gratifying to live the dream of owning your own small business, but the hard work required to generate revenue makes paying taxes extra painful. This is especially true because of the “pay as you go” tax system that the United States uses, asking business owners to make estimated quarterly payments. While employees pay their taxes ahead via payroll deductions withheld by their employers, no such automatic system is set up for small business owners. That leaves many with the temptation of delaying making payments to maintain liquidity. 

Unfortunately, failing to pay taxes quarterly can put you in the uncomfortable position of still having to pay at one point, with the additional burden of penalties and interest resulting from your delay. Though setting aside the money to pay taxes requires discipline, doing so will save you from the penalties charged by the IRS. These are calculated based on the amount you should have paid each quarter multiplied by your shortfall and the effective interest rate during the specific quarter (established as 3 percent over the federal short-term rate – C corporations pay a different rate). Even if you don’t calculate your quarterly estimated rates correctly, the safe harbor rule allows small businesses to pay the lower amount, which is either 90% of the tax due on your current year return or 100% of the tax shown on your last filed tax return. For those whose AGI was over $150,000 in the previous tax year, the safe harbor percentage is 110% of the previous year’s taxes. 

It is always a good idea to increase the amount you send in if you have a higher-income year. By doing a simple calculation of your safe harbor number and dividing it by four, you have a reasonable quarterly payment that you can safely send in on the due dates (April 15th, June 15th, September 15th, and January 15th of the following year). By setting aside the appropriate percentage that you will owe from each payment you receive, you can easily set aside the money you will need to pay and entirely avoid concerns about penalties or interest. Payment is most easily submitted using the online link for IRS Direct Pay, though many people opt for sending in the paper vouchers for IRS Form 1040-ES, along with a check. There is also an EFTPS system available for C Corporations’ use. 

Choose Your Accounting Method Carefully

Each small business owner calculates their income and revenue differently, with many using a method of accounting that is based on when money is received rather than when an order is placed and counts expenses when they are paid rather than the item or service ordered. This is known as the cash method of accounting. 

Whatever method of accounting you use, smart business owners can strategically adjust their approach—reporting their annual income based on cash receipts to reduce their end-of-year revenues, especially if there is reason to believe that next year’s income will be lower or they anticipate being in a lower tax bracket. 

An example of how this approach would be helpful can be seen in a business that expects to add new employees in the new year. Between that expense and other improvements planned, it makes sense to anticipate that net income will be down. The tax bracket for the business will be lower, so any work is done or orders placed towards the end of the current tax year should be accounted for when payments arrive so that the income can be taxed at a lower rate. The contrast to this is if you anticipate your business revenue to increase and be forced into a higher tax bracket in the new year. In that case, it makes sense to try to collect monies for work done in the current year early so that you can take advantage of your current, lower tax rate. This can be done for business expenses such as office supplies and equipment, which can be deferred and accelerated in the same way so that you can take advantage of tax deductions in the most advantageous way. 

Establish and Make Deposits Into a 401(k) or SEP 

One of the smartest ways to lower your taxable income is to contribute to a retirement account. Not only does doing so reduce your business’ tax liability, but it also ensures a more secure future. As a small business owner, either a 401(K) plan or a Simplified Employee Pension (SEP) plan will do the trick while benefiting both you and those who work for you in the future. 

While a 401(k) that is established before year-end will let you deduct any contributions you make (with contributions limited to the lower of $57,000 or the employee’s total compensation), business owners who fail to set up this type of plan by December 31st can still turn to the SEP as an alternative. Though SEP contributions are restricted to 25% of the business owner’s net profit, less the SEP contribution itself (technically 20%), a SEP can be established, and contributions made up until the extended due date of your return. Suppose you obtain an extension for filing your tax return. In that case, you have until the end of that extension period to deposit the contribution, regardless of when you file the return.

If You Took Out a PPP Loan, Plan on it Being Forgiven 

Many small businesses took advantage of the PPP loans that were offered by the government in the face of the COVID-19 crisis. While these loans were attractive because they are forgivable and gave businesses a chance to survive the dire circumstances, in April of 2020, the IRS issued Notice 2020-32, which indicated that even though the forgivable loans can be excluded from gross income, the expenses associated with the money received cannot be deducted. This effectively erases the tax benefit initially offered because losing the employee and expense deduction increases the business’ income and profitability. 

There is some chance that this issue will be resolved by Congress, as it contradicts the original intent of the tax benefit that accompanied the PPP funds, but that action has not yet been taken. It’s a good idea to talk to our office about this as soon as possible. Having to pay taxes on expenses incurred may be particularly challenging in the face of the difficulties the pandemic has imposed. Being financially prepared to pay more taxes than you originally intended may be a bitter pill to swallow. However, it will still be better than paying penalties and interest if you fail to pay what the government says that you owe. 

Though all of these strategies can be helpful, they may not all be appropriate for your situation. Keep them in mind as you go into the end of the year, and be prepared to ask questions to determine which apply to you when you speak with our office. Contact us to discuss tax planning for your business today.

How Do You Create Price Levels in QuickBooks?

You may know that when you create a product or service record in QuickBooks, you must assign a sale price to it. But did you know that QuickBooks gives you a great deal of flexibility when to comes to pricing items you sell? The software allows you to create one or more additional Price Levels that you can access for invoices, estimates, sales receipts, credit memos, and sales orders. 

There are three ways you can use these. Once you’ve created them, they’ll be available in a drop-down list in the Rate field. This allows you to assign them manually to individual transactions. The second option is to assign them globally to specific customers or jobs. Once you’ve done so, that price will apply every time you create a transaction for one of them. Finally, you can create price levels for selected items. 

Here’s how it works. Let’s say you want to create a price level that’s 15 percent below the actual price that you can use in individual transactions. You open the Lists menu and select Price Level List. Click the arrow in the lower-left corner next to Price Level and choose New. A window like this will open:

You can create price levels in QuickBooks and assign them to individual sales transactions. 

Fill in the field next to Price Level Name, and then click the arrow next to Price Level Type. Select Fixed %. Select decrease from the drop-down list on the next line and enter your percentage number. Round up to the nearest is an optional field; click OK when you’re done. The next time you create a sales transaction, your new price level will be available as an option when you open the drop-down list in the Rate column. 

When you need to edit or delete a price level, go to Lists | Price Level List again and click the arrow next to Price Level in the lower-left corner. You have several options here. For example, you can make a price level inactive, so it doesn’t appear on the list. The field next to Price Level is labeled Reports. Click on the arrow to see what’s available there. 

Customers and Jobs 

You can also apply a price level you’ve created to a specific customer or job, perhaps to reward a customer for frequent purchases. When you do so, that rate will appear every time you enter a sales transaction for the customer or job you selected. 

Open the Customers menu and select Customer Center. Double click on a customer or job’s name to open the record. Click on the Payment Settings tab. Click the arrow in the field next to Price Level and select the right one, then click OK. 

 

You can assign a Price Level to specific customers or jobs. 

Per Item Price Levels 

QuickBooks also allows you to set custom prices for specific items associated with preferred customers or jobs (this option is only available if you’re using QuickBooks Premier or Enterprise). Let’s say you want to give a 10 percent discount to specific customers who purchase your website development services. Go to Lists | Price Level List and click the arrow next to Price Level in the lower-left corner again, then select New (you can also get to the New command by right-clicking anywhere in the window). 

Give your price level a name (like Web Development 10 Off), then select Per Item from the Price Level Type drop-down list. Click in front of the Item you want to include. The next line’s fields should read as pictured in the image below: 10% | lower | standard price. Click Adjust. You’ll see your reduced prices in the Custom Price column in the table above. 

You can establish a Price Level for specific items in QuickBooks.

Again, the rounding field is optional. When you’re finished here, click OK. The next time you create a sales transaction for a customer eligible for the lower price, you’ll select Web Development 10 Off from the drop-down list in the Rate column. 

Feel like you’re outgrowing your current version of QuickBooks, or is it several years old? Contact us about upgrading. We’re here to support you and help you more effectively use the software as your business changes and grows.

10 Tips for Better Budgeting

If you already have a budget, it’s probably been difficult for you to stick with it for the last several months. Unless you provide products or services that have been in high demand since the COVID-19 pandemic took place, you’ve had to adjust your budget significantly. 

Now is an excellent time to start doing some planning for 2021. While there are still uncertainties next year, creating a budget will give you a starting point. A budget increases your awareness of all of your projected income and expenses, which may make it less likely to find yourself always running short on funds. 

Here are some ways you can make your budgeting process more practical and realistic. 

Use what you already know. Unless you’re starting a brand-new business, you already have the best resource possible: a record of your past income and expenses. Use this as the basis for your projections. 

Be aware of your sales cycle. Even if you’re not a seasonal business, you’ve probably learned that some months or quarters are better than others. Budget conservatively for the slower months.

Distinguish between essential and non-essential expenses. Enter your budget items for bills and other costs that must be covered before you add optional categories.

You can use data from a previous year to create a new budget in QuickBooks Online.

Keep it simple. Don’t budget down to the last paper clip. You risk budget burnout, and your reports will be unwieldy. 

Build-in some backup funding. Just as you’re supposed to have an emergency fund in your personal life, try to create one for your business. 

Make your employees part of the process. It would be best if you weren’t secretive about the expense element of your budget. Try to get input from staff in areas where they have knowledge. 

Overestimate your expenses. Doing so can help prevent “borrowing” from one budget category to make up for a shortfall in another. 

Consider using excess funds to pay down debt. Debt costs you money. The sooner you pay it off, the sooner you can use those payments for some non-essential items. 

Look for areas where you can change vendors. As you’re creating your budget, think carefully about each supplier of products and services. Can you find less costly alternatives? 

Revisit your budget frequently. You should evaluate your progress at least once a month. You could even start by budgeting for only a couple of months to allow yourself to learn a lot about your spending and sales patterns that you can use for future reference. 

How QuickBooks Online Can Help 

QuickBooks Online offers built-in tools to help you create a budget. Click the Gear (also known as the wheel) icon in the upper right corner and select Budgeting under Tools. Click Add budget. At the top of the screen, give your budget a Name and select the Fiscal Year it should cover from the drop-down list by that field. Choose an Interval (monthly, quarterly, or yearly) and indicate whether you want to Pre-fill data from an existing year. 

QuickBooks Online supplies a budget template that already contains commonly used small business items.

The final field is labeled Subdivide by, which is optional. You can set up budgets that only include selected Customers or Classes, for example. Select the desired divider in that field, choose who or what you want to be included in the next. Click Next or Create budget in the lower right corner (depending on whether you used pre-filled data) to open your budget template. If you subdivided the budget, you’d see a field marked View budget. Click the down arrow and select from the options listed there. 

To create your budget, you enter numbers in the small boxes supplied. Columns are divided by months or quarters, depending on what you specified, and rows are labeled with budget items (Advertising, Gross Receipts, Legal & Professional Fees, etc.). You enter numbers in the boxes that apply. When you click on a box, a small arrow appears pointing right. Click on this, and your number will automatically appear in the rest of that row’s boxes. When you’re done, click Save in the lower right. You can edit your budget at any time. 

QuickBooks Online provides two related reports. Budget Overview displays all of the data in your budget (s). Budget vs. Actuals shows you how you’re adhering to your budget. 

We know creating a budget can be challenging, but it’s so important – especially right now. We’d be happy to look at your company’s financial situation and see how QuickBooks’ budgeting tools—and its other accounting features—can help you get a better understanding of your finances. Please contact us with any further questions. 

Asset Sales Versus Stock Sales: What You Need to Know

Selling a business is never a decision that should be made lightly. A business is something that you’ve likely worked hard to build from the ground up into the entity that you always hoped it could be—you don’t want to sell yourself short now that you’re moving onto bigger and better things. When it comes to selling a business, one of the most important decisions that you’ll have to make has to do with how the sale itself will be structured. In this situation, there are two main types that you have to decide between—an asset sale and a stock sale. What is the difference between these two options? Who benefits the most from each type of scenario? Thankfully, the answers are relatively straightforward.

What is an Asset Sale?
When selling a business as an asset sale, the important thing to understand is that the seller actually retains possession of the legal entity that represents the business. What the buyer is purchasing are the individual assets that the company holds. Those can include things like equipment and fixtures, but also extends all the way up to trade secrets, telephone numbers of customers and business contacts, inventory items and more.

An asset sale usually does not include any cash-based assets and the seller actually retains any long-term debt obligations that the business holds along with the legal entity of the business itself. However, normalized net working capital is also usually one of the assets that is handed over from seller to buyer in this type of a sale. This can include certain elements like accounts receivable, accounts payable, accrued expenses and more.

What is a Stock Sale?
With a stock sale, on the other hand, the buyer is really purchasing the shareholder’s stock of the seller directly. Even though the assets and liabilities that are transferred as a result of this type of sale tend to be very similar to an asset sale, the seller is also getting the legal entity or stake in the business at the exact same time. In a stock sale, any particular asset or liability that the buyer doesn’t expressly want will either be distributed (in the case of assets) or paid off entirely (in the case of liabilities) prior to the sale being completed.

An important difference between an asset sale and a stock sale is that in a stock sale, no separate conveyance of individual assets is required for the sale itself to be completed. This is largely due to the fact that the original title of each asset rests within the corporation, meaning that both are transferred from seller to buyer at the exact same time.

Who Benefits From Each Type of Sale?

Once you understand a little more about the differences between an asset sale and a stock sale, you must also understand which benefits in each type of situation. As is common with most business decisions, the different parties involved will usually favor one or the other depending on which side of the fence they fall on. Buyers tend to prefer asset sales, for example, as it affords them certain tax benefits that they won’t get from a stock sale. Sellers, on the other hand, tend to prefer stock sales because it often makes them less responsible for certain future liabilities that may present themselves like product liability claims, employee lawsuits and even benefit plans.

Perhaps the biggest reason why an asset sale is preferred from the point of view of the buyer is because the company’s depreciable basis regarding its assets is highly accelerated. An asset sale typically gives a higher value for assets that depreciate quickly. A particular piece of equipment that the business owns, for example, likely has a three- to seven-year shelf life. At the same time, lower values are given to certain assets that amortize much more slowly. Goodwill, for example, is generally considered to have a 15-year shelf life. This generates additional tax benefits on behalf of the buyer, doing a lot to reduce taxes as quickly as possible and thus improving the overall cash flow of the company during the first few years of its life. Buyers also tend to prefer asset sales because it’s much, much easier to avoid any potential liabilities like contract disputes or product warranty issues as a result.

This doesn’t mean that asset sales are universally easier for buyers, however. Certain types of assets are inherently hard to transfer due to certain issues like legal ownership and any third party consent that may be required. Intellectual property, for example, would likely require the seller to obtain some type of consent that can slow down the process of a sale dramatically.

One of the major reasons why sellers tend to prefer stock sales is because all of the proceeds they get from the sale are taxed at a much lower capital gains rate. When dealing with C-corporations, corporate level taxes are avoided entirely. Also, in a stock sale the seller is usually less responsible for any future liabilities – a products liability claim officially becomes the problem of the buyer at that point.

The Popularity of Asset Sales versus Stock Sales
According to research, approximately 30 percent of all business sales in the last few years were stock sales. It’s important to keep in mind, though, that this number varies wildly based on the size of the company that is being sold. Larger companies have a much higher chance of being stock sales than asset sales.

Regardless of whether you’re a buyer or a seller, it is always important to consult with your business partners, your legal representatives and your accounting professionals throughout all points of the process to help make sure that you’re making the most informed decision possible. The need to understand exactly what you’re buying, how you’re buying it and what it means for the future is of paramount importance, regardless of which party you belong to.