Article Highlights:
- Tax Strategy Optimization
- Buy Equipment and Other Fixed Assets
o Section 179 Expensing
o Bonus Depreciation
o De Minimis Safe Harbor - Year-end Inventory Management
- Contributing to a Retirement Plan
- Maximize the Qualified Business Income (QBI) Deduction
- Review Accounts Receivable for Bad Debts
- Pre-Pay Expenses
- Deferring Income
- First Year in Business
- Avoid Underpayment Penalties
- Are You a Working Shareholder in an S Corporation?
- Planning on Paying Your Employees a Bonus?
- Reassess Your Business Entity
- Conclusion
As the year comes to a close, small business owners face a critical period for financial planning and tax strategy optimization. With the potential to drastically decrease your 2025 tax payment, establishing smart tax strategies is now critical. You may strengthen your business's position for the following year by optimizing savings, managing cash flow, and assuring compliance with tax obligations. Taking decisive action before December 31 is critical. To help you navigate this vital period, here's a year-end tax preparation checklist to help small businesses gain control and identify valuable tax-saving options.
Buy Equipment and Other Fixed Assets : One of the most successful strategies to create tax deductions is to purchase business-related equipment, machinery, and other fixed assets and put them into service by December 31. These assets are typically capitalized and depreciated over a number of years, however there are a few possibilities for deducting some or all of these expenses immediately, including:
- Section 179 Expensing: Deduct up to $2.5 million ($1.25 million if married filing separately) for qualified tangible property and computer software placed in service in 2025. It is phased away on a dollar-for-dollar basis as Sec. 179 expenditures approach $4 million.
Section 179 expensing lets firms to deduct the cost of some eligible property right once, rather than depreciating it over time. This includes tangible personal property acquired for use in an active trade or business, such as machinery, equipment, and off-the-shelf software. Certain upgrades to nonresidential real estate, such as roofing, HVAC systems, and fire suppression systems, also qualify. Buildings and structural components, on the other hand, do not often qualify unless they are classified as "qualified real property," which includes particular leasehold, restaurant, and retail improvements. The property must be used at least 50% for business purposes and placed in operation during the tax year for which the deduction is claimed.
- The OBBBA's legislative revisions boosted bonus depreciation to 100% for qualified properties purchased after January 19, 2025. Previously set at 40% for 2025, this adjustment, which OBBBA makes permanent, allows firms to instantly deduct the whole cost of eligible property in the year it is placed in service, providing a valuable tax-saving tool.
Bonus depreciation is available for tangible personal property with a Modified Accelerated Cost Recovery System (MACRS) recovery term of 20 years or fewer, as well as most computer software, some leasehold improvements, and specific transportation utility properties. This depreciation benefit is applicable to both new and used assets acquired and placed in operation after the specified date, giving businesses more flexibility in managing their capital expenditures.
- The de minimis safe harbor rule allows businesses to directly expense low-value products without capitalizing and depreciating them as fixed assets. If your company keeps relevant financial accounts, you can deduct up to $5,000 per item or invoice for certain purchases, provided they are also expensed for accounting purposes. Without these financial statements, the ceiling is reduced to $2,500. Despite the "de minimis" title, this clause provides for significant instant deductions. For example, acquiring 10 computers for $2,500 each may result in a $25,000 upfront deduction.
Year-end Inventory Management : Year-end inventory has a huge impact on a company's profit or loss since it directly influences the Cost of Goods Sold (COGS), which is an important component in calculating gross profit.
The cost of goods sold (COGS) is computed as the beginning inventory plus purchases made during the year less the ending inventory. Thus, the value of the ending inventory directly lowers the COGS. A bigger ending inventory leads to a lower COGS, increasing gross profit and taxable income. In contrast, a lower ending inventory leads to a higher COGS, which reduces gross profit and taxable income. Here are several year-ending strategies:
- Identifying and writing down outmoded or slow-moving inventory at year-end might result in lower taxable revenue, as the reduced value is reported as a loss.
- Delaying inventory purchases after year-end helps businesses minimize COGS and lower taxable income, leading to better financial performance for the current year.
Contributing to a Retirement Plan : Retirement plan contributions not only provide considerable tax benefits, but also allow for future savings for both business owners and employees. Self-employed individuals might benefit greatly from contributing to a retirement plan such as a Simplified Employee Pension (SEP) IRA. Business owners may pay up to 25% of their net self-employment earnings, with a maximum contribution of $70,000 in 2025. A SEP IRA has a flexible contribution deadline that extends until the tax return filing date, giving you more time to plan.
A Solo 401(k) is a good option for single businesses, freelancers, and independent contractors because of its dual-role contribution mechanism, which considers you both employer and employee and allows for significant contribution limits. This makes it an excellent option for increasing retirement savings. Employers can also increase employee satisfaction and retention by providing year-end incentives and tax-deductible retirement plan contributions. This combination of tax savings and employee incentives benefits both the company's financial condition and labor stability.
Maximize the Qualified Business Income (QBI) Deduction: As the end of the year approaches, business owners should take strategic steps to maximize the Qualified Business Income (QBI) deduction (also known as the Sec 199A deduction), which is a critical tax benefit that allows for a 20% deduction on qualified business income. To maximize this deduction, first evaluate your income levels to ensure they are less than the $197,300 for single filers or $394,600 for joint filers thresholds (2025 amounts) to prevent phaseouts. For organizations established as S corporations, it is critical to properly adjust a "working shareholder's" W-2 pay to correspond with industry standards while taking IRS inspection into consideration. Making capital investments can increase deductions through Section 179 expensing or bonus depreciation, resulting in decreased business income.
Review accounts receivable for bad debts: As the end of the year approaches, business owners should review their accounts receivable and consider writing off bad debts, which can yield considerable tax savings. A bad debt is an uncollectible amount owing to your company, typically resulting from unpaid client invoices or unreturned loans, and can be classified as either business or nonbusiness. To be eligible for a business bad debt deduction, the debt must have previously been included in your company's income and be tied to normal business activities.
For accrual method taxpayers, these debts become deductible in the year they become worthless. Documentation of rigorous collection efforts and the debt's worthlessness is critical for IRS compliance. Effective bad debt management not only cleans up financial records but also maximizes taxable income, thereby improving your company's financial health. Consult a tax expert to ensure that you fully utilize this deduction as part of your year-end tax strategy.
Prepay Expenses: As the end of the year approaches, business owners can strategically manage their cash flow by prepaying expenses to lower taxable revenue and, as a result, tax liabilities. You can efficiently reduce this year's taxable income by accelerating deductible business expenses such as insurance premiums, office supplies, or marketing costs before December 31st. This is especially useful for organizations that use the cash accounting method, which deducts expenses in the year they are paid. Prepaying up to 12 months of expenses, as permitted by the IRS's safe harbor rule, can be an effective strategy to bring deductions into the current tax year, assuming revenue can be deferred correctly without endangering cash flow needs.
Deferring Income: Deferring income to the following year can help a corporation stay under specific tax thresholds, hence optimizing tax outcomes. For cash basis taxpayers, deferring client billing until after the new year implies that income is counted when received. Deferring income, however, must be carefully considered to ensure that it does not have a negative impact on corporate operations or relationships. Balancing these tactics enables business owners to actively manage their taxable income, resulting in smoother cash flows and potentially significant tax savings.
First Year of Business? If so, you may deduct up to $5,000 in start-up and organizational expenses in the first year of company. Each of these $5,000 sums is lowered by the portion of the total start-up or organizational expense that exceeds $50,000. Expenses not deductible in the first year of business must be amortized over a 15-year period.
Avoid Underpayment Penalties: If you will owe taxes in 2025, you can take steps before year-end to avoid or reduce the underpayment penalty. The penalty is calculated quarterly, thus making a fourth-quarter projected payment only reduces the fourth-quarter penalty. However, because withholding is viewed as paid ratably throughout the year, increasing withholding at the end of the year might minimize penalties for the previous quarters. Here are a few alternative solutions:
- If you have a qualified retirement plan, you can temporarily resolve under-withholding by taking an unqualified payout. When receiving the payout, 20% is automatically withheld for federal income taxes, giving you the opportunity to make up on due tax payments and avoid underpayment penalties. Meanwhile, you can reduce tax implications by rolling the whole dividend, including the withheld portion, back into the plan within the 60-day period. This method necessitates the use of other assets to cover the withheld amount during the rollover, but it permits the retirement savings to remain tax-deferred and ensures compliance with rollover laws. This strategy provides a novel but realistic method for aligning tax payments without incurring additional tax responsibilities on the dividend.
- If you are married and your spouse is employed, they can boost their withholding for the end of the year. With the support of a willing employer, you can withhold up to the entire paycheck.
- If you have other sources of income, raise the withholding accordingly.
It may be useful for you to speak with our office to estimate your underpayment and determine whether an underpayment penalty exception is applicable.
Are you a working shareholder of a S Corporation? If so, you may be unaware of the IRS's "reasonable compensation" standards, which might affect your Section 199A (qualified business income) deduction and payroll taxes. Reviewing the regulations as they pertain to your situation may help you prevent future issues with the IRS.
Are you planning to give your employees a bonus? Consider paying your employees' incentives before the end of the year rather than at the beginning of the new year. This allows you to benefit from the tax deduction a year earlier.
Reassess Your Business Entity : The end of the year is an excellent opportunity to assess whether your present business structure is still the greatest fit for your operations. Each structure has different tax and responsibility implications. Sole proprietorships, partnerships, limited liability companies, S corporations, and C corporations are all viable options.
Conclusion : While year-end measures are primarily intended to manage and decrease income tax bills, it is necessary to consider their broader financial implications. Implementing these measures may also reduce the burdens of self-employment and business payroll taxes. Businesses can reduce taxable income to more favorable levels by transferring income, optimizing deductions such as the Qualified Business Income (QBI) deduction, and making strategic investments or prepayments, resulting in lower overall tax obligations. Such comprehensive tax preparation not only improves cash flow, but it also strengthens the company's financial position, preparing the way for a more robust and tax-efficient new year. As you finish your year-end financial plans, speak with this office to ensure that you optimize these opportunities across all tax dimensions.
