Thinking ahead can protect you from waiting until there may be too little time to do things in a thought-out way. Here are some year-end tax planning tips that should be considered before you start planning your end-of-year celebrations. These can help you begin the next tax year in the best position to plan for future wealth. This way, you’ll really have something to celebrate in your company!
Here’s how to get to work:
Trevor McCandless’s Year-End Tax Planning Tips
Phase 1: Update your records and stabilize your finances
Reconcile your bank and credit card accounts
Reconciling and including all transactions from the property’s or entity’s bank and credit card accounts is absolutely mandatory.
If you aren’t the one managing your accounting or QuickBooks files, you may have no idea how to check this. That’s common for some property owners, but all owners should at least have access to their QuickBooks files even if your internal team is not doing the day-to-day data entry.
The action item here is for you as the owner or your Finance Lead to log in and run a Balance Sheet report. Eyeball the balances for each of your bank accounts and credit card accounts.
If there are differences, start asking your accountant a lot of questions. You may have a real big problem if you see negative balances in these accounts. Fortunately, we can fix these short-term accounting problems by correcting the entries for missing transactions, double-counted transactions, or misclassified transactions.
Make sure your Escrow accounts are up to date
This process is very similar to your checking and credit card reconciliation. Compare these Escrow accounts to your lease contracts, your closing statements, or for whatever you’re using the Escrow accounts.
If you’re delegating this reconciliation step to someone internally who HATES reading legal contracts, you’re likely going to find errors.
Loan payment reconciliations
You would be surprised how often we see THIS screwed up. The action item for your team is to make sure that you have your amortization schedules in hand and that you compare them to the financial statements.
First, you’re making sure the debt balances as reported on your balance sheet match the debt balance as reported on your year-end mortgage statements and amortization tables.
Secondly, you want to confirm that the interest deductions on your income statement match the interest payments on the year-end mortgage statements, as well as the amortization schedule.
Where we see misreporting is:
- When we see accountants or owners trying to deduct the entire mortgage payment, which is is the most common among “DIYers.”
- When we see the entire loan payment treated as a distribution, it would be fully non-deductible.
- When there was some mid-year change to the accuracy of the amortization schedule. Inaccuracies can occur if you missed a payment or terms were re-negotiated on interest rates, or there could also be some debt forgiveness, etc.
In this light, Phase 1, the stabilization phase, can be very smooth depending on if you’re currently managing the accounting yourself or if you have a great CPA that’s overseeing it on an ongoing basis for you.
Phase 2: Analyze where you can save with tax planning
Phase 2 is entirely dependant on the accuracy of Phase 1. For most of our clients, we are handling the adjusting of journal entries and the reconciliations during the stabilization phase that we mentioned, but we do have clients that have high-quality internal accountants with which we can coordinate the review of these items.
Qualified tax deductions
We’re often asked, “What can I deduct?” or “What is a qualified business deduction?” The IRS defines qualified deductible expenses as Ordinary and Necessary expenses that are incurred in the carrying on of your business. The definition can obviously then raise more questions. CPAs commonly think of Ordinary expenses as those that are helping to further the growth and sustainability of your venture. For example, paying for real estate taxes on your commercial property is going to help you sustain your ownership of that property. Paying your vendors and employees is necessary to running your business. What likely does not qualify is the vacation you may take to Italy for Christmas with no business purpose.
Understand Net Income and Cash Flow
Firstly, let’s clarify the differences between Net Income (which your taxes are based off of) and Cash Flow because quite frequently entrepreneurs confuse the two when thinking about how much taxes they may owe.
In commercial real estate versus, say, professional services companies like accounting or law, the differences between Net Income and Net Cash Flow are FAR greater. For commercial real estate owners, depreciation is a much bigger deduction and thus has a much BIGGER EFFECT (because of all of the Capital Intensive Assets that we need to acquire) on the difference between Net Income and Cash Flow.
For example, while you may have $100k of cash on hand, we may only have $20k of Net Income on which you’re taxed due to depreciation (which is a paper deduction). Depreciation isn’t actually cash coming out of your pocket. In a similar manner – LOANS & DEBT also create similar differences between Net Income and Cash Flow. For example, when a loan is being paid off in any given year, you may have $100k in Net Income but $20k of cash on hand, but in this case, you’re being taxed on the $100k. In this case, paying off debt isn’t deductible.
Therefore, Cash on Hand and Cash Flow is very different than Net Income and what you’re being taxed on.
Proactively estimate your tax liability
So, let’s chat about how to proactively estimate your tax liability in any given year.
Option A: The full tax return
The more complex (but most accurate) method is to proactively prepare a full tax return with all of the information that you have for the coming year. Most of the time your CPA is going to do this, so just let your CPA firm do it for you behind the scenes. It’s not going to slow you down.
For example, if it’s June of 2021 and we want to accurately know what our 2021 tax liability looks like, we’ll roll over all of the prior year’s information (2020) that we know of, edit any changes to prior year investments, sources of income and expenses that we have in 2021 and add in new acquisitions or disposals of assets and sources of income from 2021. In this example, we’re doing this in June with some assumptions of what’s going to happen for the final six or seven months, but if we have a business that has large swings of income, we could edit this every quarter for the actual performance that occurs. Keep in mind that this isn’t a DIY method for the most part, but this next one can be if you’re so inclined.
Option B: The projection
In the more simplified method, we’re not preparing a whole tax return and doing a projection which is best used if there have been very little to no changes in the amounts and sources of the Net Income of your company and properties from the prior year.
In this scenario, you can simply look at your previous year’s tax return and divide your Taxable Income by your Total Tax calculation and you’ll come to your Effective or Average tax rate across all of the marginal tax brackets.
If you are looking at the 2019 tax forms, you can find the Taxable Income amount on line 11(B) on page 1 of the Form 1040 and then the Total Tax amount can be found on page 2 of the Form 1040 on line 16, then this can be more of a DIY method or if you want to get a quick calculation for how much to budget.
Put these dates on your calendar
Estimated quarterly tax payments are due on April 15, June 15, September 15, and January 18. Good to put these in your calendars or sign up for our tax deadline reminders.
Bonus best practice
There isn’t a general difference in taxation of bonuses as either performance or general, but generally it’s a good idea to pay them before 12/31 to get the deduction in the current year.
Benefits to review for this year-end
There were several programs and benefits created in 2020 and 2021 to provide assistance to individuals and businesses impacted by the COVID-19 emergency. Many of the benefits provided by the Coronavirus Aid, Relief, and Economic Security (CARES) Act expired in 2020.
Several benefits continued through all or a part of 2021, while others were added by the Consolidated Appropriations Act of 2021 and the American Rescue Plan Act of 2021. Here are several areas to review as part of your 2021 year-end tax planning activities.
Many taxpayers were eligible to receive of up to $1,400 per individual (or up to $2,800 for eligible married couples filing a joint return) plus $1,400 per eligible dependent. If you didn’t receive your stimulus payment, or if you did receive a payment but for an incorrect amount, you will correct any discrepancy when you file your 2021 tax return.
Child Tax Credit
The Child Tax Credit (CTC) saw a significant increase in 2021 for taxpayers who can claim a child who qualifies as a dependent. For ages 6 through 17, you can receive up to $3,600 for each qualifying child. For each qualifying child age 5 and under, you can receive up to $3,000 each. Taxpayers also had the option to receive 50% of the credit in six monthly payments from July through December 2021. If you took advantage of these advanced payments, be sure to report these amounts to your tax preparer.
Child and Dependent Care Tax Credit
This credit also saw a significant increase for 2021. If you have one qualifying dependent, you can claim up to $8,000 of dependent care expenses and get a 50% tax credit, resulting in a maximum credit of $4,000. If you have more than one qualifying dependent, you can claim up to $16,000 in dependent care expenses and get a 50% credit, resulting in a maximum credit of $8,000.
Earned Income Credit
The earned income credit (EIC) for individuals without qualifying children has been expanded by providing special rules for 2021. To qualify to receive the credit, the age threshold was decreased from age 25 to age 19, while the upper age limit of 65 years was eliminated. The maximum credit for a taxpayer with no children was also almost tripled, from $538 to $1,502.
The amount of a student loan that is discharged (or forgiven) after December 31, 2020, and before January 1, 2026, will not be included in the gross income of the debtor, unless the discharge is made on account of services rendered to the lender.
Primary and secondary educators are permitted an above-the-line deduction of up to $250 when determining AGI for certain expenses that would be ordinarily allowed as unreimbursed trade or business expense deductions. Often these expenses are related to instructional supplies purchased by teachers.
Flexible Spending Arrangements
Employers may allow unused amounts (up to $550) remaining in a healthcare flexible spending arrangement to be carried forward to pay healthcare expenses incurred in the following year. Check with your employer to determine if this benefit applies to your flexible spending account.
For 2021 only, a $300 charitable deduction is available for single filers who don’t itemize deductions on their tax return. This charitable deduction can be up to $600 for married filers. The limit for charitable contributions in 2021 is 100 percent of your income. This limit for noncash contributions is 50 percent of your income.
Paycheck Protection Program
Consider if your business is eligible to take advantage of the safe harbor threshold that allows businesses to deduct certain 2020 expenses on your 2021 tax return.
You can deduct 100% of business meals if certain qualifications are met. Be sure to keep your receipts of each meal and notate when the meal took place, who attended and the business purpose of the meal.
Don’t forget about claiming 100% bonus depreciation for qualified new and used property that was acquired and placed in service during your 2021 business year.
Let’s help you make this end-of-year the best one yet
Phase 3: Strategies to make more money and maximize your cash flow
Set up a separate checking account for your tax budget
Best practice note: after we’ve established what our estimated tax liability is going to be we commonly like to recommend moving those funds into a separate checking account that is somewhat out of sight and out of mind. That way, we don’t go spending our tax budget by accident.
Don’t reinvest every dime
When we’re profitable, your tax liability to the Federal and State governments should be paid and in a timely manner. We want to avoid paying massive amounts of penalties and interest. Don’t reinvest every dime you make as this can lead to cash flow problems when there is an economic downturn as you’ll have tax liabilities from the previous year to budget for.
Analyze your spending
I’ll share a story on how we recently did this with a client. The client frantically called me not too long ago and was very stressed. As he put it, he felt like he “was swapping dollars”. In other words, cash was coming in and going right back out. He said, “Trevor man, I’m a sales guy, I know how to close the deal and then I’m onto the next. I don’t know what these numbers mean.” We were already doing his bookkeeping and tax work, and so he said, “Man, let’s activate the CFO consulting side of things. I’m hurting.” Long story short, we helped him grow his bottom line and take home another $20k per month in just 45 days.
Look at sales and marketing ROI
We started by analyzing his sales and marketing efforts. What was driving his sales, and what was the associated cost of it?
He had a large advertising spend, so we began by analyzing the ROI of each of the platforms that he was advertising on. Very quickly we were able to determine that on one of these platforms, for every $1 he spent, it was generating $15 in gross revenues. A 15-1 ROI. That’s RIDICULOUSLY AWESOME. As you can imagine we froze spending on each of the other platforms, and re-allocated all of the budget to just that one.
The second step was to analyze his other sales costs. When he started the company, he gave a sweetheart deal to his VP of Sales. His comp was 20% off the top of all gross revenues, regardless of whether his team even closed the deal. So this gentleman was getting 20% of all deals whether he was involved or not! The sales guy was making more cash than the owner, without any of the risk or expenses. Thus, our second step was renegotiating a proper compensation plan that was more aligned with his sales role. These steps resulted in another $20k per month in his pocket and that was just analyzing sales and marketing.
I’m sure that when we dive into the operational structure of his business, we’d be able to do more. There is a great book called EOS Traction. We actually follow the framework of Traction when we’re consulting in this 3rd phase of growth execution. We also give the leadership team of all of our new clients a copy of the book so we can all begin speaking the same growth-oriented language and have a lot of fun conversations.
Now that we’ve whipped through the 3 Phases of properly closing out the year and rolling into the new year with steam, we want to invite you to talk to us about outsourcing some of your financial responsibilities so you can reach your goals. Whether you’d like more financial freedom or time off, it can be done!
Find out about our outsourced financial services
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.