Business owners need to consider many specifics every year end when it’s time to plan for their tax filings. But, every so often, it’s a good idea to take a step back and ask yourself some big-picture questions. Here are three to consider.
Calendar or fiscal year?
When starting up, many business owners choose calendar year filing because it’s simple and familiar. But, over time, many companies move to a fiscal year basis to improve workflow and maximize data efficiency.
For example, a construction company in a cold-weather state started up doing home repairs but now finds itself reaping the most revenue from snow removal. Because the business has a distinct busy season between November and March, its owner doesn’t want to deal with tax planning during that period. So he chooses a fiscal year that runs from July 1 to June 30.
If, over the years, your business has developed a distinct “busy season,” you may want to consider making a switch to a fiscal year. Then again, if the calendar year works, stick with it.
Cash basis or accrual basis?
Businesses have two primary options when it comes to a tax accounting method:
- The cash-basis method, under which you record income as you receive it and expenses as you pay them, or
- The accrual-basis method, under which you report income and expenses as they’re incurred — no matter when you actually receive the money.
Whether you should change depends on how, if at all, your company has changed over the years. Many businesses start out relatively small and cash-basis tax accounting makes sense because it’s simple and requires less bookkeeping.
But, as a company grows, many business owners find that accrual accounting more accurately reflects current revenue and expenses. There may also be tax advantages. For instance, if you incur expenses in December 2013, but don’t pay them until January 2014, you can still claim expense-related tax deductions for 2013 if you’re an accrual-basis business. You wouldn’t be able to claim them until 2014 as a cash-basis business (unless you paid them by credit card in 2013).
On the other hand, if your company has contracted in size recently because of the uncertain economy or just for “leaner, meaner” strategic purposes, going to the cash-basis method may allow you to streamline operations even further. Just bear in mind that, to switch in either direction, you’ll have to get IRS approval by completing Form 3115, “Application for Change in Accounting Method,” and following some lengthy administrative steps.
Defer or accelerate income?
Generally, you want to try to defer tax liability to next year. So, if you’re a cash-basis company, you might decelerate income and accelerate expenses.
You could, for example, put off billing for your products or services as a cash-basis company. If you’re an accrual-basis business, you might delay shipping products or delivering services into the new year — assuming there’s a customer-friendly way of doing so.
When it comes to expenses, both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid. Cash-basis companies may also make state estimated tax payments before Dec. 31, to deduct in the current year rather than the following one. There could be negative alternative minimum tax consequences to doing so, however.
Deferring tax liability to the following year, however, doesn’t always make sense. And this is where income projection and tax planning come into play. If your company will likely be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax dollars.
The power of deductive reasoning tells us to start with the general and move to the particular. Why not make that your approach this year? Contact us – we can help you review your company’s general approach to tax planning and then work with you to target the right particulars.