We all know the importance of reviewing your business’s tax position in “good times;” but what about the “bad times?” Managing your taxes is a critically important piece of the financial planning process in any given year.
In profitable times, a common tax planning technique is to prepay expenses or accelerate deductions. The goal of this strategy is to limit income from being taxed at a higher tax bracket than normal. No one likes paying taxes, but doesn’t it make more sense to pay a 12-15 percent tax rate consistently rather than be surprised with a 32 percent rate or higher? In good times, this consistency can help manage your business and keep the surprises at bay.
When a business faces headwinds, planning is just as important. Generally, it serves little or no good business purpose to have a tax loss. Your business can lose the benefit of permanent tax deductions like the standard deduction. Net operating losses can reduce taxable income in those years and thus ordinary tax, but not self-employment tax. Self-employment losses from one year are not available to reduce self-employment income in carry-back or carry-forward years.
If you do find yourself in a not-so-good year, here are some strategies we can help deploy to even out taxable and self-employment income and consistently take advantage of the lowest marginal tax brackets:
- Delay unessential repair expenses. Postpone the wish list and focus on the necessary expenses to produce income in the most economically efficient manner possible.
- Accelerate recognition of income in this year. Instead of holding off until just after the first of the year to market crops, consider selling them right after harvest. That will get the income into this year instead of next. Beware of market swings, of course. Evaluate the tax savings with market fluctuation.
- Talk with your vendors and ask if you can delay payment of an account until the first of next year without added fees or interest.
- Slow depreciation. Don’t take the special depreciation allowance. You must, however, attach an election to your return. You can also use a slower method like straight-line over a longer life to reduce the depreciation deduction on current year purchases.
- Elect to capitalize repair expenses. This is done by attaching an election to your return and capitalizing or depreciating those repair costs over time.
- Convert a traditional IRA to a ROTH IRA. All traditional IRA’s will have tax owed upon distribution. Only question is, at what rate? The conversion of an IRA to a ROTH IRA is a taxable event, but if there is negative income this year that can absorb it, why not pay tax at zero percent now instead of whatever tax bracket you would be exposed to in retirement? In addition, ROTH accounts generally grow tax-free and have no minimum distribution requirements.
These are just a few examples of techniques we can use to manage tax liabilities. What it really comes down to is communication between the business owner and the tax preparer. Farm Credit East’s tax specialists stay up-to-date on the most recent income tax regulations, deductions and credits applicable to agricultural businesses. Give us a call today. We can help you maximize your business’s success and retain your profits.