What You Need to Do NOW to Prepare for Tax Season
While income tax filings have an annual deadline, the management of your taxes is ongoing, especially as business owners.
The key to managing your tax taxes is Proactive Tax Planning. This can mean many things to business owners, depending on the size and complexity of your business. But for the sake of keeping things simple and pragmatic, we’ll refer to proactive tax planning as a periodic review of your financials and projected tax liability DURING the tax year. This allows you to forecast your potential tax liability and position yourself to maximize any credits or deductions you may qualify for. This is the best way to make sure you’re paying the least amount in tax that you’re legally obligated to pay. But what does this look like in practice?
What you SHOULD have been doing (from January to September)
It is currently the beginning of the 4th quarter in 2021 (early October). If you were actively managing your taxes throughout the year (with the help of a tax pro, of course), you will have done these things:
- Know your tax liability for the previous year—This number is the basis for what you may need to pay as quarterly estimated taxes.
- Pay your quarterly estimated taxes—If profitable, you should have been paying quarterly estimated taxes.
- Review your financials on a monthly basis—You should know if you are more or less profitable as you were this time last year. This will give you a strong clue if you should increase or decrease your quarterly estimated tax payments.
- Review your financials on a quarterly basis with your tax pro/advisor—They will help forecast your tax liability, identify any tax savings opportunities, and help you make your estimated tax payments.
- A-la-carte consultations—Between quarterly consultations, you should have reached out to your tax pro before making any major decisions that will have a large tax consequence, like real estate or large asset purchases.
What you should do for the rest of the year (from October to December)
One of the biggest benefits that we have as business owners is the ability to control how much our businesses are taxed. How? By controlling how profitable we are. But we can only exercise that power by having up-to-date financials (a profit and loss statement and balance sheet).
You can’t know what your tax liability will be until you close out your books after December 31. This is why they call it ESTIMATED taxes. However, by having accurate financial statements, we can make very accurate projections of what you may owe. And by knowing how profitable you are as we near the end of the year, you have the ability to increase or decrease business spending, which ultimately gives you great control over what you’ll be taxed on.
There’s one popular, yet horrible strategy that I want to warn you against. There are accountants and “advisors” who will encourage business owners to sped off all of their profit in order to save on taxes. This is equivalent to spending $10 to save $3. It’s not illegal, but it’s just a bad strategy if you’re looking to build wealth. Instead, you want to focus on increasing PROFIT while budgeting for and minimizing your tax liability.
So, here are the things you’ll want to do for the remainder of the year:
- Have all of your financial statements cleaned up and updated ASAP if you haven’t done this already. You cannot plan for taxes effectively without accurate financial statements.
- Compare January through September 2021 to January through September 2020. Are you more or less profitable than the year before? This will give you a large clue if you should anticipate a larger or small tax bill.
- Consult a tax pro. Have them do tax projections and forecasts based on your year-to-date Profit and Loss Statement, and based on what you think your net profit will be at the end of the year. Have them identify any potential tax savings opportunities.
- Pay your quarterly estimated taxes if you haven’t done so yet. It’s important to pay 2021’s taxes with 2021’s dollars.
- Plan to meet with your tax pro before the year ends and keep a really close eye on your net profit as you approach December 31.
- Catch up on your quarterly estimated taxes if you haven’t done so yet or start planning for it. You should have very accurate estimates if you consulted a good tax pro. If not, use last year’s tax liability as your basis.
Profit First has a wonderful system to help keep sufficient tax reserves. It’s simple, painless, and can help make sure you have enough for taxes, no matter how little or how much you make. Sign up now for an assessment and let’s get you started!