Strategies for Small Businesses and Sole Proprietors to Save Money on Taxes -Part 4 of 10
If you’re a small business owner or sole proprietor, taxes are always on your mind, whether you like it or not. The reality is, tax obligations are inevitable, but with smart planning, you can legally reduce what you owe and keep more cash to reinvest in your business. One of the most tried-and-true strategies? Deferring income and accelerating expenses. It’s all about timing—shifting income and expenses between tax years to lower your taxable income this year and lighten your tax bill.
In this article, we’ll get into the details of how this works, when it makes sense, and how you can use these strategies to your advantage while staying on the IRS’s good side.
1. What Does Deferring Income and Accelerating Expenses Actually Mean?
Let’s break it down:
- Deferring income: This is when you push income you could receive this year into the next tax year. By delaying the recognition of that income, you postpone the tax hit.
- Accelerating expenses: On the flip side, this involves paying expenses this year that you would normally handle next year. By speeding up these payments, you increase your deductible expenses now, which reduces your taxable income.
It’s all about timing your income and expenses to reduce your tax liability in the current year, which is especially useful if you expect to be in a lower tax bracket next year or if you want to smooth out fluctuations in your taxable income.
2. Why Bother with These Strategies?
The main reason: lowering your tax bill in the short term. Here’s why it might make sense for you:
- Cash Flow Management: Lower taxes now mean more money in your business’s pocket to keep things running smoothly.
- Avoiding Higher Tax Brackets: If you’re on the verge of moving into a higher tax bracket, deferring income can keep you in a lower bracket and save you some serious cash.
- Expecting a Slow Year: If you know your income will take a dip next year (seasonal slowdowns, big investments, or personal reasons), pushing income to that year can help keep you in a lower tax bracket now and later.
- Maximizing Current Year Deductions: If you’ve had a great year and want to offset some of that profit, accelerating expenses gives you a bigger deduction right now.
3. Who Should Use These Strategies?
These strategies are gold for businesses using the cash method of accounting (which most small businesses and sole proprietors do). This method lets you recognize income when it’s received and expenses when they’re paid, so you have more flexibility in how you time things.
Even if you use the accrual method, where income is recognized when earned and expenses when incurred, you’ve still got options—think adjusting invoice dates or prepaying expenses. If your business has ups and downs throughout the year (hello, seasonality), this strategy is especially useful.
4. How to Defer Income
There are a few tried-and-true ways to push your income into the next year:
- Delay Invoicing: Instead of sending that final invoice in December, hold off until January. For cash-basis businesses, you won’t recognize the income until it’s actually received.Example: Finished a $10,000 project in December 2023? Wait until January 2024 to send the invoice, and boom—you’ve deferred that $10k to the next year.
- Postpone Payments: If a client already has an invoice but hasn’t paid yet, you can ask them to wait until January to settle up. This requires a little finesse and some good client relationships, but it can work.
- Slow Down Project Completion: If you’re wrapping up a big job toward the end of the year, consider slowing things down so the final deliverables (and payment) spill over into the next tax year.
- Max Out Retirement Contributions: Contributing to retirement accounts like a SEP IRA or Solo 401(k) is a classic way to reduce your taxable income in the current year. It’s not deferring income per se, but it helps by sheltering some earnings from taxes until retirement.
5. How to Accelerate Expenses
On the flip side, pulling expenses from next year into this year is another great strategy. Here’s how:
- Prepay Future Expenses: You can prepay up to 12 months’ worth of expenses like rent, insurance, or subscriptions, and deduct them in the current year.Example: In December 2023, prepay $12,000 in rent for January to June 2024 and deduct that full amount in 2023.
- Buy Supplies and Inventory: If you’re going to need supplies early next year, why not buy them now? As long as you’ll use them within the next few months, you can take the deduction this year.
- Pay Bonuses or Wages Early: If you typically pay bonuses in January, consider moving those payments up to December. This works for employee wages too.
- Make Big Purchases: Planning to buy new equipment or a vehicle for your business? Pull the trigger before year-end, and you can often deduct the full cost thanks to Section 179 expensing and bonus depreciation.
- Maximize Retirement Contributions: Again, contributing to your retirement plan by year-end can help reduce your taxable income while boosting your future savings.
6. Things to Watch Out For
As powerful as these strategies can be, there are a few things to keep in mind:
- Don’t Overdo It: If you get into a habit of deferring income and accelerating expenses year after year, the IRS might start paying closer attention. Make sure your moves are legit business decisions and not just about avoiding taxes.
- Watch Out for Constructive Receipt: If the IRS considers that the income was made available to you—even if you didn’t actually receive it—they’ll count it as income for the current year. So if a client mails you a check in December, even if you don’t cash it until January, the IRS still considers it December income.
- Keep Cash Flow in Check: Accelerating expenses is great, but don’t mess up your future cash flow by tying up too much money now. Balance is key.
7. Work with a Tax Professional
Look, taxes are complicated. Deferring income and accelerating expenses can save you a ton of money, but it’s best to have a pro in your corner to make sure everything’s done right. A good tax advisor can help you analyze your income patterns, plan your deductions, and make sure the IRS doesn’t come knocking.
TL;DR…
Deferring income and accelerating expenses are two of the smartest moves you can make to manage your tax bill as a small business owner. With a little planning, you can strategically time your income and expenses to lower your taxable income for the year, freeing up more cash to reinvest in your business.
Just remember—these strategies are tools in your overall tax plan, not one-size-fits-all solutions. Make sure they align with your broader financial goals, and when in doubt, consult a tax pro. That way, you’ll not only reduce your taxes but also keep your business on solid financial footing year-round.
