Tax season may be over for those who didn’t extend, but for business owners, it’s time to start thinking ahead and reviewing tax strategies for the upcoming year. Whether you have a financial advisor or not, it’s critical to plan ahead for the next year’s tax obligations. Here’s an inside look at how we assist our clients through the tax planning process.
Reviewing Your Tax Return
The first step in tax planning is reviewing the previous year’s tax return thoroughly. This ensures that no crucial information or tax-saving opportunities have been overlooked. Many business owners still handle their taxes themselves, which can sometimes result in missing out on valuable tax benefits or mistakenly overpaying.
Some common mistakes we’ve seen include:
- Backdoor Roth contributions being mistakenly reported as taxable.
- Missed tax exemptions like Qualified Small Business Stock (QSBS).
- Charitable contributions not being properly reported.
- Restricted Stock Units (RSUs) being taxed twice due to inaccurate cost basis reporting.
- Post-year-end contributions to retirement plans like Solo 401(k)s not being accounted for.
- Missing filings for gift tax returns after contributing large sums to accounts like 529 plans.
By reviewing tax returns carefully, we help our clients avoid these common mistakes and make sure they’re not paying more than necessary.
Safe Harbor Tax Planning
Once we’ve reviewed the tax return, the next step is planning for safe harbor payments for the following year. Safe harbor ensures that you won’t be penalized for underpaying taxes throughout the year. To meet safe harbor, you need to either pay 110% of your previous year’s tax liability or 90% of your current year’s expected liability. These payments need to be made quarterly unless you’ve arranged with your tax team to annualize income, which can be more complex and may incur extra costs.
For clients expecting a higher income in the upcoming year, we typically go with 110% of the previous year’s tax liability. If income is expected to decrease, we help track this and adjust payments to ensure that they meet the 90% threshold.
For example, if your tax bill for 2024 is $250,000, you’ll need to pay $275,000 in 2025 (110% of $250,000). After accounting for any withholdings, we break down the remaining amount into quarterly payments. This ensures that you avoid any penalties, even if your income increases during the year.
Estimating Your Actual Tax Liability
Safe harbor planning helps prevent underpayment penalties, but it doesn’t provide an accurate estimate of your overall tax liability. To avoid surprises, it’s essential to forecast what you’re likely to owe based on current projections.
For instance, if your safe harbor payment is $275,000, you may be saving $30,000 each month for taxes. But if your actual tax liability ends up being $500,000, saving only $275,000 may leave you unprepared. We give clients a clear picture of both their safe harbor payments and expected tax liability, ensuring they’re ready for what’s to come.
If clients don’t plan for their tax liabilities accurately, they often face one of two problems:
- They hoard cash in their business until tax time, only to repeat the same cycle the following year.
- They take too much money out of the business, spending it without considering tax obligations and then struggle to cover the taxes when they’re due.
Our goal is to ensure that our clients avoid both of these situations by helping them understand their tax responsibilities throughout the year.
Planning Tax Moves for the Year
The final step in our process is identifying specific tax strategies that can help reduce tax liabilities or optimize long-term wealth. These strategies could involve actions that lower your taxes in the short term, such as:
- Contributing to a Solo 401(k) or Cash Balance Plan
- Maximizing deductions and credits
- Purchasing vehicles or business assets that can be depreciated
- Setting up Donor-Advised Fund contributions for charitable giving
- Implementing cost segregation studies to accelerate depreciation
Alternatively, we may discuss strategies that increase taxes in the current year but reduce overall tax liability over time, like:
- Roth 401(k) contributions
- Mega Backdoor Roth conversions
- Tax gain harvesting
- Roth conversions
Planning these moves in advance ensures that we’re not only minimizing your current-year tax liability but also helping you build wealth and reduce your lifetime tax obligations.
Ongoing Tax Strategy for Business Owners
Tax planning doesn’t stop after the initial review and strategy session. It’s an ongoing process that continues throughout the year, adjusting based on changes in income, business performance, and new tax laws. Business owners, especially those with high incomes, need to be proactive in managing their taxes to maximize their financial success.
By partnering with a financial and tax planner, business owners can stay ahead of the curve, avoid costly mistakes, and ensure that their tax strategy aligns with their long-term financial goals.
