2021 Year end planning Guide for Freelancers and small businesses
A brief overview of the topics we’re discussing with our clients this month to save taxes and set things up for success in 2022!
Full details below, but here’s the TL:DR
If income was DOWN in 2021:
Don’t rush to prepay expenses for year end, deductions might be more valuable with higher 2021 income.
Expenses may also be down, meaning your taxable income might not be as low as you think!
If you have extra cash, it might be a good year to convert your traditional IRA to a Roth IRA!
If income was UP for 2021:
Cash basis taxpayers can spend down cash to lower their 2021 taxable income.
Consider prepaying 2022 expenses, but don’t spend just to save taxes
Consider putting $ into retirement accounts
Advice for S-corps:
Even with lower income, you still have to hit a “reasonable compensation” threshold for owners.
If you will owe taxes, paying then in as a payroll bonus can reduce estimated tax penalties
Advice for everyone:
If you or your employees have moved, you likely have filing requirements in new states this year!
Get your books in order now to avoid the crunch during tax time!
If your estimates need to be revised, reach out ASAP! December goes by quick!
Those are some of the major items we’re discussing with clients this December. As always, consult us about your unique situation as there may be topics specific to you that we’ll want to cover or that might change our advice.
My income is lower, do I need to make a Q4 estimate? - Maybe! Even if your income is lower, a lot of our clients tightened up their business and home budgets, and weren’t able to travel or go out as often, so you may not have reduced your taxable income as much as you think! If you’re not sure, get your books in order now so you’re not surprised come tax time!
Do I need to buy a bunch of stuff and spend all my profits by 12/31? - This is a very common question we get this time of year, and rightfully so! For cash basis taxpayers, spending down profits is a way to reduce their tax liability for the current year, but there are a few things to keep in mind:
Don’t spend money you don’t have! (borrowing to spend and reduce taxes is generally a bad idea)
Don’t buy things you don’t need! Even if you’re saving 30-40% of the cost in tax savings, it still doesn’t make sense to spend $100 to save $40!
Do prepay items you were going to spend anyway, such as business rent, insurance, vendor payments etc.
Do spend as part of your overall financial plan. Taxes isn’t an excuse to break from the plan!
Do keep in mind any upcoming financing needs. Lower income means lower taxes, but it also means you might not qualify for that mortgage.
Should I contribute to a retirement plan? - Maybe! Retirement plans are another great way to reduce your taxable income but it’s important to remember that this is something we plan for with extra cash. By extra, we mean that your taxes are paid, debts are clear, you have a well funded emergency fund, and you have enough cash for your short to mid-term goals before we start maxing this out. Once they money is in the retirement account, it’s in there until you retire at 59.5 and if you need to withdraw $ before then, you’ll be subject to income tax on the withdrawal PLUS a 10% penalty! We like to make sure clients are in a great place financially before we start putting those kinds of restrictions on their money.
If you want to start setting money aside but you aren’t able to check all those boxes, remember that the most important part of saving for retirement is the saving part. You can always just accumulate that extra cash in a savings account, and we can then slide it into a retirement account when you’re financially ready. While it’s not as tax efficient, keeping cash liquid keeps your options open and allows you to respond to changing conditions!
Should I convert my traditional IRA to a Roth this year? - Maybe! If your income is a lot lower than usual, and you’re expecting it to come back in 2021, then 2020 would be an ideal year to convert your traditional IRA to a Roth. When you do that, you’ll be adding the traditional IRA to your income in 2020 and paying the tax on it, so make sure you have enough cash on hand not to need to take an early distribution for the tax amounts!
I (or my employees) moved! Do I need to pay taxes in 2 (or more) states now? - Probably! You’ll need to file in each of the states where you or your employees worked, though there are mechanisms in place to make sure that you aren’t taxed twice on the same money. Most states allow for an allocation of your part year residency, and also offer a credit for taxes paid to another state while you’re a resident of their state. For businesses, remote employees could cause nexus in new states for you this year, but for most states the income is allocated based on sales. If you’re not tracking sales by location yet, it’s time to start!
I haven’t paid myself wages this year, do I need to? (S-Corps only!) - S-corporations are required to pay the owners “reasonable compensation” based on their duties and the work performed during the year, which means that just about every S-corp should have their owners on payroll. If you haven’t paid yourself wages for 2020 yet (or only minimal amounts) then we need to discuss what your reasonable compensation for 2020 should be, and make arrangements for a December bonus to meet that threshold.
What else should I do before year end? - Read a book, see some family, meditate, exercise, stay hydrated, support small businesses, look out for your friends and neighbors and most importantly continue to pursue your happiness.
Oh you meant for taxes? Well we covered a lot of the most common topics, but feel free to reach out and schedule some time with us to go over your unique situation!