There are a number of tax reduction strategies for a small business. The bulk of these reduction opportunities involve the recognition of expenses in the current period, rather than delaying them. By doing so, some portion of the taxable income recognized by a business is deferred to a later period, along with the associated income tax liability. These expense acceleration techniques are as follows:
- Higher capitalization limit. Set a high threshold for the amount of money spent on an asset that will be recognized as a fixed asset. By doing so, a larger proportion of expenditures is recognized as expense in the current period. For example, if the capitalization limit is set at $2,500, this likely means that all laptop computers are charged to expense when purchased, since their cost usually falls below this amount. A variation on this concept is to acquire below-the-threshold assets somewhat early, so that the expense recognition falls into the current year.
- Accelerated depreciation. Use an accelerated depreciation method to calculate depreciation for tax purposes, thereby increasing the amount of taxable depreciation expense in the current period. A less-aggressive method can still be used for financial reporting purposes.
- Accelerated asset purchases. There may be instances in which it makes sense to acquire assets sooner than is strictly necessary. For example, if a fixed asset no longer has a competitive efficiency level or breaks down frequently, consider replacing it with the latest-and-greatest assets. Doing so not only increases depreciation expense, but might also provide the business with an enhanced competitive advantage.
- Inventory write off. Conduct a review of inventory just prior to the end of the year, and eliminate all items that are obsolete. The cost of the eliminated items is added to the cost of goods sold, and so reduces taxable income.
- Receivables write off. Conduct a review of both trade receivables and all other types of receivables just prior to year-end, and write off anything that is not collectible. Doing so reduces taxable income.
In addition, here are two tax reduction strategies that do not involve the deferral of income recognition:
- Family expenses. If family members are employed by the business, it is allowable for the business to incur certain expenses on their behalf. The largest of these expenditures is the company car. The business can buy or lease cars on behalf of family members, as long as the cars are used for business purposes. Doing so creates an additional expense that can reduce the amount of taxable income.
- Additional debt. If there is a choice between making an additional equity investment in the business or acquiring debt to meet the funding need, consider using debt. By doing so, the related interest expense can reduce taxable income.