Year End Tax Strategy for Business Owners: Actionable Steps Before December 31

Year end is the most important period for tax strategy because decisions made now affect income, deductions, and audit exposure for the entire year. Business owners who wait until tax season often find that most opportunities are gone. This guide explains the specific actions that matter before December thirty one. Every recommendation is based on established IRS rules and practical compliance.

1. Entity Structure Review and Owner Compensation Testing

Many owners choose an entity years ago without evaluating whether it still produces the best tax outcome. Tax law changes and business growth demand an annual review.

• Step 1. Estimate Net Business Income.
  Your choice of structure affects self employment tax, the Qualified Business Income Deduction, and payroll obligations.

• Step 2. Test S Corporation Compensation for Reasonableness.
  Your salary must be reasonable based on industry standards and the services you perform. If your compensation is too low, the IRS can reclassify distributions as wages. If it is too high, you lose potential payroll tax savings. Adjustments must be finalized before year end to count for the current year.

• Step 3. Analyze Conversion from Sole Proprietor to S Corporation.
  This evaluation depends on income level, QBI eligibility, and state rules. An S corporation election is not retroactive for the current year unless you qualify for late election relief. Most taxpayers will need to wait until the next year. This is a critical strategic decision warranting expert analysis.

2. Finalize Payroll and Owner Distributions

Payroll errors frequently create significant issues in audits.

• Step 1. Confirm All Compensation and Benefits are on Payroll.
  Items such as health insurance for more than two percent S corporation owners, retirement contributions, and specific fringe benefits must be recorded in payroll if required by law.

• Step 2. Review Distributions and S Corporation Basis.
  If total distributions exceed your basis, the excess becomes taxable income. A year end basis calculation prevents a sudden, unwelcome tax liability in April. Poor preparers often skip this vital step.

3. Implement or Update a Written Accountable Plan

Many business owners pay expenses personally without a formal reimbursement process. This creates two substantial tax risks. You miss legitimate business deductions, and you risk having reimbursements reclassified as taxable wages.

• Step 1. Prepare a Written Accountable Plan.
  The plan must be documented. It must require substantiation of the business purpose and mandate the return of any excess reimbursements within a reasonable time.

• Step 2. Submit Expense Reports Before Year End.
  Receipts for mileage, travel, supplies, and home office expenses must be supported with clear documentation. Without an approved plan and supporting data, the IRS treats the payment as income, not a tax free reimbursement.

4. Strategic Review of Asset Purchases and Depreciation

A common mistake is rushing to buy equipment solely to generate a deduction. A deduction only offers value if the purchase is necessary and genuinely supports business operations.

Hypothetical Scenario Example: A necessary equipment purchase can be strategically timed.

• Step 1. Determine Business Purpose.
  Internal Revenue Code Section 162 requires the expense to be ordinary and necessary. Buying an asset only to reduce tax does not meet this standard.

• Step 2. Analyze Depreciation Options and Limits.
  Section 179 expensing and Bonus Depreciation have specific limits and qualification rules. Certain assets must be depreciated over their statutory life. Vehicles are listed property and require specific use logs for full deduction.

• Step 3. Consider Future Income Projections.
  Accelerating depreciation into the current year reduces future deductions. If you project higher taxable income in the next year, spreading deductions over time may produce a better overall tax result.

5. Maximize Retirement Plan Opportunities

Retirement contributions reduce taxable income, but the specific rules differ by entity type.

• Step 1. Determine the Optimal Plan Type.
  Options include SEP IRA, SIMPLE IRA, and Solo 401k. A Solo 401k allows for both employee and employer contributions, but the plan must be formally established by year end in most cases.

• Step 2. Accurately Calculate Contribution Eligibility.
  Wages for S corporation owners and net earnings from self employment for sole proprietors determine the legal limits. Poor preparers often calculate contributions incorrectly, which leads to excess contributions and costly corrective filings with the IRS.

6. Bookkeeping Reconciliation: The Foundation of Accuracy

Accurate books are the non negotiable foundation of good tax planning and defense against an audit.

• Step 1. Reconcile All Accounts.
  Reconcile all bank and credit card accounts. Unreconciled accounts lead to missed deductions or an inaccurate count of income.

• Step 2. Separate Personal and Business Expenses.
  Commingling funds is one of the most common and easily identified audit triggers. Any personal charges must be identified and adjusted out of the business expenses.

• Step 3. Review Accounts Receivable and Payable.
  Cash basis taxpayers must understand the timing rules for income recognition. Accrual basis taxpayers need accurate balances to support income and expense deductions.

7. Estimate Total Tax Liability and Safe Harbor Payments

Surprises in April nearly always stem from a failure to plan in December.

• Step 1. Calculate Estimated Taxes.
  Apply the safe harbor rules to avoid underpayment penalties. High income taxpayers must often pay one hundred ten percent of the prior year tax to meet the safe harbor requirement.

• Step 2. Project Cash Flow for Estimated Payments.
  Review current distributions, payroll, and upcoming expenses. Making a final fourth quarter estimated payment based on an accurate projection often prevents penalty assessments in the spring.

8. Validate Basis, Elections, and Carryforward Items

These technical items are high risk areas that are frequently mishandled by low cost or unskilled preparers.

Crucial Areas for Expert Review:

• Carryover Losses: Net Operating Loss, capital loss, and Passive Activity Loss carryovers must be accurate and correctly tracked year to year.

• Depreciation Schedules: Incorrect or unsupported depreciation schedules cause significant, long term problems.

• S Corporation Basis: The owner's basis must be updated annually to determine if losses are allowed and if distributions are taxable. A year end basis calculation is one of the clearest indicators of whether a preparer understands complex S corporation rules.

9. A Warning Against Online Tax Schemes

This is a dangerous area where many business owners get into unnecessary trouble.

Social media and non expert sources often promote improper uses of strategies like:

• The Augusta Rule rental strategy.

• Vehicle write offs without the required business mileage logs.

• S corporation tax savings without a legally reasonable salary.

• Hiring children without meeting wage and payroll compliance rules.

Challenge: Each of these strategies requires full, specific compliance with the applicable tax code. None of them work automatically. They become red flags when compliance is absent or flimsy.

Conclusion

Year end planning protects business owners from penalties and creates legitimate opportunities to reduce tax in a manner that follows IRS rules. Most strategies must be implemented before December thirty one. A careful, strategic review now, with a credentialed expert like Han S Kim, CPA, EA, MST, avoids significant problems in April and strengthens the financial position of the business going into the next year.