You’ve got a small business, and it’s finally starting to turn a profit. Your capital gains are rising, and things are looking good. But you’re not out the woods quite yet. There are still multiple ways you can lose money and reduce your capital gains.
Overall, to keep more of what you make, you need to minimize your tax liability. As a small-business owner without a huge accounting department or in-house financial advisors, you’re going to need all the help you can get.
For example, one big area where you might find yourself losing out is through capital gains tax. When you sell capital assets (investments such as real estate and stocks) through your business the difference between the amount you paid for the assets and the amount you sold them for is considered a capital gain or loss. When capital gains are involved, you owe capital gains tax. Effective capital gains management leads to a smaller tax bill, which means you have more working capital and better cash flow. Capital gains tax directly affects how small-business owners deal with assets, which makes proper handling of this tax issue important. Any slip-ups in dealing with capital gains can cost small-business owners valuable tax dollars and result in substantial legal and accounting fees.
10 Unseen Money Losers That Impact Your Capital Gains:
- Not holding on to capital gains for at least 12 months. Short-term capital gains refer to assets that are sold within one year of when they were acquired, and these are taxed at a higher rate than long-term gains. The capital gains tax rate for short-term capital gains is taxed at the ordinary income tax rate, which can be up to 39.6 percent for 2018. Long-term capital gains apply to assets held longer than one year and generally result in a lower tax. In fact, the current top rate for long-term capital gains is 20 percent in 2018 and can be lower, depending on the tax bracket. Due to these substantial differences in tax rates, it is beneficial to refrain from selling an asset that is going to result in a gain 12 months after you have received it so that the gain will be taxed at the lower rate.
- Not taking advantage of installment sales. This method of reporting for a non-dealer is available if at least one payment is to be received after the close of the taxable year in which the sale occurs. The taxpayer can then defer the gain as payments are received in subsequent years. Basically, if you can arrange for an installment payment for capital to have at least one payment to come in after the close of the year, you can defer capital gains tax on it until the following year.
- Not offsetting capital gains with capital losses. If you have excess capital losses of up to $3,000, they can be deducted against ordinary income, and remaining capital losses can be carried forward indefinitely.
- Whether a capital gain is considered capital property or dealer property. Capital property is generally held for investment, whereas dealer property is usually meant for sale. If you are considered to be a dealer in an asset, it will be considered inventory, and capital gains tax treatment won’t be available. Remember: intent is everything. Dealer property versus capital property is the subject of much litigation throughout the history of the tax courts, so much care must be exercised in determining the character of the asset being sold.
- Not doing a Section 1031 exchange. This involves purchasing a “like-kind” piece of property within 180 days of the sale of another. It must be property held for investment or used in the trade or business. The basis and debt of the new property must equal or exceed the basis and debt of the property sold. This law provides the opportunity to defer gains until the subsequent year.
- Not deferring eligible deductions. You might choose to use Section 179 deductions instead of regular depreciation for assets. Section 179 deductions can’t produce or increase a loss and will carry over to next year.
- Not carrying over losses one year forward. Losses in one year can optionally be carried forward to a subsequent year. If your business has a net operating loss of $20,000 this year, you can use that to offset a gain of up to $20,000 in a subsequent tax year. In this way, you can still have a business that’s profitable in one year, (meeting the IRS’s guidelines of showing a profit three out of five years) yet keep the tax advantage from the previous loss. Profit or loss from business is not limited to one year.
- Not taking advantage of business losses that are not deductible in the year when you have the loss. You may be required to, or choose to, deduct these losses in past or future years. It is called a tax loss carryback or loss carry forward, and — it’s something with which you must get a tax professional to help.
- Not structuring your business the proper way. This may be the single most overlooked aspect of tax planning. Most businesses that start out small don’t change the structure of their business when they should. For example, if you have a closely held company in which the income passes through to you, the owner, those are usually set up as an LLC or an S corporation. While there is nothing wrong with those structures, you might be able to gain tax advantages by structuring your company as a C corporation, in which the first $50,000 of your income is taxed at a rate of 15 percent as opposed to a 35 percent rate if you’re in the highest tax bracket.
- Not being proactive about your tax plan. One of the best ways to maximize the benefits of a business loss is to be proactive. You need to look at your business throughout the year and make decisions based on your tax situation. In some cases, making some last-minute purchases can put your business into a state of loss, especially if you’re just on the cusp of profit or loss from business. For example, if you have income from another source, you can also use that business loss to offset your tax burden and keep yourself in a lower tax bracket.
The Tax Blueprint which Financial Gravity’s team members can help you create is that proactive tax roadmap that you can use throughout the year to guide your business tax decisions.
So how can you avoid those money losers and put the tax code to work for you? Call one of our Financial Gravity team members today and make an appointment for a free tax assessment: Let’s Talk!