When you make bigger purchases and apply strategic investments, amortization and depreciation come into play as well. These allow you to deduct the cost or value of an asset over a number of years. It’s how many businesses end up cash-flow positive at the end of each calendar year, but owe little in actual taxes due to earlier acquisitions.
Then there’s the question of accrual accounting versus cash basis accounting. In accrual accounting, businesses record revenue at the completion of a project or milestone, and they recognize expenses as they are incurred. While this is the more commonly used method of accounting, a disadvantage is that companies generally end up paying taxes on income they haven’t yet received from customers or vendors.
In cash-basis accounting, revenue and expenses are registered only when invoices are paid. This makes it easier for businesses to manage their tax liability when customers are delinquent on their payments, as companies only get taxed on cash received minus expenses paid. Generally, smaller businesses benefit more from cash-basis accounting while larger companies with millions in sales are more likely to take advantage of accrual accounting.
There are a few best practices every small business owner should follow to remain compliant with tax law, as well as strategies to reduce your taxable business income. Remember to follow these tips:
Keep your invoices and receipts. Between donations, vendor payments, and other purchases, it’s important that you collect and store all your receipts as original documentation.
Correctly classify contractors and employees. The government levies high fees on employers in instances where contractors meet the criteria of a regular employee but are not part of the company’s formal payroll.
Apply depreciation on large purchases. Deduct the value of larger assets over their full use period so you can spread the expense across multiple fiscal years.
Look out for tax credits and strategic deductions. Each year, federal and state governments announce incentives and programs that qualifying small businesses owners can take advantage of to reduce their tax liability.
Collect and pay all applicable sales taxes. Online purchases and software licenses are among the newest categories of products and services that are subject to sales tax. Make sure you charge your customers any required sales taxes so you can remit those fees to the government at a later date.
Overall, bookkeeping can become complicated. That’s why many entrepreneurs opt to use accounting software for small businesses while others enlist support from a licensed Certified Public Accountant (CPA).