Economic downturns, such as recessions, market contractions, and periods of high inflation, are unavoidable calamities that put every small business's fortitude to the test. Consumers think twice, and cash flow becomes tight. Careful financial management is frequently necessary for survival.
Knowing what tax relief is and putting into practice its many options can spell the difference between surviving and failing. This article highlights the strategies offered by professionals about the main tax reliefs available to small businesses in hard economic circumstances.
1. Leveraging Net Operating Losses
Your company experiences a Net Operating Loss (NOL) when costs are greater than revenue. Even though a loss is never ideal, there are ways that tax laws might lessen the impact:
- Carryforwards – This is a tool that allows companies to carry forward losses indefinitely and deduct them from future taxable income. It lowers tax obligations. Even without cash flow at present, carryforwards can be applied to forthcoming incomes.
- Carrybacks – This can be used when a company has a net operating loss and decides to apply that loss to the profitable earnings of the previous years (usually two years). This can immediately result in a tax refund. Consult a tax expert to confirm the most recent regulations that may apply.
2. Maximizing Tax Credits
A tax credit is financial assistance provided by the government that lowers one’s tax liability. When the tax is reduced to zero, the said credit becomes a refundable amount. Here is what you can avail of:
- Employee Retention Credit – This was a relief scheme launched during the COVID-19 pandemic. If you missed it, check with a tax expert who specializes in ERC to see if your company might still qualify.
- Work Opportunity Tax Credit – This gives credit for hiring members of specific groups who face obstacles in finding work (veterans, SNAP recipients, and the long-term unemployed). This is still in effect.
- Research & Development Tax Credit – Eligibility applies to those who develop, design, or improve products, processes, or software. Credit of up to $500K per year against payroll taxes may be availed.
- Energy Efficiency Credits – There are credits for commercial buildings that install solar power or other energy-saving systems that cut down consumption costs by at least 25%.
- State & Local Credits – Credits for the creation of jobs and investments in particular industries are available in many states and municipalities. Explore what applies to your business.
3. Accelerating Deductions & Deferring Income
Two tax planning strategies can be useful during recessions because of the short-term cash flow they bring by controlling the timing of income and expenses.
- Accelerating Deductions
- Prepay Expenses – Pay in advance what’s due early in the next tax year (rent, office supplies, and fees). Ensure they are to be used within the next 12 months. That’s the time limit for prepaid expenses.
- Bad Debt Write-Offs – Examine accounts receivable closely. Bad debts should be written off during the tax year they lose value. For increased deduction possibilities, use the specific charge-off method.
- Inventory Write-Downs – Write down your inventory to its fair market value. Factor in the drop in value due to damage or market conditions. The cost of goods sold (COGS) can then be immediately deducted.
- Deferring Income (All use the approach of getting delayed payments applied to the following year.)
- Cash Method Accounting – You can record income solely when it is received and deduct costs when they are paid. If you wait until after December 31st to send invoices, this defers income and reduces tax burden.
- Delayed Billing – A simple strategy of charging for supplies or services at the end of the year to guarantee payment in the subsequent tax year.
- Deferred Payment Contracts – Contracts should be drawn up so that large sums of money for goods or services delivered in the last few months of the year are paid for the next year.
4. Optimizing Accounting Methods
- Switching to the Cash Method – By moving from the accrual to the cash method, businesses (mostly service-based or smaller inventory-based businesses) can defer income and improve cash flow visibility.
- Inventory Method Changes – A shift in accounting principles that’s only permitted when it improves a business's financial picture. Such modifications will require disclosures in the financial report.
- Accrual Method Adjustments – Accuracy in recognizing fixed liabilities and expenses as incurred is crucial. Carefully managing the recognition of income until it’s already generated is equally important.
5. Utilizing Retirement Plans Strategically
- Owner Contributions – Postponing owner payments to retirement plans, like the SIMPLE IRAs or Solo 401(k)s, can free up immediate corporate cash flow but harm the owner personally.
- Employee Contributions – To save money, matching payments may be temporarily halted if the plan permits. Be open and honest with the staff.
- Profit-Sharing – Discretionary profit-sharing contributions can be reduced or eliminated in lean years. This offers flexibility, as contributions may be more in good years.
6. Exploring Disaster Relief & Special Programs
Governments usually implement certain tax relief measures during officially recognized calamities like pandemics or natural disasters. This can be another measure for gaining available funds.
- Payment Deadlines – In many cases of calamities, automatic extensions for the filing of returns and paying taxes are offered to affected businesses.
- Casualty Loss Deductions – Although rules vary significantly, accelerated deductions for uninsured losses due to disaster may be applicable in some instances.
- Retirement Plan Hardship Loans – Restrictions are loosened, and retirement funds can be accessed by the plan holder without penalty.
- SBA Disaster Loans – This is not a tax relief, but it does offer low-interest loans and may be deductible. Keep an eye out for SBA disaster designations and IRS notifications during these trying times.
7. Other Things to Remember
Take note that half of the reminders suggest sitting down with a tax professional.
- Meet with your tax professional at least quarterly to stay ahead.
- Keep accurate records (receipt, invoice, and bank statement) of all transactions.
- Seek professional help since tax rules change all the time and can be complicated.
- Cash is the ultimate goal. Prioritize strategies that provide actual funds rather than tax breaks.
- Beware of scams that guarantee huge refunds. Stay with reputable advisors.
- Lastly, talk to your bank or lenders if you're having a tough time getting payment extensions.
Planning for a Downturn
An economic slump demands smart financial stewardship. In such a case, tax planning is a powerful strategic tool in the survival kit of any small business enterprise. Remember that knowledge is power, and the proficient application of that information is the key.
So, what is tax relief? It’s a system that can be utilized to reduce the tax burden of a company and unlock vital cash flow that will strengthen the financial footing of a business. Get help from a tax professional. Call Richard Hackerman at 410-243-8800.
