Year-End Bonuses
Are They A Smart Tax Strategy For Businesses Or Not?
“Business owners often get close to the end of the year, realize they haven’t made their recommended tax payments, and discover they’re now subject to penalties and interest,” explained John Vance, Founder and CEO of Vance Wealth. “To avoid these penalties, they may decide to issue a bonus payroll, believing it will bypass the same penalty issues.”
However, due to recent tax changes, this strategy may not work as well as in years past. “For example, we had a fairly high earner who paid himself a $1 million year-end bonus to avoid tax penalties. But by paying that extra $1 million, he lowered the net profit of his business that year, eliminating two really important deductions,” John explained.
First, the qualified business income (QBI) deduction allows business owners to deduct up to 20% of their net profit federally tax-free. Secondly, the pass-through entity (PTE) tax gives entities, taxed as a partnership or S corporation, the ability to pay what they owe to the State of California directly from their corporate tax return.
“In this example, the QBI deduction that was lost for the client was $132,000, and the PTE tax was right around $93,000,” John explained. “As you can see, using year-end bonuses as a fallback option to ensure you have paid enough tax isn’t working as well as it has previously. Today, business owners are better served by a more proactive plan.”
By paying estimated taxes on a set schedule throughout the year, business owners can avoid penalties. There are two effective options: Business owners can either make regular payments for 100% of the current-year estimated taxes, or they can pay 110% of the prior-year taxes – and become penalty-proof. Depending on the size of the business, advisors can place tax payments in an account earmarked for taxes, and the money can earn over 5% interest in some cases.
“We typically default to having our clients pay their estimated taxes on a schedule to become penalty-proof,” John explained. “Or we advise them to withhold more throughout the year, so we’re not stuck with the year-end bonus as their only option.” Clients of Vance Wealth receive a customized spreadsheet that maps out all their tax payments throughout the year. Wealth advisors work with their clients’ accounting teams to ensure all payments are made correctly and on time.
“In the past, business owners would use these year-end bonuses as a way to get around being proactive. Now that choice is costing real money,” John explained. “If you paid substantially more in taxes this year because you’ve been accustomed to using the year-end bonus to avoid paying penalties and interest, we can set up a more effective way to do this for you.”
If you’re tired of scrambling to avoid tax penalties and want a more proactive approach to managing your business taxes, we’re here to help. Schedule a consultation with Vance Wealth today to develop a tailored tax strategy that maximizes your deductions and minimizes your stress. Visit us at vancewealth.com or call our office at 661-775-0950 to get started. Let us help you secure your financial future with confidence.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor. This illustration is assuming a 45% blended tax rate.
