Many entrepreneurs start a business after previously having occupied a high income tax bracket. During the startup phase entrepreneurs may not have as much income which may place them in lower tax brackets. This provides a window of opportunity for entrepreneurs to take advantage of some specific tax planning strategies. Some options are as follows:
- Convert traditional retirement accounts to Roth accounts. Traditional retirement accounts (IRAs, 401Ks) are typically made up of pre-tax contributions. When you take distributions from pre-tax retirement accounts they are typically taxed as ordinary income (and subject to penalties if taken out early and not converted to another account). Roth retirement accounts (IRAs, 401Ks) are comprised of contributions made post-tax. Distributions are typically taken tax free (as long as they are not taken early). If you have little to no other income in a given year, it may make sense to shift some of your retirement nest egg from pre-tax to post-tax in a year without other income so that you take advantage of low income tax rates for the lower brackets.
- Postpone personal itemized deductions. You may not need to claim all your itemized deductions such as mortgage interest, charitable contributions, etc in order to reduce your taxable income. As much as you can, you may be able to control the timing in order to hold the deductions out for a future tax year where you have more income to offset.
- Maximize refunds. In none of the above apply or make sense, use your cash flow from refunds to help subsidize your living expenses. Take advantage of nice refunds while you can!
- In 2014 and forward take advantage of the health insurance subsidies. You may qualify for health insurance subsidies for coverage for yourself and your family (you need to have at least $16,000 in income to qualify). One of the biggest financial challenges that I faced as an entrepreneur was to pay for my families health insurance when that burden is combined with decreased cash flow. The subsidies can help offset that for entrepreneurs moving forward.
As always, we recommend discussing your specific situation with a CPA firm before taking action.