Tax Deferral for Small Business Owners

A printout of instructions for Form 1120
As individuals and businesses cope with the economic fallout from COVID-19, it is important to be aware of all your options when it comes to weathering financial hardships.

As individuals and businesses cope with the economic fallout from COVID-19, it is important to be aware of all your options when it comes to weathering financial hardships. For some small business owners and employees, a tax deferral may be an effective way to keep money on hand now when it is needed most. While navigating tax laws and regulations can feel overwhelming at times, keep reading to learn more about the basics of tax deferrals and their potential benefits.

Basically, a deferred tax liability exists when your income tax expenses exceed your taxes return. This is a common occurrence when business expenses or other losses can be deducted before they are registered in the income statement. While you might not be necessarily operating at a loss, it will appear that way in your ledger and you can leverage this to defer taxes. 

For small businesses, tax deferrals usually take one of two forms

1) various retirement accounts 

2) claiming losses in order to defer paying taxes on revenue. 

Both of these techniques can be used to reduce the amount of taxes paid immediately and over the lifetime of an account.

Employees can use tax deferrals to put off paying taxes on the retirement accounts until they begin to make withdrawals. This allows the account to enjoy tax-free growth. Instead of paying on current investments and, you can make payments once you enter retirement, which typically also means a lower overall tax rate.

Calculating deferred taxes can be complicated, but there are some important steps to remember:

  1. Deferred tax calculations is the last thing you should do after you have recorded all your assets and liabilities.
  2. All assets should be listed as positive numbers and liabilities are negative numbers.
  3. Don’t forget to bring equity accounts into the equation.
  4. If done completely, the total of all accounts should equal zero.

Deferred taxes is just one tool that small businesses can use to preserve existing funds and reduce tax payments over the life of an account. If your small business is being hit hard by the coronavirus, tax deferrals could be a helpful tool to help with financial challenges.

Is deferred compensation subject to state tax?

Yes, if you choose to receive your deferred compensation in a lump sum, it will be taxed according to the laws in the state where you worked. However, if you choose to take payments over a 10+ year period, the deferred compensation will be taxed in the state where you live when you are receiving the payments.

What is a tax deferral?

Essentially, you can choose to receive deferred compensation and that money will be taxed in the year you receive the funds rather than when you earned them. Typically, this takes the form of a retirement or investment account.

What are the benefits of a tax deferral?

Delaying taxes allows accounts to grow without being slowed down by removing tax payments. In addition, tax rates and earnings are typically lower during retirement, so you will end up paying less in taxes.

Is deferred tax an asset or a liability?

Deferred tax asset occurs when a business overpays taxes or pays them before they are due. This allows them to receive a refund and an injection of cash into the business. This creates an asset and not a liability.

How is deferred tax calculated?

In order to calculate deferred tax, you will need to: list all your assets and liabilities, calculate a tax base of each asset and liability, calculate temporary differences, determine your tax rate, calculate your deferred tax asset of liability, and identify any items that are outside the statement of your financial position. 

What is a tax deferral for small business owners?

Tax deferrals for small businesses can come in the form of a Simplified Employee Pension IRA, an individual 401(k) or a Savings Incentive Match Plan for Employees IRA.

How long can a business defer taxes?

It depends on the type of deferral you are using. In some cases, the deferral will buy you a few years. However, there are options, such as a cascading life insurance policy, that can defer taxes for an entire generation. 

How do companies defer taxes?

Corporations can use accelerated depreciation to defer taxes. This approach involves either reducing the amount of declared revenue of increasing expenses. Ultimately, this means paying higher taxes in the future, but it can delay payments and allow more access to cash now. 

What is the benefit of a tax deferral?

A tax deferral allows you to minimize the amount of taxes you pay over the life of an account. With a tax deferral, you are able to immediately benefit from tax deductions, but one you begin making withdrawals, the amount will be taxed according to your current income.

What is an example of deferred tax?

If a company owns certain equipment that is listed as an asset, they can accelerate depreciation so that higher deductions are taken out early on. 



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