By all means, do take in the season’s festivities, but do not neglect solid year-end planning. The way your firm brings 2023 to a close will have a major impact on how your GovCon fares next year. CAVU has developed a three-part series to help prepare your firm to tackle year-end planning and set yourself up for future success. We continue the series with what you need to know about taxable income. (Catch up on Part 1 – Balance Sheet Reconciliations here).
If you are a cash method taxpayer, the time is now to set and fulfill one early New Year’s resolution for a prosperous 2024: year-end tax planning. Take care of this crucial aspect of your business before the year’s end, and you will save yourself an unwelcome call from your tax accountant in 2024. Unfortunately, after December 31, there is little you can do related to tax planning other than make additional retirement contributions. Read through the tips below for smart tax moves to make now and throughout the coming year:
The Cash Method: Who Qualifies and How Can It Help?
The cash method can be advantageous to business owners because it allows them to align cash reality with their growth. Generally, the cash method allows a business to defer paying income taxes for money not yet received. This will help manage cash flow.
Also, for GovCon’s the tax return gross receipts are most often represented in calculating your NAICS size standard. For growing companies, the cash method may defer some income to future years and keep your size standard lower.
Year-Round Management Techniques for Year-End Planning
Here are more tools and techniques to handle taxable income now and throughout the coming year:
Accrual-to-Cash Income Calculator
One best practice is to prepare your annual budget along with an accrual-to-cash income calculation. Download CAVU’s accrual-to-cash instructions and an Excel template to get started. Build in year-end assumptions for:
- Days receivable (this is often the biggest driver)
- Prepaid expenses
- Timing of operating and overhead expense payments
- Deferred revenue
- Payroll timing, including Bonus payouts
Note that being on a cash method for tax purposes does not necessarily mean that all expenses may be deducted on a cash basis. There are several items for which cash method and accrual method taxpayers must use the same methods of accounting. These include:
- Non-incidental materials and supplies (deducted when used or consumed)
- Tangible and intangible property (depreciated or amortized beginning when the property is placed in service)
- Meals and entertainment expenses (tax limits the amount of the deduction)
Please consult your tax advisor during your planning process to help identify other items that may require special treatment.
Preparing an accrual-to-cash income conversion along with your budget is crucial to determining if you need additional year-end financing—such as a line of credit—to support tax planning. Bankers can arrange for your line to peak from December through February, for instance, to accommodate your needs. With up-front planning, you can lay the groundwork in advance and illustrate effective planning to your banker.
Taxable Income Conversions
As part of preparing an accrual-to-cash income conversion, your income and expense items reported on an accrual basis will need to be adjusted by the change in certain Balance Sheet accounts to report income under the cash method. For example, sales or revenue reported on an accrual basis will need to be adjusted for changes in the accounts receivable balance during the year so that sales or revenue reflect the cash collected from sales during the year. In addition, you will also need to adjust expense amounts to reflect the correct tax treatment (e.g., depreciation expense from assets that use different methods of depreciation for tax purposes).
Considering that the conversion of income is the majority of your taxable income, you and the tax preparer can establish a target on behalf of the company that best meets the owner’s interest. If you manage to reach this target, your firm and your tax preparer will have something extra to toast on December 31.
Mid-Year Outlook
Perform a mid-year outlook. As you update your forecast for the first half of the year, send a year-end outlook to your tax accountant in July for the income statement and balance sheet. The outlook should have ½ year of actuals and ½ year of the most likely outlook for the remainder of the year. Send your accrual-to-cash conversion as well to ensure there is an agreement with how you have classified accounts on your balance sheet between adjusting items and permanent items.
Fourth Quarter Ramp-Up
A best practice for the last three months of the year is to take a closer look at planning and, in December, manage results weekly or more often as needed. Many companies are in a flurry to manage collections and payments this time of year. CAVU recommends preparing a soft close by booking expected transactions, and having timesheets submitted a few days early for the year-end.
If you need more information on the planning tools and management techniques to get taxable income in order now and next year, feel free to contact CAVU’s GovCon experts in finance and accounting.