Many people and businesses hope to get a substantial refund. Individuals see a tax refund as “forced savings” and this extra windfall can be used to pay off debt, invest, build savings, or splurge on special purchases.
However, a small business tax refund should be used properly, which could include being reinvested into the business by improving technology, raising employee bonuses, contributing to retirement accounts, improving deduction timing, having fun activities and managing bad debt!
Is a small business tax refund always good?
Refunds are usually seen as a good thing, but they aren’t always that great. For example, tax refunds mean that an individual or business overpaid their tax burden. This usually happens if there are little or no allowances, which causes over-withholding. Instead of getting a refund, that business or individual could have used the money throughout the year to save and invest. Tax refunds have been called “interest-free” loans since they wouldn’t receive any additional payments on top of their refunds.
Therefore, the optimal situation is to break even or have a small business tax refund (less than $1,000). A business or individual can also be more organized and make sure to pay the correct amounts to each government using proper tax software. Being organized will also help businesses and especially self-employed individuals avoid any late or under-withholding penalties.
1. Improve technology
Technology is improving and has the potential to make workplaces more efficient. Unfortunately, many employers are stuck in the past and have sub-par technology. Not only does this lower employee morale, but it can also increase errors and redundancy.
Some inefficient employers value “facetime” or the hours an employee spends working over the efficiency of their work. Efficient employees can even be seen as “lazy” if they leave early after completing their work. Employers shouldn’t have this mentality, but instead use small business tax refunds to invest in proper technology.
One way employers can invest to improve technology is by reducing the number of emails. Email can be a time suck, as employees can spend up to 2.5 hours daily with it. Instead, consider investing in project management software like Slack. Slack is a very popular software that allows teams to chat in multiple threads, which has greatly reduced the number of emails. This improves communication, increases efficiency and boosts morale.
Another way employers could use a small business tax refund to invest in technology includes ensuring their systems (phones, computers, printers) are up to speed. Having systems that don’t crash and are reliable will save time and make everyone’s life easier. Some suggestions to improve these systems include having a competent I.T team and frequent employee training.
Other progressive employers are replacing computer hard drives with personal laptops. Each employee would receive a laptop which could help make computers run quicker and take up less space. Investing in company laptops would improve efficiency and could allow employees to work from home.
Working from home is another popular perk that gives employees a better work-life balance and efficiency. In fact, Stanford professor Nicolas and Stanford alum James Liang, co-founder and CEO of Ctrip, China’s largest travel agency, conducted a 2-year productivity study regarding working from home. Ctrip has 16,000 employees and 500 of those employees were used in the study. The study found that half of the employees who telecommuted had accomplished 2 days of work in a one, compared to the half that went to the office.
This experiment proves a potential win-win scenario, but businesses should use this perk with caution. For example, consider offering this perk to trustworthy employees who have been with the company a specific amount of time (i.e minimum of 6 months) and are high performers. Some employees can’t work from home as they would be distracted and wouldn’t provide value to the company.
2. Raise employee compensation
Unfortunately, many US-based employees feel underpaid and overworked. The average American works 47 hours a week and has a median individual income of $44,408 (males) or $31,610 (females). In addition, inflation along with large price increases for necessities like healthcare, higher education, and housing, make the average American worker strapped for cash.
An optimal way to help mitigate these problems would be to use the small business tax refund to increase employee bonuses. Recognizing employees for their efforts would improve retention and enhance employee morale.
One case study to note occurred when President Trump passed the Tax Cuts and Jobs act in 2017, which helped business save $320 billion in taxes. The Tax Cuts and Jobs Act also cut the corporate tax rate from 35% to 21%, which incentivized businesses to raise employees’ salaries and bonuses.
Besides increasing employees’ salaries and bonuses, consider creating a transparent performance plan. Quantifying ways that will allow an employee to earn more will make it easier for them to reach their goals. In turn, this will boost productivity, morale, and business revenue.
3. Contribute to retirement accounts
Related to the previous suggestion is using a small business tax refund to start or raise contributions to employees’ retirement accounts. These accounts include 401(k)s, 403(b)s, SEPs and SIMPLE IRAs. These plans will help employees save for retirement on a pre-tax basis and have different features along with contribution limits. Businesses can deduct the amounts they contribute to employee retirement accounts on a pre-tax basis and these contributions are also referred to as “employer matches.”
For instance, a common employer match might be “50% of the first 6%” of the employee’s contribution. This means that every employee that contributes 6% of his or her salary to the company retirement plan would receive an additional 3% (6*0.5) contribution to the plan. This is also called “free money” and is one of the best personal finance concepts employees and employers can implement.
Employer matches will not only help employee accumulate retirement nest eggs, but also will also improve culture. If employees feel that they’re on track for retirement, they will be less stressed, more productive and align their interests with the company.
Another similar action employers could take would be to create a profit sharing plan. This plan would allow employees to share in the annual or quarterly revenue of the company. Profit sharing plans are more flexible than the standard 401(k) and businesses can establish these plans if even they have established traditional retirement plans.
4. Small business deductions and timing
One advantage that the self employed and small businesses have are various tax deductions and credits. These tax breaks can be used to lower taxable income and increase reinvestment in the business. There are many small business tax deductions, but this guide will cover a few of the most important ones below:
General business deductions
These are standard costs like rent, utilities, employee wages, health insurance premiums, office supplies and equipment. Surprisingly, the IRS doesn’t have a specific guide on what businesses can and can’t deduct, but sets the rule as a “cost of carrying on a trade or business.” This gives businesses some wiggle room, but it’s important not to get carried away. Therefore, consider using both tax software and a competent tax professional to maximize your deductions as well as stay in compliance.
Section 179 expensing
Section 179 expensing is a common strategy which can be used to deduct up to $1,000,000 of new fixed expenses and equipment in 2019. Most small businesses qualify for this strategy and can expense not only purchased equipment, but also financed items. Some common types of expenses that fall under this rule include office furniture, equipment, buildings, business vehicles, improvements to business offices like fire alarms, and computers. One way to take advantage of this rule is to buy and implement equipment towards the end of the tax year, instead of waiting till next year. This way, businesses will be able to increase their deductions for that tax year. Timing deductions is a common strategy and pre-paying property along with state taxes is another way to do this.
This code might seem tricky, so this picture which assumes a $1,150,000 equipment purchase and 35% tax rate, will explain how it works:
Another common deduction includes training materials. Having training materials not only increases tax deductions but can improve employees’ morale. As discussed earlier, having quality technology as well as training materials will make employees happier and more productive. These materials could also include the costs of seminars and reference guides.
More business owners are working from home, which gives them an additional tax break: The home office deduction. The home office deduction allows taxpayers to either choose the standard de minimus method ($5 per square foot up to 300 square feet for a total of $1,500) or the more complex actual method. The actual method allows taxpayers to add all home office costs and multiply it by the home office square footage/total home square footage. Tax payers can potentially receive a larger tax break with this strategy, but it’s more complex and could increase audit risk.
If a business caters lunch for employees or has a meal related to business matters, it can deduct 50% of those costs. Meals can be a great way to improve employee and client relationships. However, it’s important to be aware of specific rules like only deducting ordinary and necessary business meals along with separating meals from entertainment expenses. Prior to the Tax Cut and Job Act, 50% of business entertainment expenses were deductible too. Currently, entertainment isn’t deductible which is why it’s important to segregate these two categories.
Businesses can also deduct 100% of the meals they provide to employees on some circumstances, known as the de minimus rule. These include small meals and beverages, like the occasional donut box or dinner for overtime staff. Related to this deduction, small business tax refunds can also be used to invest in fun activities.
5. Invest in fun activities
This might seem counter-intuitive, but it’s possible to excel in business and have fun at the same time. In fact, many employers are realizing the power of play, especially with team building exercises. Some examples of using a small business tax refund to invest in fun activities include having summer game days, holiday parties, and monthly outings. These activities have many advantages which include boosting morale, improving productivity and even tax deductions (i.e meal deduction). Having activities that allow employees to get to know one another will make the workplace a happier and more open environment.
A happier, more collaborative environment will motivate people to solve problems quicker and create new ideas. A 2015 study by the University of Warwick discovered that fun activities increase employee productivity by 12-20%. This proves that something as simple as a ping pong table or the occasional employee event can do wonders for any business.
6. Bad debt
If a business operates under the accrual accounting system, then it has accounts receivable (AR) and accounts payable (AP). These two accounts represent future revenues and expenses that will be paid or paid out. One problem for many businesses is unpaid accounts receivable, which represent unpaid revenues.
One good aspect of unpaid accounts receivable is that businesses can treat it as bad debt. A business that makes multiple attempts to receive payment on unpaid AR can deduct the amounts as “bad debt.” If the business eventually does receive payment on this amount, it would report it as revenue. Bad debt can be a tricky subject, but the IRS has a guide on business bad debt here.
Tax season or “refund season” as coined by tax preparation firm H&R Block, is well underway. Many businesses and individuals will be hoping for a large refund, and are thinking of how to allocate those funds. Tax refunds can be good, but they’re also referred to as “interest-free loans.” Therefore, it’s wise to properly plan withholding amounts to fit specific needs.
A small business tax refund could be used to improve technology, increase employee compensation, contribute to employee retirement accounts, improve deduction timing, properly manage bad debt and invest in fun activities.
Disclaimer: This article is not tax advice, but education. Refer to a CPA or tax adviser for tax advice.