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Covid-19 has disrupted tax and retirement plans for small business owners, especially those who have focused on saving their businesses from the aftermath of the pandemic earlier this year. However, with a little hard work, there will still be time to get back on track by December 31st.
Here is a good example. One of my customers didn’t take a paycheck for six weeks after his business replenished this spring. To save money, he also lowered his withholding tax at the federal and state levels and stopped contributing to his company pension scheme. Fortunately, his business has largely recovered over the past few months. To his own surprise, sales for 2020 will be higher than forecast at the beginning of the year.
Now that he’s cashless, he’ll need to make some proactive adjustments, starting with his tax withholding and pension plan contributions. And because his profit sharing contribution is tied to his compensation, we also adjust his wages and make his salary retrospectively to the level before the pandemic so that he can get the maximum benefit.
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Many small business owners across the country are facing the same scenario. If you’ve taken similar steps this spring, there are some actions you need to take by the end of the year.
First, increase your compensation, tax deduction and pension plan contributions. As with my client, start bringing your wages and tax withholding back to pre-pandemic levels. And work on evaluating your retirement savings.
When your business has recovered, there will still be time to contribute before the end of the year. For 2020, the maximum deferral contribution for 401 (k) Plan Salary is $ 19,500, or $ 26,000 for those aged 50 and over.
In my client’s case, he’ll have to contribute an additional $ 3,250 by the end of the year to make up for the months he’s stopped his deferrals. We just took his remaining six pay periods and split it into $ 3,250 to catch up with him.
If you’re making additional employer contributions, review the amounts you’ve contributed to your Safe Harbor, Profit Sharing, and Cash Balance since the start of the year against your original 2020 funding strategy. While Qualifying Employer Contributions won’t be due until 2021, I recommend now act so as not to fall further behind. If not, you could run into a cash flow crisis in early 2021 when both taxes and retirement contributions are due.
It’s also time to get back on the market. Many small business owners held on to much of their money and stopped investing their “after-tax” income that spring and summer because they feared that every dollar would be needed to keep their businesses going. Unfortunately, equity markets rebounded quickly and faltered late in the spring – and these investors missed out on significant gains.
Now is the time to reevaluate your liquidity needs. Start by setting aside a reasonable amount of money or opening a line of home equity. These measures provide you with a safety net without jeopardizing the long-term benefits of compound returns from future investments.
Once you are comfortable with the amount, I recommend resuming the after-tax savings with a dollar cost averaging strategy. This will reduce the excess cash by making regular purchases over time and reducing the impact of daily market volatility.
Make some wise donations to charity. Despite the difficulty of running a business, many owners tried to donate money to nonprofits in their communities to help the less fortunate weather of the Covid-19 storm. One way to achieve this goal is to give away valued stocks. Instead of selling the stock and capturing capital gains, a security may be donated to deduct fair value including profits.
For example, one of my clients wanted to support a local community organization that provides rental and utility assistance to those in need. He had an oversized position in a well-functioning stock that he wanted to reduce. Instead of giving money to the nonprofit, he donated the stock and was able to reduce his exposure while saving on capital gains.
This strategy achieved several goals: the client supported a local non-profit organization in times of crisis, saved future capital gains and was able to take and reinvest the money he would otherwise have given away to add to his portfolio by buying a new security in his place diversify.
As we continue to wait for a Covid-19 vaccine, millions of small business owners know that this winter will bring some challenges. By keeping a close eye on income and cash flow on a daily basis, they can get on with business while funding their tax obligations and retirement plans. Now is the time to implement these plans.