It is not easy to open a business. Still, it is even more difficult to engage in it and develop it later since doing business involves many difficulties, including the need to navigate tax legislation. As you know, effective tax planning can help business owners minimize their tax obligations and maximize the use of their resources, which ultimately contributes to the growth and success of their business.
Now, we will look at the seven most important points of tax planning that every business owner should know.
Understanding the importance of tax planning
Since tax planning is an important component of financial management for any business, implementing strategic tax planning can ensure that business owners take full advantage of available deductions, credits, and other tax savings opportunities.
This not only reduces the amount of overpaid taxes but also frees up capital that can be invested in the business.
1. Choose the right structure for your business
It is important to understand that your business’s structure significantly impacts your tax obligations. Therefore, different legal entities, such as sole proprietors, partnerships, limited liability companies (LLCs), and corporations, have different tax consequences.
- Individual entrepreneurs and partnerships are the simplest business structures; they are relatively easy to create and use. However, these structures have limited possibilities in tax planning.
- Individual entrepreneurs. Business income is indicated on the owner’s personal tax return, and the owner is subject to self-employment tax. This simplicity benefits small businesses but may be limited as the business grows.
- Partnerships. Like individual entrepreneurs, partnerships indicate business income in their tax returns. Each partner pays tax on their share of income. Partnerships are required to file an annual information declaration but do not pay corporate income tax.
The involvement of business tax accountants can help to understand the complexities of these structures and optimize tax planning in them.
Limited Liability Companies (LLCs)
LLC companies, for example, provide flexibility in the tax regime and protection of owners’ liability. The thing is that an LLC can be taxed as an individual entrepreneur, partnership or corporation, depending on its structure and the preferences of the owners.
- LLC, consisting of one participant. It is important to know that for tax purposes, they are considered individual entrepreneurs, and the income from the business is indicated in the owner’s personal tax return.
- Companies consisting of several participants are generally taxed as partnerships, and income and deductions are reflected in the participants’ personal tax returns.
- Choosing to tax as a corporation. An LLC may also choose to be taxed as a Category S corporation or a Category C corporation, which may provide additional tax benefits.
Corporations
Corporations, of course, more often have a more complex structure, but nevertheless, they can also provide significant tax advantages, especially as the business grows.
- C corporations. For example, with double taxation, a corporation pays taxes on its income, and shareholders pay taxes on dividends. However, it is important to take into account that such a corporation can keep profits at a lower corporate tax rate and provide various benefits to employees and even the owner.
- S corporations. On the contrary, other corporations offer preferential taxation and avoid double taxation. Moreover, shareholders report income and losses on their personal tax returns, which can very likely lead to tax savings, which is very convenient. However, keep in mind that not everything is so simple, and S corporations must meet certain requirements of the US Internal Revenue Service, including restrictions on the number and types of shareholders.
So, if you own a business, you should carefully choose the right business structure to easily optimize your tax situation and ensure that you use the most favorable tax regimes available.
2. Take advantage of tax deductions and credits
One of the most effective ways to reduce your company’s tax liability is to take full advantage of available tax deductions and credits.
These can significantly lower your taxable income, thereby reducing the amount of tax you owe.
Common business deductions
Business deductions are expenses that are both ordinary and necessary for the operation of your business. Some common deductions include:
- Office expenses and supplies. Office supplies, computers, software, and other office-related expenses are deductible.
- Travel and entertainment. Business travel expenses, including airfare, lodging, and meals, are deductible. Entertainment expenses for clients and employees are also deductible, although recent tax law changes have limited some of these deductions.
- Home office deduction. If you use a portion of your home exclusively for business, you can deduct expenses related to that portion of your home, such as rent, mortgage interest, utilities, and insurance.
Valuable tax credits
Tax credits are even more beneficial than deductions because they reduce your tax liability dollar for dollar. Some valuable small business tax credits include:
- Research and development (R&D) tax credit. Available to businesses that incur expenses for research and development activities. This credit can be a significant savings for companies that invest in innovation.
- Work Opportunity Tax Credit (WOTC). Encourages businesses to hire individuals from targeted groups facing significant employment barriers. Employers can claim this credit for each qualified new hire.
- Small Business Health Care Tax Credit. This credit is provided to small businesses that offer health insurance to their employees. It is designed to help offset the cost of providing coverage.
3. Retirement plan implementation
Retirement plans benefit employees and provide significant tax advantages for business owners. Offering retirement plans can help attract and retain talented employees while reducing your taxable income.
Types of Retirement Plans
There are several types of retirement plans for small business owners to consider:
- Simplified Employee Pension (SEP) IRA. Allows business owners to contribute to their employees’ retirement accounts. Contributions are tax-deductible, and the plan is easy to set up and maintain.
- Savings Incentive Match Plan for Employees (SIMPLE) IRA. Suitable for small businesses with 100 or fewer employees. Both employer and employee contributions are tax-deferred.
- 401(k) plans. Offer higher contribution limits than SEP and SIMPLE IRAs and offer different investment options. Employers may choose to match employee contributions, which are tax deductible.
Tax benefits of retirement plans
There are several tax advantages to implementing a retirement plan:
- Employer contributions are tax-deductible. Company contributions to employee retirement accounts are deductible, reducing taxable income.
- Potential for tax credits. Small businesses may qualify for tax credits when establishing a new retirement plan, such as the Retirement Plans Startup Costs Tax Credit.
- Reduces business taxable income. By contributing to retirement plans, business owners can reduce their taxable income, resulting in tax savings.
Offering retirement plans can also provide long-term benefits by helping business owners save for their own retirement while supporting the financial futures of their employees.
4. Optimize depreciation
Depreciation allows businesses to recover the cost of certain assets over time, reducing taxable income. By optimizing depreciation, business owners can take advantage of tax deductions that align with the useful life of their assets.
Depreciation methods
There are several depreciation methods that companies can use, depending on the type of asset and the company’s financial strategy:
- Straight-line depreciation. This method spreads the cost of an asset evenly over its useful life. It’s easy to calculate and is widely used because of its consistency. For example, if a piece of equipment costs $10,000 and has a useful life of 10 years, the annual depreciation expense would be $1,000.
- Declining balance method. This accelerated depreciation method allows for larger depreciation charges in the early years of an asset’s life and smaller charges as the asset ages. This can benefit businesses that want to reduce taxable income more in the early years. For example, the double-declining balance method would double the straight-line depreciation rate.
- Unit of production method. This method bases depreciation on the actual use of the asset, making it useful for machinery or equipment whose wear and tear is based on output. Depreciation is calculated based on the total number of units the asset is expected to produce during its useful life.
Bonus depreciation
Bonus depreciation allows businesses to immediately deduct a significant percentage of the cost of eligible assets in the year they are placed in service rather than spreading the deduction over the asset’s useful life.
- 100% bonus depreciation. Currently, businesses can deduct 100% of the cost of eligible property purchased and placed in service. This includes most tangible personal property and certain qualified improvement property.
- Eligibility and phase-out. It’s important to note that bonus depreciation percentages are subject to change. For example, the Tax Cuts and Jobs Act set bonus depreciation at 100% through 2022, but it may phase out in subsequent years unless extended by new legislation.
5. Plan for estimated tax payments
Everyone knows that business owners make estimated tax payments quarterly, and that is why it is very important not to get lost and confused and to plan these payments correctly every time. Even if you don’t understand why you need it now, it will help you avoid penalties in the future.
Calculation of estimated taxes
It is not difficult to calculate the estimated taxes at all, and to do this, business owners only need to calculate their annual income, deductions, and credits. Here is a step-by-step approach of how it is done:
Calculate the taxable income
- You need to first predict your expected income for the year, including business profits, interest, dividends, and other sources, and then determine deductions and benefits;
- Immediately after that, do not delay and calculate your tax obligations so there will be no confusion later. Well, after that, you just need to use your estimated taxable income and deductions to calculate tax liabilities;
- And if you divide the estimated annual tax liability into four equal payments, then this will be your quarterly fee;
As you know, business owners must make quarterly estimated tax payments and proper planning of these payments will help to avoid penalties and effectively manage cash flows.
6. Thorough and accurate record keeping
It is very important to keep your financial records carefully and accurately because this is the basis for effective tax planning. Proper accounting is one of the most important things that allows you to justify your income, deductions, and credits if necessary and greatly simplifies the entire process of filing a tax return.
In order to do this, businesses only need to keep the following types of records:
- Income records;
- Expense records;
- Payroll records;
- Bank statements;
- Tax Returns and filings;
7. Consult with a tax professional
For some reason, many entrepreneurs underestimate working with a tax specialist, although it can obviously provide very valuable information and ensure compliance with tax legislation. And if you try harder and find a highly qualified tax specialist, then it will become easier to understand the complexities of the tax code and develop strategies to minimize your tax obligations.
The right choice of a specialist
When choosing a tax specialist, consider the following options:
- Certified Public Accountant (CPA). CPAs are licensed professionals who have received extensive training in accounting and taxation. That is why they can provide comprehensive tax planning and tax preparation services.
- Registered Agent (EA). Tax consultants are federally licensed tax practitioners who specialize in tax matters and can represent the interests of taxpayers in the Internal Revenue Service of the United States. They are generally more aware of a wide range of tax issues than others and, therefore, can provide more qualified advice.
- A tax lawyer. However, tax lawyers already specialize specifically in tax law and can provide legal advice and representation on complex tax issues such as audits, appeals, and litigation.
Advantages of professional consultation
- Individual tax planning strategies. The undoubted advantage of a tax specialist is that he can develop an individual tax strategy tailored to your specific business needs and financial goals.
- Modern knowledge of tax legislation. Another advantage of tax specialists is that they are always aware of changes in tax legislation and regulations, which of course ensures that your business complies with them and uses new opportunities to save taxes.
- Assistance in solving complex tax issues. Such a specialist can help you understand even the most complex tax issues, such as taxation in several states or international tax issues and business reorganization.
Working with a tax professional can provide valuable insight and ensure compliance with tax laws. A knowledgeable tax professional can help you navigate the complexities of the tax code and develop strategies to minimize your tax liability.
Choosing the right professional
When selecting a tax professional, consider the following options:
- Certified Public Accountant (CPA). CPAs are licensed professionals with extensive training in accounting and tax matters. They can provide comprehensive tax planning and preparation services.
- Enrolled Agent (EA). EAs are federally licensed tax practitioners who specialize in tax matters and can represent taxpayers before the IRS. They are knowledgeable about various tax issues and can provide expert advice.
- Tax attorney. Tax attorneys specialize in tax law and can provide legal advice and representation for complex tax issues, such as audits, appeals, and litigation.
Benefits of professional advice
- Customized tax planning strategies. A tax professional can develop personalized tax strategies tailored to your business needs and financial goals.
- Up-to-date knowledge of tax laws. Tax professionals stay abreast of tax laws and regulations changes, ensuring that your business remains compliant and takes advantage of new tax-saving opportunities.
- Help with complex tax issues. A tax professional can help you navigate complex tax issues, such as multi-state taxation, international tax issues, and business reorganizations.
Conclusion
Effective tax planning is crucial for the success of any business, so it is important to apply competent strategies and choose the right and profitable business structure. By consulting with a tax specialist, as a business owner, you can significantly minimize your tax obligations and maximize your financial resources so that you can focus solely on your business’s growth.
