Business tax planning and compliance is just one of Meaden & Moore’s areas of expertise. We specialize in tax planning and compliance for privately-held businesses, business succession planning, retirement planning, and individual tax planning. It’s no surprise that we get many questions about optimizing tax liability. Below, we’re discussing several tax-reducing tips that businesses can use to keep more of their hard-earned profits.
Which tax strategies should every business owner know?
As a business owner, the tax planning you do up front can pay huge dividends in the future. Here are five tax strategies every business owner should consider.
- Entity Selection - Of the structures that a business owner can operate in – a sole proprietorship, regular C corporation, a subchapter S corporation, limited liability company (LLC), a general partnership, or a limited partnership – all except a C corporation offer business owners one level of taxation. The earnings of the business are taxed only once and then the owner is permitted to distribute those earnings to themself without further taxation.
- Tax Year - There is flexibility under the tax code to choose the tax year that best fits your business. For example, with a C corporation, any calendar month end is permissible, so picking a month that coincides with a low point in your business cycle allows certain income and tax deferral benefits. The other types of entities have less flexibility and will generally permit a tax year ending with any month from September through December. There are some tax deferral savings to be had, but they will typically be much less than with a C corporation.
- Tax Accounting Methods - Any time you can push off paying taxes into the future, your business will have a greater retention of cash to fuel its growth. There are many ways to defer income or accelerate deductions, including whether to use an overall cash or accrual method of accounting for tax purposes. Your business may even keep regular books and records on an accrual method but elect to use the cash method for filing tax returns.
- Tax Reporting and Filing Deadlines - Stay on top of tax filings, reporting transactions, and making tax payments. As a business owner, you can be personally responsible to pay if the business fails to do so.
- Capital Gains Income - If your business operates as a “flow-through” entity, there are tax savings of 17-20% when income is characterized as long-term capital gains instead of ordinary income. These savings can be significant for business owners.
Which tax strategies are recommended for privately held businesses?
Good tax strategies for privately held businesses can help to maximize your company's profits and personal income while reducing your overall income tax bill. Here are four strategies privately held business owners can use.
- Leasing Instead of Buying - If you lease a car for business use, payments are almost fully tax deductible. When you buy a car for business use, on the other hand, you can write off the out-of-pocket expenses, but your annual depreciation is limited based on your purchased cost. Leasing will likely produce the best after-tax approach.
- Hire Your Children - Hiring your children as employees reduces your tax liability while providing them with a view of how the family business works. They will be able to offset their earned income to the extent of their standard deduction without paying tax and are exempt from federal unemployment taxes. If your business is not structured as a corporation, the compensation paid to them will be exempt from the employee and employer shares of FICA as well.
- Mix Business and Personal Travel - If you’re on a trip primarily related to business, you can deduct your travel costs. Incorporate personal travel into a primarily business trip to take advantage of this tax strategy. For example, many people set up meetings late one week and early into the next so they can enjoy the weekend to themselves.
- Entity Choice - You may be able to reduce your tax liability on the income you earn depending on your business entity choice. When you are a pass-through entity such as an LLC or general partnership, your net income is subject to income and self-employment tax. As an S corporation, your net income is subject to income tax, but only your wages are subject to FICA and Medicare taxes.
What tax strategy is recommended for taking advantage of foreign sales?
There is a tax strategy for taking advantage of foreign sales that can result in substantial tax savings for business owners: an IC-DISC.
What is an IC-DISC Company?
An IC-DISC company is a tax entity that can be set up to receive a commission on foreign sales from the “producer” company (your existing company). The “producer” company receives a tax deduction for the foreign sales commission at regular ordinary rates (maximum rate 35% for C corporations and 39.6% for flow-through entities). The IC-DISC company is a tax-free entity that pays no tax on the commission income received from the “producer” company until it is distributed to the owners. When the income is distributed, it is taxed at qualified dividend rates which are lower than ordinary tax rates (15-23.8% depending on income levels). This savings is a “play” between the regular rates (maximum of 35-39.6%) and the qualified dividend rates (23.8-15%) that results in permanent tax savings that can be quite substantial (11.2-20%). For example, the tax savings on a $100,000 foreign sales commission could save $11,200 to $20,000.
Calculating Foreign Sales Commissions
Generally, you are allowed to calculate the foreign sales commission based on the largest of 4% of qualified foreign revenue plus 10% of export promotion expenses or 50% of net income on foreign sales plus 10% of export promotion expenses. Within the 50% of taxable income method, there are marginal costing rules that can be utilized. The calculation can be done on a transaction-by-transaction method (T by T) that “slices and dices” sale transactions out by various categories such as product lines, product categories, etc. It looks at each foreign sales transaction individually and calculates the commission based on the greater of the various methods.
If you are a company that has foreign sales and meets the requirements for an IC-DISC, you should investigate whether an IC-DISC would be beneficial to your organization. If you have an IC-DISC but are only calculating the foreign sales commission on an overall basis, you should investigate whether utilizing the transaction-by-transaction marginal costing method would be cost-effective and result in additional income tax savings.
Which tax planning strategies should you consider at the end of each calendar year?
- Timing of Income and Expenses - Many cash-based businesses take advantage of this year-end tax strategy. The idea is to defer income from the current year into the following year to lower the current year’s taxable income while accelerating expenses from the next year into the current year to boost deductions.
One way to defer income is to hold off on sending out December invoices until late in the month so you don’t receive payment until after the end of the year. To accelerate deductions, record deductible expenses you’ll incur early next year and pay them before December 31. Examples include insurance, utilities, salaries, commissions, property taxes, advertising, and interest expense.
- Purchase New Business Equipment - Purchase and place new business equipment in service before the end of the year. This allows you to claim an immediate deduction for the current tax year (up to a certain limit) when you buy and place in service depreciable assets. Depreciable assets include manufacturing and industrial equipment, software, computers, telecommunications equipment, and office furniture.
- Retirement Account Contributions - Make year-end contributions to your employees’ 401(k) and profit-sharing accounts, which are deductible to your business up to the contribution limits. If cash flow is tight at the end of the year, take advantage of the fact that you have until your tax-filing deadline to make the contributions.
- Write Off Bad Debt - If there are outstanding accounts receivable that you don’t think you have a realistic chance of collecting, write them off as a bad debt expense before the end of the year. You can still keep trying to collect the money – if you do, it will count as income during the year in which it is collected.
- Consider Targeted Tax Breaks - There are some business tax breaks that are targeted to certain types of businesses and industries. Find out if any apply to your business. An example is the research & development tax credit, which gives businesses that design, develop, or improve products, processes, techniques, formulas, inventions, or software a tax credit.
Every business has a unique tax situation, so it’s important to consult with your tax advisor about whether these strategies make sense for your company. If you’re looking for tax planning and compliance services, consider Meaden & Moore. We are the total tax specialists that prioritize protecting your best interests. We’re committed to complying with federal and state regulations while optimizing your tax liability. Contact us today.