Tax Planning for Small Business OwnersPosted on April 15th, 2017
Marianne Kern, CPA
Kern & Associates CPA, P.A.
Tax planning is the process of looking at various tax options to determine when, whether, and how to conduct business transactions to reduce or eliminate tax liability.
Many small business owners ignore tax planning. They don’t even think about their taxes until it’s time to meet with their accountants, but tax planning is an ongoing process and good tax advice is a valuable commodity. It is to your benefit to review your income and expenses monthly and meet with your CPA or tax advisor quarterly to analyze how you can take full advantage of the provisions, credits and deductions that are legally available to you.
Although tax avoidance planning is legal, tax evasion – the reduction of tax through deceit, subterfuge, or concealment – is not. Frequently what sets tax evasion apart from tax avoidance is the IRS’s finding that there was fraudulent intent on the part of the business owner. The following are four of the areas the IRS examiners commonly focus on as pointing to possible fraud:
- Failure to report substantial amounts of income such as a shareholder’s failure to report dividends or a store owner’s failure to report a portion of the daily business receipts.
- Claims for fictitious or improper deductions on a return such as a sales representative’s substantial overstatement of travel expenses or a taxpayer’s claim of a large deduction for charitable contributions when no verification exists.
- Accounting irregularities such as a business’s failure to keep adequate records or a discrepancy between amounts reported on a corporation’s return and amounts reported on its financial statements.
- Improper allocation of income to a related taxpayer who is in a lower tax bracket such as where a corporation makes distributions to the controlling shareholder’s children.
(See also, “Are You at Risk of an IRS Audit.”)
Tax Planning Strategies
In order to plan effectively, you’ll need to estimate your personal and business income for the next few years. This is necessary because many tax planning strategies will save tax dollars at one income level, but will create a larger tax bill at other income levels. You will want to avoid having the “right” tax plan made “wrong” by erroneous income projections. Once you know what your approximate income will be, you can take the next step: estimating your tax bracket.
The effort to come up with crystal-ball estimates may be difficult and by its very nature will be inexact. On the other hand, you should already be projecting your sales revenues, income, and cash flow for general business planning purposes. The better your estimates are, the better the odds that your tax planning efforts will succeed. (See also, “The Most Common Budgeting Errors.”)
Consider Filing Your Business Return as an S-Corporation
In my previous article, “Choosing the Right Business Entity,” I pointed out some major tax advantages to filing your taxes as an S-Corporation, primarily: 1.) Net income is taxed only once at the lower personal tax rate, vs. on both the net income and dividends paid to the owner in the case of a C-Corporation, and 2.) Self-Employment Tax is calculated only on the amount of Officer Salaries (W-2 wages) declared, vs. on the entire net income in the case of sole proprietorships and partnerships. Thus, the S-Corporation tax structure is very popular with small businesses. However, extreme caution must be exercised as the IRS closely monitors these types of business returns for owner abuse, particularly under-declaring Officer Salaries to reduce self-employment taxes.
Choosing the Most Appropriate Method of Accounting for Tax Purposes
For businesses that sell on credit terms and have accounts receivable, and/or a large amount of inventory, using the “Cash Basis” of accounting can provide significant tax savings. This is due to the fact that “accrual” revenues that have not yet been collected are deducted from income for tax purposes, and inventory purchased can be immediately expensed. But the other side of this is if your business also has a large amount of accounts payable, those are also subtracted from Cost of Goods Sold, thus reducing your deductible expenses. Therefore, an analysis should be conducted to determine which way your company is better off reporting its taxes, i.e. between the Accrual and Cash Basis of accounting. (See also, “Profit vs. Taxable Income,” and “The Relationship Between Turnover Ratios and Cash Flow.”)
Maximizing Business Entertainment Expenses
Entertainment expenses are legitimate deductions that can lower your tax bill and save you money, provided you follow certain guidelines.
In order to qualify as a deduction, business must be discussed before, during, or after the meal and the surroundings must be conducive to a business discussion. For instance, a small, quiet restaurant would be an ideal location for a business dinner. A nightclub would not. Be careful of locations that include ongoing floor shows or other distracting events that inhibit business discussions. Prime distractions are theater locations, ski trips, golf courses, sports events, and hunting trips.
The IRS allows up to a 50 percent deduction on entertainment expenses, but you must keep good records and the business meal must be arranged with the purpose of conducting specific business. Bon appetite!
Important Business Automobile Deductions
If you use your car for business such as visiting clients or going to business meetings away from your regular workplace you may be able to take certain deductions for the cost of operating and maintaining your vehicle. You can deduct car expenses by taking either the standard mileage rate or using actual expenses. In 2017, the mileage reimbursement rate is 53.5 cents per business mile (54 cents per mile in 2016).
If you own two cars, another way to increase deductions is to include both cars in your deductions. This works because business miles driven is determined by business use. To figure business use, divide the business miles driven by the total miles driven. This strategy can result in significant deductions.
Whichever method you decide to use to take the deduction, always be sure to keep accurate records such as a mileage log and receipts. (See also, “Deducting Business-Related Car Expenses.”)
Increase Your Bottom Line When You Work At Home
The home office deduction is quite possibly one of the most difficult deductions ever to come around the block. Yet, there are so many tax advantages it becomes worth the navigational trouble. Here are a few tips for home office deductions that can make tax season significantly less traumatic for those of you with a home office.
Try prominently displaying your home business phone number and address on business cards, have business guests sign a guest log book when they visit your office, deduct long-distance phone charges, keep a time and work activity log, retain receipts and paid invoices. Keeping these receipts makes it so much easier to determine percentages of deductions later on in the year.
You can also deduct a percentage of your rent or mortgage interest (unless you itemize and claim it elsewhere on your return), utilities, repairs and maintenance, and other housing expenses. The percentage used to calculate these deductions is the square footage of your home office as a percentage of the total square feet of your home (living area).
Section 179 expensing for tax year 2016 allows you to immediately deduct, rather than depreciate over time, up to $500,000, with a cap of $2,000,000 worth of qualified business property that you purchase during the year. The key word is “purchase.” Equipment can be new or used and includes certain software. All home office depreciable equipment meets the qualification. Some deductions can be taken whether or not you qualify for the home office deduction itself.
As always, seek help from a tax professional to discuss specific tax planning strategies for your business.