The Rose Report: Tax Planning: Is it too Late?
With year-end right around the corner, business owners are reminded that they are faced with a more complex tax situation than most Americans. Business owners must navigate the complexities of corporate and personal income tax law in order to minimize the impact taxes have on their business. Lack of proper tax planning can result in excessive tax bills, penalties and interest, and inadequate cash flow to retire tax liabilities as they come due.
To properly develop and execute a comprehensive tax plan, business owners and their advisors must have a clear understanding of the company’s:
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Current financial statements
Current financial statements•Projected financial results
Projected financial results•Corporate structure
Corporate structure•Corporate and personal tax laws
Corporate and personal tax laws•Accounting system
Accounting system•Business processes
Business processes•Business owner’s personal tax situation
Business owner’s personal tax situationTax planning requires the involvement of the business owner, their tax accountant, and their internal accounting staff.
What are the key components of corporate structure to consider when creating a tax plan?
•Entity type
Entity type•Is taxable income subject to corporate income tax or does it pass-through to shareholders?
Is taxable income subject to corporate income tax or does it pass-through to shareholders?•When is the tax year-end for the company?
When is the tax year-end for the company?•Is taxable income calculated on a cash basis or accrual basis?
Is taxable income calculated on a cash basis or accrual basis?Today, most companies large enough to hire employees are formed as corporations or limited liability companies (LLCs). Corporations, also known as C-corps, must pay corporate income taxes unless they make an S-Corp election. If an S-Corp election has been made, the entity is not subject to corporate income taxes, but instead will have its taxable income “pass-through” to the shareholders.
Limited liability companies that are owned by an individual are considered disregarded entities for tax purposes. These entities are taxed on schedule C of the business owner’s personal tax return. If the LLC has more than one member, it is taxed as a partnership unless the entity elects to be taxed as a C-Corp. If this election is made, the entity can then elect to be taxed as an S-Corp as well. In all cases other than C-Corp, the taxable income of the LLC will “pass-through” to the business owners.
While most companies with taxable income “passing-through” to shareholders have their fiscal tax year-end on December 31, there are many entities, primarily C-Corps, that elect to be taxed at various other times of the year. Most frequently these year ends take place at the end of a quarter like March 31, June 30, or September 30. Having a tax year-end other than the calendar year-end does open up unique tax planning opportunities.
When an entity is formed, it can elect to be taxed on a cash basis. This allows the company to pay taxes on income as it is collected from its customers and take tax deductions for expenses as they are paid to employees and vendors. Of course, there are tax code exceptions to this rule and not all companies are eligible to be taxed on a cash basis. Accrual based taxpayers pay tax on their accrual based income which can result in the entity being responsible for tax on accounts receivable that have not been collected. Without proper financing, this can cause cash flow issues.
When should we build our tax plan?
Tax planning should begin before you form your business. This is when business owners make decisions that can have a significant impact on the taxes paid by the entity. The wrong decision in the beginning can result in double taxation upon the sale of the entity or having more of the sale price of your company being taxed as ordinary income (up to 35%) instead of capital gains (15%). Once the company’s structure is in place, businesses will need to build their annual tax plan as early in the year as possible. It is preferable to build a multiple year plan when possible. Tax planning should be performed no later than October or November and revisited in December to verify the projections are correct and that no material changes have been made. If business owners procrastinate, they risk not having enough time to get through all of the tax planning steps effectively.
How can I create my tax plan today?
The primary objective of a tax plan is to defer taxable income into future tax periods. For cash basis taxpayers, this can be accomplished by accelerating expenses into the current tax year or deferring income into future tax periods. Keep in mind that there are times when this objective changes (i.e. based on alternative minimum taxes or when tax rates are expected to go up in the future).
Tax Planning Steps to Consider
•Project your company’s financial performance for the current tax year.
Project your company’s financial performance for the current tax year.•Start with your financial statements through September or October and project the results for the remaining months.
Start with your financial statements through September or October and project the results for the remaining months.•If you maintain your books on an accrual basis, and are taxed on a cash basis, you will need to adjust the financials to the cash basis.
If you maintain your books on an accrual basis, and are taxed on a cash basis, you will need to adjust the financials to the cash basis.•For example, accounts payable are subtracted from expenses and accounts receivable are subtracted from income.
For example, accounts payable are subtracted from expenses and accounts receivable are subtracted from income.•The financial results are then analyzed to determine what steps can be taken before year-end to minimize taxes. Examples include:
The financial results are then analyzed to determine what steps can be taken before year-end to minimize taxes. Examples include:•Accelerating cash disbursements
Accelerating cash disbursements •Attempting to slow down cash receipts
Attempting to slow down cash receipts•Accelerating fixed asset purchases
Accelerating fixed asset purchases•Evaluating when firm’s bonus strategy is tax efficient
Evaluating when firm’s bonus strategy is tax efficient•Project your compensation for the tax year (How much are your W-2 wages or guaranteed member payments?).
Project your compensation for the tax year (How much are your W-2 wages or guaranteed member payments?).•Determine whether taxable income of the company is reasonable when compared to owner compensation.
Determine whether taxable income of the company is reasonable when compared to owner compensation. •Evaluate the company’s current retirement plan.
Evaluate the company’s current retirement plan.•This is a critical component of any tax plan. There are many types of retirement plans to choose from, so a careful analysis of the options is required.
This is a critical component of any tax plan. There are many types of retirement plans to choose from, so a careful analysis of the options is required.•Ensure that estimated tax payments are adequate to avoid penalties and interest.
Ensure that estimated tax payments are adequate to avoid penalties and interest.•Evaluate new tax laws and their relevance.
Evaluate new tax laws and their relevance.To be successful, business owners are responsible for building the companies revenue streams and managing the company’s expenses. Corporate income taxes (or personal income taxes related to the business) are one of the largest expense categories a business will have each year. Examples of other major expense categories are payroll, rent, and direct cost of sales. Inadequate tax planning may result in over paying taxes, penalties and interest, or paying taxes too early. All of these situations can have an adverse affect on cash flow and ultimately the financial health of your company. Make sure you consult your tax advisor annually or when there are material changes in the business to ensure your tax plan is up to date.
Source: Ted Rose is the President of Rose Financial Services, based in Rockville, MD. If you have any comments or questions, he can be reached at info@rosefinancial.com or 301.527.1130.
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