Tax planning has to do with what’s deductible and what’s not. It has to do with a strategic approach to saving money and keeping wealth. It is the present and future of your business, life, and children’s lives. Tax planning pays for itself. But I need to explain more because every good business owner deserves good answers.
Here’s what I’ll cover:
- What tax planning is and what you might not know it does
- Whether you need tax planning
- The difference between tax planning and tax preparation
- The goal of tax planning
- The strategies that make up a strong tax plan
Let’s start with the big picture first and then get more specific.
Tax planning is a big-picture concept that comes down to keeping and growing the money you’ve earned.
Here’s the technical definition: Tax planning is the process of looking at your personal and business’s tax situation to reduce tax liability starting now and extending into retirement.
Strategic tax planning is essential for business and complex personal taxes. A lack of planning will, without fail, lead to overpaying on taxes. Small businesses must secure the services of a competent Certified Public Accountant (CPA) because there’s simply not enough bandwidth in most organizations to prioritize tax and finance.
Tax Planning is forecasting.
Forecasting is fundamentally about seeing ahead so you know what to do now. Call it “understanding the art of the possible.” I say art because art is difficult and takes a lot of effort and time to do well. Those who do it well see rewards.
What is the reward? Let’s put aside savings for a moment. How about knowing what kind of taxes you’ll be facing? Just knowing what is coming is half the battle. You’ll know how to conduct your operations and how much to spend. That’s reward number one.
Your competitors are planning for the future while you’re already there—two or three years ahead. That’s reward number two.
Tax planning lowers the overall cost of doing business.
Do you want to lower the overall cost of doing business? Of course. l know that sounds like a task reserved for owners and executives, but in strategic tax planning, your CPA is part of your leadership team. The only difference is you’re not paying a salary.
Tax planning comes with informed cost-cutting suggestions and ways to fund capital or manage debt. Saving money on taxes, too, lowers the overall cost of doing business.
Personal tax planning is just as important as business tax planning.
Let’s talk personal returns. Several elements of an individual tax return, like the standard deduction and our annual tax rates, are based on a full year of income. That means forecasting twelve months into the next tax year. It starts at the top with wages, then interest, dividends, or disbursements.
Bottom line: What you want to be doing on the business side, you want to be doing on the personal side, and tax planning drives savings from both directions.
Do you need tax planning?
Here’s an easy test: Have you had any of the thoughts listed below?
“I think I could be paying less taxes, and no one’s taking on a leadership role to address the issue.”
If you want to take full advantage of tax-saving strategies, someone in the organization should be thinking about taxes year-round. Someone should be looking at the tax implications of operations, sales, and labor. No leadership on tax means you need tax planning.
“The business is growing, revenue is increasing, and my financials are getting complex.“
Expansion comes with major tax implications. The activities of independent actors in human resources, sales, and even leadership should come under scrutiny from a tax perspective.
A great tax plan makes for a great growth plan.
“I’m unsure if my money or assets will be enough for retirement and my children.“
That’s why retirement planning and tax planning are inseparable. You need tax planning to sustain wealth and protect your assets into retirement.
Tax planning is not tax preparation.
Many people confuse tax planning with tax preparation. While CPAs tend to offer both services, the two are very different.
Tax preparation is an end-of-year exercise in paper shuffling.
If you hire a CPA, an in-house tax professional, or use software to file your taxes in the spring, you’re paying for tax preparation. Tax preparation is the process of gathering together, organizing, and submitting tax documents. Tax preparation is a matter of compliance.
Now, should you work with a CPA on tax preparation? Yes. Compliance is serious, and mistakes are made. Remember that CPAs can represent you in the event of an audit. A typical tax professional cannot and is not capable of doing the same.
Tax planning never stops because great tax plans yield better results over time.
Tax planning is a year-round process. Well, that’s an understatement. Tax planning is one of the key drivers of growth and profitability throughout each year—and the rest of your life.
Tax planning is a plan. Plans take decision-makers out of a reactive state of mind and into a proactive one. I’ve seen the effects myself over twenty years. It can be transformative. I’ve always looked at tax preparation as a necessary ritual. The cause for celebration was the year of strong decision-making and measurable progress—tax planning.
Tax planning reduces more in taxes than it costs to implement.
For businesses looking to generate revenue, diligent planning is a must. There are two primary reasons why tax planning is so important.
First, tax planning decreases what you pay in taxes. There are several methods businesses can utilize to lower liability, and we’ll get into them in more detail below.
Second, a business can improve cash flow and the management of revenue, thereby increasing growth opportunities.
Tax planning is a collection of strategies that sustain and grow wealth for business owners.
“Tax efficiency” is a broad term that results from effective planning. What we’re talking about is how a business can allocate spending to reduce tax liability.
If you anticipate that your tax bracket will change next year—as frequently happens with growth-stage businesses—a CPA with tax planning experience may recommend accelerating your income or deferring your earnings, depending on whether you expect to move into a higher or lower tax bracket, respectively.
Here are five key objectives that reduce taxable income and protect the value of your assets now and in the future. For every objective, there’s a strategy. As I mentioned earlier, it all starts with bookkeeping. But let’s move ahead.
- Maximize deductions and credits.
- Choose a tax-efficient legal entity structure.
- Get excellent healthcare and insurance that saves money on taxes.
- Plan to manage and sustain wealth into retirement.
- Use a constellation of “loopholes” to protect assets from tax liability now and in the future.
First, we get serious about tax credits and deductions.
Here’s the rule: take advantage of every available tax credit and deduction available under the law, and your investment in tax planning will pay for itself. Effective tax planning requires a professional knowledge of tax credits and deductions and an ongoing investigation into their applicability to your business. Here’s the difference between the two:
- Tax credits directly reduce your tax liability.
- Tax deductions reduce the amount of your income that is subject to taxes.
So, the first, most conspicuous, and most exigent function of strategic tax planning is to maximize the value of tax credits and deductions. Why? It’s the simplest part of tax planning to execute, and the return is high within a short time.
Let’s start with common tax deductions that save you more when you plan.
Get the most out of common deductions and credits. It’s simple. Let’s get into some examples.
Deduct travel and meal costs down to the penny.
Entertaining clients is critical to maintaining strong business relationships, and fortunately, you can deduct 50% of the costs of food and beverage for qualifying business meals.
What is tax deductible under the business meal category is fairly generous. It includes buying dinner for employees who are working late, for example. Additionally, meals purchased for an office party are 100% deductible.
Take advantage of depreciation on assets from electronics to real estate.
Depreciation is a class of tax deductions that covers the total cost of a depreciable asset throughout its useful life. A depreciable asset is defined as a property that has value, generates cash flow, or is used to satisfy a debt. The useful life of an asset is determined by the tax code and enforced by the Internal Revenue Service (IRS).
When a business claims depreciation for a given asset, the business receives a tax deduction for every year of the asset’s useful life. This deduction compensates the business for costs associated with the gradual depreciation of the value or usefulness of the asset.
Pay yourself with money that’s tax deductible.
For example, small business owners can deduct 100% of their health insurance premiums. Let’s say it’s that time of the month for a disbursement. You know exactly how much you can disburse because you have a working tax plan. It’s your decision whether you want to write “healthcare reimbursement” or “disbursement” on the memo line. Of course, that cash is going to come out of your bank account, but it will escape being classified as a portion of your gross taxable income.
Additional tax planning strategies are available to businesses interested in attracting better employees with quality healthcare.
For example, the small business tax credit rewards businesses that enroll in the Small Business Health Options Program (SHOP) plan. Businesses must have fewer than 25 employees and meet several other criteria to qualify.
Tax planning is about keeping what you earn in retirement.
Retirement savings accounts are powerful tools that can reduce your current tax bill while helping you reach a comfortable retirement.
The retirement accounts available to you are:
- Traditional 401(k)
- Safe Harbor 401(k)
- Solo 401(k)
- SIMPLE IRA
- SEP IRA
- Traditional IRA
- Roth IRA
- Defined Benefit Plans
- 412e3 Plans
Contributing to a tax-advantaged account allows you to deduct contributions from your taxable income, which may push you into a lower tax bracket.
Plus, the funds in these accounts can grow as tax-deferred wealth until retirement, when you withdraw them.
Optimize your business structure for taxes.
LLC or S-Corp? Restructuring is tax planning 101. Your legal entity structure can change your tax liability and potential profitability for better or worse. I don’t handle the legal aspect, but I offer strong recommendations based on potential tax pitfalls or opportunities.
The truth is that most small and growing businesses do not structure their businesses with long-term tax savings in mind. Fortunately, thorough tax planning gives business owners a chance to step back and look at their company from a more informed financial perspective. (Remember that tax deadlines vary depending on your business structure.)
Monitor new regulations and look for opportunities.
Tax law and regulation change between tax seasons, and available deductions change yearly, fueled by new legislation. Tax planning helps your business track changes and adjust its strategy appropriately.
Even some local codes are difficult to track. IRS regulations, meanwhile, are closer to labyrinthine than complicated.
Because minor alterations to tax codes can radically change your situation, tax planning minimizes potential disruption and looks at every new line of tax code as an opportunity to reduce tax liability.
A volatile business environment is a risk and an opportunity.
The last few years have underscored the importance of keeping our ears and eyes open to changes. We all know what hit this country four or five years ago and what it did to small businesses. Many failed. Some capitalized. Either way, out of the pandemic came new laws and regulations. Small businesses got checks. Small businesses with access to tax planning got much, much larger checks.
Am I excited about government meddling? Not particularly. But when the government picks winners and losers with financial programs, the businesses with strong financial and tax sense win.
Stay tax compliant.
Finding ways to reduce tax liability and stay compliant is challenging for small business owners. Decision-makers do not have time to track obscure regulations.
The solution? Offload the responsibility to a CPA specializing in tax compliance.
Here’s why CPAs are the best way to stay compliant: For CPAs, compliance isn’t just a matter of day-to-day work. When CPAs approve a return or document, they stake their license and career on its accuracy.
Tax planning protects real estate holdings and investments from drive-by taxation.
1. Cost Segregation
Cost segregation is a method of looking at building costs to identify and quantify business property eligible for accelerated depreciation for tax reporting purposes. It’s essentially a tax savings and cash flow planning tool for businesses involved in commercial buildings and other real estate properties.
2. Passive Real Estate Losses
By default, all rental real estate activities are considered passive activities for tax purposes; this poses a problem because losses from passive activities—passive activity losses (PALs)—can only offset income from other passive sources or up to $3K of income from nonpassive or ordinary sources.
3. 1031 Exchanges
Many property owners assume that selling property comes with taxes, no question. It’s not an unreasonable assumption, but it is incorrect.
In fact, I’ve saved clients who own or deal in real estate significant sums of money with simple 1031 exchanges. Business owners can sell a piece of property without paying taxes so long as they purchase another property with their earnings. It’s a way to see appreciation and stay flexible with your real estate investment strategy, free from taxation. Also, owners can defer any capital gains taxes associated with that sale.
Hire and invest with confidence.
1. Deferred Compensation
Starting a deferred compensation plan is good for business because employees benefit, and employees like that. The plans defer a portion of an employee’s compensation by a year, which offers employees lower immediate tax liability.
2. Tax Loss Harvesting
Tax loss harvesting offers investors a chance to replace losing investments with investments of a similar value and then offset realized investment gains with those losses. The result is that less of your money goes to taxes, and more stays in the market working for you.
It’s a strategy that changes an investment loser into a tax winner. We’ve all been the former. Try the latter.
3. Installment Sales
When selling your property or business at a gain, one tax-saving strategy that business owners miss is using an installment sale. An installment sale is the sale of property or a business in which at least one payment is not made until after the tax year of the sale.
When you enter into an installment sale, you receive payments from the buyer over time, and that is when you report the gain, saving you money in taxes.
So, we went from the general to the specific. Let’s get back to the big picture.
Now is the time to start tax planning.
If your business is ready for strategic tax planning, schedule a discovery call today.
Talk soon,
Jeremy A. Johnson, CPA