Tax planning is the process of looking at a person or business entity’s tax situation and business structure to legally reduce tax liability and improve efficiency.
Strategic tax planning is essential for business and complex personal taxes. Unfortunately, many companies only consider their taxes once a year during tax season.
If you’re running a small business, your skill set may skew toward operations and sales. Tax issues are not prioritized. It’s understandable. However, a lack of planning will, without fail, lead to overpaying on taxes and missing lucrative credits and deductions.
Tax Planning is a Must For Growth-Stage Businesses
Over my long career as a CPA and tax consultant, I’ve seen consistent value from strategic tax planning, both in terms of reduced tax liability and improved cash flow. That’s why tax planning is crucial for small and growth-stage businesses.
If you’re here, complexity has or will catch up to you. Good news—your business can start creating a tax plan right now.
In this article, I’ll explain the ins and outs of tax planning, including:
- The difference between tax preparation and tax planning
- Why it’s so important for small businesses
- Core components and strategies
Feel free to read on. But, if you’d like to get started with tax planning specific to your business, schedule an appointment, and we’ll talk.
Tax Preparation vs. Tax Planning: What’s the Difference?
Many people confuse tax planning with tax preparation. While CPAs tend to offer both services, the two are very different.
Tax Preparation is a Once-A-Year Service
If you hire a CPA to help you file your taxes in the spring, you’re paying them to do tax preparation. Tax preparation is the process by which a person or business files their tax return, with an emphasis on ensuring that it meets state and federal tax laws.
Limited Scope, Limited Time.
As part of tax preparation, a CPA will sometimes provide general advice—for example, answering questions that fall outside the scope of that year’s return. But while tax preparation is a valuable service, it’s limited in scope. Tax preparation alone will not benefit your company in the same way that tax planning does.
Tax Planning is a Year-Round Process
Effective tax planning means managing a business’s financial situation throughout the year.
Broad Scope, Plenty of Time
Unlike tax preparation, tax planning is geared towards achieving long-term goals and orienting toward success, whether that means sustaining growth or increasing efficiency. While tax preparation is a (small) element of tax planning, the latter involves consistent, year-round work and a much larger scope.
Why Tax Planning is Valuable
For businesses looking to generate revenue, diligent planning is a must. There are two primary reasons why tax planning is so important:
Tax Planning Lowers Your Tax Liability
First, tax planning decreases what you pay in taxes. There are several methods businesses can utilize tax planning to lower liability, and we’ll get into them in more detail below.
Key elements of strategic tax planning include:
- Tax Efficiency
- Tax Deductions
- Tax Credits
- Entity Structuring
- Monitoring Legislation & Regulation
It Orients Your Business Toward Future Growth
With strategic tax planning, a business can improve cash flow, thereby increasing the opportunity for growth. Revenue fuels growth; so do adaptive tax strategies.
The Components of Tax Planning
“Tax efficiency” is a broad term that results from effective planning. What we’re talking about, though, is the way a business can allocate spending to reduce 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 that you either accelerate your income or defer your earnings, depending on if you expect to move into a higher or lower tax bracket, respectively.
Additionally, a business can reduce taxable income through reinvestment in:
Tax Credits & Deductions
Effective tax planning requires a professional knowledge of and ongoing investigation into tax credits and deductions. 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.
Strategic tax planning for businesses means adjusting reporting and classifications to maximize the value of tax credits and deductions. A CPA in tax planning will know the credits and deductions relevant to your industry and unique tax problems.
Always look for active, motivated CPAs. We’re the ones who know the past, present, and (likely) future credits and deductions. Take advantage of every available tax credit and deduction available under the law, and your investment in tax planning will pay for itself.
LLC or S-Corp? Restructuring is tax planning 101. Your legal entity structure can change your tax liability and potential profitability, either for the better or worse. It may make sense to change to an LLC, S Corporation, or Partnership.
The truth is, most small and growing businesses do not structure 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. (Keep in mind that tax deadlines vary depending on your business structure.)
Monitoring Legislation & Regulation
Tax law and regulation change between tax seasons. Tax planning helps businesses track changes and adjust their strategy appropriately.
Changing Tax Codes: A Risk & Opportunity
Available deductions change every year, fueled by new legislation and regulatory changes. 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 both minimizes potential disruption and looks at every new line of tax code as an opportunity to reduce tax liability.
The last few years have underscored the importance of rigorous legislation monitoring. For example, the COVID-19 pandemic resulted in new laws and regulations. Small businesses largely benefited. Businesses with access to tax planning benefited more.
Real tax savings takes year-round commitment and someone who can take direct ownership of tax planning.
With taxes comes compliance. For small business owners, finding ways to reduce tax liability and stay compliant is challenging. 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 make good tax planners. For CPAs, performance isn’t just a matter of reputation. When CPAs approve a return or document, they stake their license and career on its accuracy. Additionally, with a CPA, you know that your tax returns will be submitted on time and avoid tax penalties.
Tax planning is about more than the current 12-month cycle. Businesses should carefully consider where they would like to be in five, 10, and 20 years and plan accordingly. The value of purchases, for example, can be spread out over many years to minimize liability.
Tax Planning Strategies for Business Owners
While every sector has niche laws that you can take advantage of to minimize tax liability, several general guidelines apply across the spectrum of small businesses.
Defer Earnings or Accelerate Income
If you expect your business to grow next year, it’s a good idea to accelerate your income, claiming revenue early so that you can claim a lower tax rate. But if next year’s forecast looks grim, you can defer earnings to make this tax season easier.
Start a Retirement Plan
If your company has seen a profit, you can put excess cash into a retirement plan for you and your employees. By setting up a 401k (or another retirement plan if you prefer), you can create a deductible business expense.
Another benefit of a robust retirement plan—you’ll become a more attractive option for future candidates.
Invest in Healthcare
You will likely need to consult with a professional to maximize your savings here, but there are huge opportunities to save through various health insurance strategies. For example, small business owners can deduct 100% of their health insurance. That’s true whether they cover their employees or not—though there are additional tax planning strategies available to businesses that do insure their employees.
The small business tax credit is available to businesses that enroll in the Small Business Health Options Program (SHOP) plan. To qualify, businesses must have fewer than 25 employees and meet a handful of other criteria.
Pay Attention to Taxes Year-Round
Set aside taxes throughout the year so you won’t have to pay penalties. Too often, businesses wait until the last minute and then realize their cash-in-hand isn’t sufficient to pay their business taxes. Shortsighted financial planning creates problems and leaves missed opportunities for savings.
Jeremy A. Johnson, CPA Offers Strategic Tax Planning Services
If your business is seeking strategic tax planning, contact Jeremy A. Johnson, CPA P.C. We are an experienced, responsive CPA firm that will work aggressively to reduce your tax liability.