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All businesses carry a tax liability. The size of the liability depends on their tax planning. Large corporations have accountants and lawyers whose focus is reducing tax liabilities. Small businesses don’t have that luxury. Business owners and executives are the ones worrying about taxes. Organizations that live somewhere in between may use an outside accounting firm to help with tax planning. A firm’s degree of involvement can vary from preparing taxes with little planning to a quarterly assessment of a company’s tax liability, to even acting as an interim CFO for companies in transition.

No matter their size, businesses can benefit from careful planning to reduce business tax liabilities. To be effective, planning should be performed throughout the year, not just before taxes are due.

What is Business Tax Liability?

Liabilities are financial obligations that a company owes another entity or individual. For example, every item sitting in accounts payable is a liability because it represents a bill to be paid. As the bills are paid, the liability decreases.

A tax liability refers to the amount a business owes the government. Most people connect tax liability with the federal government, but it includes taxes owed to state and local jurisdictions. Tax liability goes beyond income taxes. Companies are taxed on capital gains and payroll. Given the scope of a business’s tax liability, year-round tax planning is an essential component of a well-managed organization.

How to Reduce Business Tax Liability

Understanding how to lower a company’s tax liability is crucial to developing a tax planning strategy. For example, business deductions can reduce taxable income. However, organizations must know what is and isn’t a tax deduction or run the risk of a tax audit. The same caution applies to the following strategies for reducing a business’s tax liability.

Know Your Deductions

According to the U.S. Internal Revenue Service (IRS), “a deductible expense must be ordinary and necessary.” An ordinary expense is an expense that is common and accepted in the industry. Necessary expenses are those that are appropriate and helpful to a business.” Obviously, the IRS definition leaves room for many a misstep. That’s why it’s wise to look at business expense deductions carefully to avoid a possible audit or missed opportunities.

In general, businesses can deduct expenses from business travel. If personal vehicles are used for business purposes, mileage and maintenance expenses are deductible. The IRS sets the amount per mile that can be deducted. Purchasing business equipment such as phones, printers, and workstations is deductible. Cellular phone bills, if the phone is used primarily for business, are also allowable deductions. Meals and entertainment expenses are deductible as long as they are business-related.

It is possible to deduct expenses for a home office; however, checking with a tax professional before including the deductions is recommended as this is an area that is often scrutinized by the IRS.

Know When to Purchase

Tax planning means looking ahead to determine the best time to make a purchase or pay for upcoming services. For example, a business needs new equipment. If the lead time for the purchase is flexible, it might be better to push the purchase out until the next tax year if the company’s tax liability is low in the current year.

Prepaying for services is another way to lower a corporation’s tax liability. Suppose a company is planning a company-wide sales event for the upcoming year. Paying for the facility where the event will be held ahead of time can lower a business’s current tax liability. Making deposits on services such as transportation, entertainment, and catering is another way to reduce current tax liabilities.

Know How to Invest

Invest in people and property. Property does not mean only real estate. Using cash reserves to make an investment can reduce tax liability as long as the investment is not sold. Once an investment is exchanged for cash, businesses must pay taxes. If a company is in a position to make an investment and hold on to it, the investment dollars can lower current taxable income. Organizations can defer the sale of the investment until the impact on tax liabilities is reduced.

People, specifically employees, can reduce a company’s tax burden. Employee compensation is usually tax-deductible as long as it meets the ordinary and necessary tests. The rendered services must be at a reasonable cost and occur in the tax year. However, the best way to lower taxes is by investing in an employee retirement plan.

The IRS allows employers to deduct their contributions to a recognized employee retirement plan. If a company has a 401k, it can match employee contributions. The precise amount depends on the retirement plan and the maximums set by the IRS.

According to Willis Towers Watson, over half of employees chose their current employer because the company offered a retirement plan. Not only will a retirement plan reduce a company’s taxes, but it can attract potential candidates. In a tight labor market, retirement plans make a business more appealing to potential employees.

Use Your Tax Credits

Tax credits do not reduce a company’s taxable income; instead, tax credits reduce the amount owed. For example, a business offers on-site childcare. The employer-provided childcare credit allows the company a tax credit of up to 25% of qualified expenditures and 10% of qualified resources. This credit is just one of many federal tax credits that a business can use.

State and local governments also offer tax credits. The credits vary by state and by municipality. Some jurisdictions may offer credits that encourage economic growth, increase employment, or serve underdeveloped locations. Many organizations do not take advantage of localized tax credits. A state’s treasury department should have a listing of all available tax credits.

DHJJ Can Help

Reducing a business’s tax liability takes careful tax planning. It requires a proactive approach that is customized to each business need. At DHJJ, our financial professionals work with clients to understand their unique requirements and to ensure that every opportunity is taken to minimize their tax liability. If you are looking for a customized approach to tax planning, contact us using our online contact form or call us at 630.420.1360.

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