Although many entrepreneurs and small business owners enlist the assistance of financial professionals, every business owner should understand basic tax code stipulations and strategies. In the simple guide below, we walk through simple tax planning terms, taxation variations based on business type, and a range of valuable tactics to promote smart business tax planning.
Small Business Tax Planning Terms
What is Tax Planning?
Business tax planning involves proactively implementing strategies to maximize tax breaks and minimize tax liability, legally and efficiently. Business owners will often face four types of business taxes: income tax, excise tax, taxes for employers, and self-employment tax. The form of your business will impact the types of business taxes experienced.
Before diving into the details, consider two central rules: business owners should “never incur additional expenses only to gain a tax deduction… and alwaysattempt to defer taxes when possible.” This balance should guide the tax planning process.
Cash Basis vs Accrual Basis Accounting Methods
There are two primary accounting methods utilized by business owners to keep financial records and prepare reports: cash basis and accrual basis. Selecting the proper approach for your business is critical, even impacting the amount of owed taxes. The right method depends on a variety of factors.
- Cash basis accounting records income and expenses according to actual cash flow. That is, expenses are recorded when they are paid, and income is recognized when it is physically obtained. For example, if you receive an invoice, the cash basis accounting method would not consider the invoice an expense until it is paid. Likewise, revenue is not considered income until the funds come in. Many small businesses appreciate cash basis accounting, because the method is simple, provides an accurate picture of cash flow, and allows for flexibility regarding when income can be taxed.
- Accrual basis accounting records income and expenses immediately, as they are recognized, even if cash has not exchanged persons. Thus, an invoice is considered an expense when it is incurred, and revenue is considered income when it is earned. Some businesses favor accrual basis accounting, because the method offers an accurate long-term picture of financial health. However, the method is more complex than a cash-basis approach.
Regardless of the preferred method, businesses often are legally compelled to abide by one or the other. For example, if a business handles inventory of any amount, accrual basis accounting is required. Additionally, most businesses making over $5 million in gross sales annually are required to utilize accrual basis accounting.
First-In, First-Out (FIFO) vs Last-In, First-Out (LIFO) Inventory Valuation Methods
Two primary inventory valuation methods must also be considered: first-in, first-out (FIFO) and last-in, first-out (LIFO). As both names imply, the methods differ based on the flow of inventory. FIFO inventory valuation assumes that the earliest purchased items are the first to be taken from inventory, while LIFO assumes that the items purchased most recently are the first to be taken from inventory.
The inventory valuation method chosen largely depends on the preference of the business owner. At times, an inventory valuation method is selected based on outside economic influences.
LIFO is generally the preferred inventory valuation method during times of rising costs. It places a lower value on the remaining inventory and a higher value on the cost of goods sold, thus reducing income and taxes. On the other hand, FIFO is generally preferred during periods of deflation or in industries where inventory can tend to lose its value rapidly, such as high technology. Companies can file IRS Form 970 and switch from FIFO to LIFO at any time to take advantage of tax savings. However, they must then either wait ten years or get permission from the IRS to switch back to FIFO.
Business Tax Planning Based on Business Type
Tax planning requirements and strategies will change based on business type.
Sole Proprietorships and Partnerships: Business owners of sole proprietorship and partnerships pay personal income tax. Thus, in many ways, tax planning resembles individual tax planning. Only two distinctions need to be made regarding tax planning for sole proprietorships and partnerships. Firstly, an additional self-employment tax is imposed. Secondly, business owners must file an informational return with the IRS and any business income utilized for personal tax return usage.
C Corporations: C corporations are taxed as corporations, separate entities under the law. As such, corporate tax rates differ based on accrued profits. Certain corporations may be subject to additional special taxes, in additional to basic corporate tax rates. Unfortunately, C corporations face double taxation: corporate income is subject to corporate tax and shareholders are subject to income distribution taxation.
S Corporations: S corporations avert double taxation. Earnings passed to shareholders are done so directly, avoiding additional distribution taxation.
Tax Planning Strategies
1. Apply for the Health Care Tax Credit
If you meet a few qualifications, you may claim savings with the health care tax credit. Eligible businesses:
- Have fewer than 25 full-time employees
- Pay an average salary of less than $50,000
- Offer at least half of employee health insurance premiums
If you are unsure of health care tax credit eligibility, inquire with a CPA to see if your business qualifies!
2. Apply for the Work Opportunity Tax Credit
If you have hired a disenfranchised group, your business may be eligible for the work opportunity tax credit. Once again, a financial professional will be able to confirm if your company is qualified for this specific tax opportunity.
3. Apply for a Child Care Expenses Credit
If your business pays for employee’s childcare expenses, claim a tax credit. Businesses who are eligible receive 25% of yearly expenses paid, up to $150,000.
4. Claim Available Deductions
Did your business recently move or acquire new property? You may be eligible to receive significant property deductions on currently acquired transportation, business, research, or manufacturing equipment.
Charitable contributions made can be deducted as well, including stocks or volunteer expenses.
Finally, be aware of miscellaneous deductions available to your business, including out-of-town business travel or ATM card fees. Business owners often reach out to financial professionals for assistance navigating properly claiming deductions.
DHJJ: Customized Tax Planning Services
Businesses seeking proactive tax planning services, customized according to unique business needs, find one-of-a-kind assistance in the team of financial professionals at DHJJ.
Careful tax planning and management can deliver significant benefits to your business and personal wealth, and we take advantage of every opportunity to minimize tax liability while remaining compliant with all legal taxation requirements.
To begin your proactive approach to tax planning, get in touch with our team at 630.420.1360 or via our online contact form!