This month, we are concentrating on the small businessperson's fifth greatest concern. According to the National Federation of Independent Businesses' most recent survey on small business owners' concerns, high federal income taxes on business income ranks fifth. This month's general business article dealt with possible ways the small businessperson could affect legislation to reduce the tax burden, but how do small businesses minimize their federal tax burdens right now? This not only affects small businesses, but in a very real way, the taxes a business pays affect every consumer.
So, how do small businesses minimize their tax costs? Put simply - planning. If you haven't already done so, now is the time to put into place strategies to minimize your year-end tax bite. Unfortunately, too many people wait until it is too late to structure transactions with an eye toward tax minimization. Either they will 1) consummate a transaction with little or no thought to tax consequences, or 2) they may know the best tax structure for a particular transaction, but procrastinate until it is too late in the year to execute the transaction. This article will hopefully give you incentive to begin your planning sooner rather than later.
In what form do you presently operate your business? Are you operating as a sole proprietor or a limited liability company? Perhaps you are operating as a limited or general partnership. Of course, you could be operating in some corporate form. Did you know that each of these types of entities has its own tax and legal consequences?
For example, operating as a sole proprietorship eliminates the double taxation inherent in a regular C Corporation, but you have no protection for your personal assets should you be sued for a business-related matter and the cost of employee benefits (health insurance, etc.) can be much higher. On the other end of the spectrum, operating as a C Corporation may offer you significant savings when it comes to payroll taxes and the deductibility of employee benefits, but it can be difficult to get your money out without being taxed twice.
If you are already in business, talk with your attorney and tax advisor to insure you are operating in the best possible form for you.
Income and Expense
If you are just starting your business, you will have a number of choices to make. One of those is the method of accounting you will use to determine your net income. In general there are two methods - cash and accrual. Each has its advantages and disadvantages. The cash method is the most flexible since it allows you to accelerate expenses and postpone income recognition much easier; however, you need access to enough cash to make the planning opportunities work. Also, cash method taxpayers can be limited in the ability to depreciate assets. For example, say Taxpayer A is a cash basis taxpayer and purchases a $100,000 widget maker at year-end. Assume the equipment maker finances the equipment purchase and Taxpayer A has no current year cash outlay. When the time comes to prepare the tax return, since Taxpayer A paid nothing on the machine, then there is no deduction for the year. Assume the exact same facts for Taxpayer B as for Taxpayer A, except B is an accrual basis taxpayer. In this case, since everything has occurred to make B liable for the $100,000 obligation, B can deduct so much of the cost of the machine as is legal. Of course, had A borrowed the money from a bank or other finance company, A would be able to deduct the equipment cost just like B could.
The accrual basis of accounting is a bit less flexible because income must be recognized when it is earned (i.e. when the sale occurs, regardless of when the cash is received); however, the accrual basis payer doesn't have to pay a bill before deducting it.
The availability of and reasons for using a particular accounting method are many and varied. Rather than extend the discussion on accounting methods here, it would be best for you to discuss the subject with a qualified tax advisor.
Do you have a piece of property with a high value and low basis? Are you looking to expand operations, but you really don't want to build on land you currently own? You know you could sell the land and take a huge gain on the sale, but you hate to pay the taxes. After all, you will need them for the new plant. Why not take advantage of a 1031 Exchange. In essence, this technique allows you to trade low basis property with a gain for property of equal value without recognizing a current gain. Of course, the basis of the new property is the same as the basis of the old property, but who cares? Bottom line is you will have your new plant and, assuming you plan on staying in the plant for a long period, you will postpone payment of taxes until you sell the plant far in the future.
Do you need working capital? Do you need long-term financing? In the alternative, do you need to pay down debt? While you could go a traditional route of borrowing money from the bank, take a look at your balance sheet first. Is there cash value to your company-owned life insurance? How do the rates compare to your current debt? Even if the rates are not favorable, remember that a cash value loan does not necessarily require any payments except interest each year. Do you have excess inventory that is tying up cash? Mark it down and sell it. Sure you may only break even on the sale, but that will essentially be tax-free cash for other business purposes.
This article could literally go on for hundreds and thousands of pages and thoroughly confuse both the reader and writer. Instead of boring us all, why not pick up the phone and give us a call. We would be glad to discuss your individual circumstances and design a plan that maximizes your after-tax earnings; earnings that can be put back into the business or distributed to the owners or employees. All we are about here is to let you know your are not necessarily boxed into your current situation. While you may be boxed-in, the only way to know how big and bad your box may be is to give your tax advisor a call. If you have one, no problem, we are glad to help your advisor help you. If you don't have an advisor, give us a call. This firm is dedicated to assisting the small businessperson maximize his or her potential income.
Have a tremendous June and great summer.