Tax Planning for Business Owners is a Year-Round Activity
For most business owners, taxes are generally the most significant expense you’ll pay in your lifetime. But because there are many tax strategies and opportunities that only exist for business owners, you are at a unique advantage when it comes to tax planning. That’s why tax planning should be an integral part of your financial plan as a business owner.
Most people only think about taxes when preparing and filing taxes in March or April. That can be shortsighted, as many tax strategies need to be implemented by December 31st of the previous year to be effective. Comprehensive tax planning must be a proactive process throughout the year and include analyzing your taxes on a multi-year basis, not just the current year. As we like to say, “it’s not who pays the least amount of tax this year that wins, it’s who pays the least over their lifetime.”
A tight focus on tax planning will pay off for most business owners. The “return on tax planning” can be very high and equivalent to your combined tax rate of federal, state, and other local taxes. Many business owners pay upwards of 50% of their income in combined tax to these entities. Therefore, every dollar saved via tax planning can produce a 50% return. In other words, instead of keeping $0.50 of each dollar you earn after-tax, you’ll keep the full $1 thanks to tax planning. (See how we saved one business owner $30,000 in taxes, after the tax filing deadline!)
Keeping on Top of a Constantly-Changing Landscape
Developments in your business will change your tax liability, and they should also change your strategy. For example, is your revenue or income for the year trending higher or lower than in years past? How are your business expenses tracking? Large purchases like equipment, vehicles and other assets can help reduce your taxable income. Similarly, large swings in your employee count due to hiring or turnover can change how much income drops to the bottom line.
As we know, “change is the only constant.” Tax laws are a great example of this principle, laws concerning individual and business taxes are constantly evolving. Try to stay on top of significant changes - are there changes in federal and state tax rates? Are there new tax deductions or credits to consider? For example, the Tax Cuts and Jobs Act of 2017 brought several notable changes that changed how business owners considered forming and running their businesses, including:
Changed the dynamics of business entity planning regarding whether a newly formed company should be a pass-through entity or a C Corp.
Created the Qualified Business Income deduction, which lets self-employed and small business owners deduct up to 20% of qualified business income from their taxes.
Lowered the top corporate tax rate from 35% to 21%.
The rules around regular business deductions also change quite frequently. For example, business-related deductions related to vehicles and driving change constantly, while the deductibility of meal costs went to 100% from 50% through the end of 2022 due to Covid.
Tax Credits Can Be a Tool for Growth and Employee Retention
Tax credits are dollar-for-dollar reductions on your tax bill. Because of this above-the-line treatment, tax credits can be more powerful than deductions, which only decrease your taxable income. So it’s worth carefully tracking opportunities for business tax credits. Common credits include:
Research & Development credits. Not just for tech or science-related companies, these credits can include R&D activities like developing new prototypes or products.
Employee-related credits. These include costs for benefits such as health care, family leave and childcare.
Electric vehicle/alternative energy credits. This credit can cover the production of alternative fuels or the use of an electric vehicle.
Credits related to qualified retirement plans. Taking this credit can offset the expense of setting up a workplace retirement plan.
It’s a Year-Round, Multi-Year Game
Beyond keeping track of changes in your tax situation, there are many proactive, year-round tax planning moves you should make. The most important planning tool is to eliminate the element of surprise – you don’t want to get caught short, and you need time to plan. Use projections based on your business and personal financials to understand your total expected tax bill throughout the year. Paying those taxes can be different depending on your corporate entity, so invest the time to set your business structure up in the way that makes the most sense, whether you’re a solopreneur paying estimated taxes or your business income will flow through to your personal tax return.
Once you have a solid sense of your tax liability, you can start planning for multi-year tax minimization strategies. Deferring or accelerating income from one year to the next can make sense, especially if you expect your tax rates to increase or decline from one year to the next. Combining these strategies with a Roth IRA investment can also mean you extend your tax-efficiency into retirement.
The Bottom Line
Any financial advisor that specializes in business owners should place a heavy emphasis on proactive tax planning throughout the year. As a business owner, you should expect tax planning as a core service from your advisor in partnership with your accountant. Consider working with a specialized financial advisor with experience supporting business owner clients.