Tax planning is a process of looking at various tax options in order to determine when, whether, and how to conduct business and personal transactions so that taxes are eliminated or considerably reduced.
Many small business owners ignore tax planning, and don’t even think about their taxes until they’re scheduled to meet with their accountant; but tax planning is an ongoing process, and good tax advice is a very valuable commodity. You should review your income and expenses monthly, and meet with your CPA or tax advisor quarterly, certainly before year end, to analyze how you can take full advantage of the provisions, credits and deductions that are legally available to you.
Although tax avoidance planning is legal, tax evasion – the reduction of tax through deceit, subterfuge, or concealment - is not. Frequently what sets tax evasion apart from tax avoidance is the IRS’s finding that there was some fraudulent intent on the part of the business owner. The following are four of the areas most commonly focused on by IRS examiners as pointing to possible fraud:
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A failure to report substantial amounts of income, such as a shareholder’s failure to report dividends, or a store owner’s failure to report a portion of the daily business receipts.
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A claim for fictitious or improper deductions on a return, such as a sales representative’s substantial overstatement of travel expenses, or a taxpayer’s claim of a large deduction for charitable contributions when no verification exists.
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Accounting irregularities, such as a business’s failure to keep adequate records, or a discrepancy between amounts reported on a corporation’s return and amounts reported on its financial statements.
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Improper allocation of income to a related taxpayer who is in a lower tax bracket, such as where a corporation makes distributions to the controlling shareholder’s children.
Tax Planning Strategies
There are countless tax planning strategies available to a small business owner. Some are aimed at the owner’s individual tax situation, some at the business, and some are aimed at the relationships between the business and its owners, lenders and employees. But regardless of how simple or how complex a tax strategy is, it will be based on structuring the strategy to accomplish one or more of these often overlapping goals:
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Reducing the amount of taxable income
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Lowering your tax rate
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Controlling the time when the tax must be paid
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Claiming any available tax credits
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Controlling the effects of the Alternative Minimum Tax
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Avoiding the most common tax planning mistakes
In order to plan effectively, you’ll need to estimate your personal and business income for the next few years. This is necessary because many tax planning strategies will save tax dollars at one income level, but will create a larger tax bill at other income levels. You will want to avoid having the “right” tax plan made “wrong” by erroneous income projections. Once you know what your approximate income will be, you can take the next step: estimating your tax bracket.
The effort to come up with crystal-ball forecasts may be difficult and by its nature will be inexact. On the other hand, you should already be projecting your sales revenues, income, and cash flow for general business planning purposes. The better your estimates, the better the odds that your tax planning efforts will succeed.
Buried in the complexities of the Internal Revenue Code are valuable money-saving strategies overlooked or undiscovered by many business owners. At the same time there are misleading passages that have been the cause of millions of dollars mistakenly paid to the IRS. Dollars that should have remained in business owners pocket.
Ways to Save on Business Income Taxes
Maximizing Business Entertainment Expenses
One effective way to save on your taxes, that can be enjoyable for you and rewarding to your business, is to deduct entertainment expenses. These deductions can save you a significant amount of tax, however there are important guidelines to consider when claiming them on your return.
In order to for a business meal or entertainment activity to qualify as deductible, business must be discussed before, during, or after the meal or entertainment activity. The surroundings must be conducive to business discussion. For instance, a small or quiet restaurant would be an ideal location for a business dinner. And although entertainment activites are deductible, expenditures for entertainment facilities are not. For example, golf club membership dues are not deductible but greens fees and club rentals paid to entertain a business associate are.
Starting in 1994, the IRS reduced the deduction for business meals and entertainment expenses to 50% of the amount spent. Proper documentation of these expenses is required in order for these deductions to qualify. Records should be maintained of the name of the person entertained, the business relationship, the business discussed as well as the usual date, payee name and amount.
Business Automobile Deductions
Operating an automobile has become increasingly expensive, especially if you own more than one. However, to the extent you can qualify these expenses as business related, your tax deduction increases proportionately. The IRS routinely modifies its mileage deduction rates to reflect automobile operating costs. The 2006 rates are 44.5 cents per business mile, 14 cents per charitable mile, and 18 cents per moving/medical mile.
Business automobile deductions can be based on the IRS per mile rate or on the business use percentage of total vehicle operating costs, including gas & oil, repairs and mainenance, insurance and depreciation. And some vehicles may be depreciated more rapidly for tax purposes than others. To figure business use, divide the business miles driven by the total miles driven. You can do this for each car driven for business purposes. However, in order to be effective, a mileage log should be consistently maintained throughout the year.
Commuting is not considered business use, however you can often structure your appointments to minimize what is considered commuting and maximize your business mileage. Consider meeting with a professional to determine the most effective way of save taxes from business automobile costs.
Increase Your Bottom Line When You Work At Home
The home office deduction is quite possibly one of the most difficult deductions ever to be made available. Yet, there are so many tax advantages it becomes worth the navigational trouble…Here are a few common tips for home office deductions that can make tax season significantly less traumatic for those of you with a home office.
A home office must be used exclusively for business AND it has to be your main place of business, or at least a place where you regularly meet customers or perform essential business recordkeeping for which no other office is available. Consider prominently displaying your home office phone number and address on business cards, having business guests sign a guest log book when they visit your office, keep a time and work activity log, retain receipts and paid invoices. Keeping these records makes it much easier to determine percentages of deductions later on in the year.
The home office percentage is usually determined with reference to the square footage of the office compared to that of the entire home. This business use percentage, applied to every expense paid toward the operation and maintenacne of your home, results in significant business deductions. You need to keep careful records of expenditures relating solely to the office because these are fully deductible. Home office deductions cannot be deducted currently if they would create or increase a business net loss, however, if not deductible in the current year due to the profit limitation, they may be carried forward and deducted in a succeeding year.
Before you start deducting home office expenses on your tax return, you need to make sure that your situation qualifies for the home office deduction. Consider meeting with a tax professional for further clarification.
