Small Business Tax Planning Overview

Tax planning is the practice of analyzing multiple tax options to decide how you want to operate your business as well as your individual transactions to minimize or wipe out your tax liability.

Most small business owners are good at what they got into business for and overlook the importance of tax planning. They sometimes are not in their tax mindset until it comes time for them to review with their CPA. However, tax planning is not a “set it and forget it” practice; it’s ongoing and high quality tax counsel is a valuable asset. You’ll greatly benefit by analyzing your income and expenses on a monthly basis. Then, on a quarterly basis, you’ll be super productive when meeting with your accountant or tax advisor to assess how you can benefit from legal tax advantages such as deductions and credits.

You’re not required by law to take advantage of tax planning. What is illegal though is tax evasion, which is reducing income through false pretenses—also known as Tax Fraud. Below are 4 areas the IRS typically focus on to identify possible tax fraud:

  • Not reporting significant income. For example, a shareholder not reporting dividends or a business owner not reporting some or all of its business receipts—selling things under the table.
  • Making false claims or inflating travel expenses or charitable deductions and no record to show for it, or a record that’s been falsified.
  • Discrepancies between what’s been reported on the business’s return and what’s reported/recorded in financial records. This can happen simply as a result of a business not keeping adequate books.
  • “Paying your kids” or someone related to you in order to lower the filer’s tax bracket and thus, avoiding higher taxes.

Strategies for Tax Planning

There are a multitude of available strategies for tax planning for owners of small businesses. Usually, these are targeted at the business or at the owner of the business. The strategy may be simple or it may be complex but it needs to be built around accomplishing one of these objectives:

  • Lowering taxable income
  • Decreasing tax rate
  • Taking control of when the tax needs to be paid
  • Taking advantage of eligible tax credits
  • Managing the impact of Alternative Minimum Tax
  • Preventing typical tax mistakes

To plan well, determine your estimated individual income as well as your business income for the upcoming 3-5 years. This is critical as most strategies for tax planning save your tax dollars for a certain level of income, however, it creates a higher tax bill at other certain levels of income. Ideally, you’ll make the appropriate plan based on accurately projected income. After you’ve identified your estimated income, you can then determine your estimated tax bracket.

Accurately projecting your income can be difficult as so many things could happen—such as being wildly successful financially, which is a good problem. However difficult these projections may be for tax purposes, you’ll still need to forecast your sales, expenses, income, and cash flow for planning to meet the needs of your business. The more accurate your forecasts, the more efficient your tax planning can be.

Benefit from Entertainment Expenses Related to Business

Expenses for entertainment related to business are deemed lawful deductions which reduce your tax owed and thus, makes you more profitable. However, you need to adhere to specific guidelines laid out by the IRS.

To be eligible for an entertainment expense deduction, business matters have to be discussed at some point during the entertainment. It’s important that the environment is appropriate for discussing business. For example, a quiet restaurant would be ideal and a loud nightclub would be less ideal.

The IRS entitles you to deduct up to 50% of expenses on entertainment. However, make sure you are maintaining accurate records and the business meal is a legitimate business meeting.

Deductions for Work-related Vehicles

There are deductions to take advantage of if you’re using your car as transportation to do business. For example, if you’re driving to a sales pitch or to a meeting with a client and it’s outside of your normal commute, you can deduct a certain amount of mileage.

In 2015, the standard mileage reimbursement rates determined by the IRS are 57.5 cents per business mile, 14 cents per mile when volunteering for a qualifying charity and 23 cents for moving (more than 50 miles from your home and the move is related to your new work) and also 23 cents per mile for medical reasons.

You can also take advantage of this deduction if you have two cars. The amount of miles driven is determined by business use and not by a specific car—although you have to own the car you’re taking the deduction with. To take this deduction, take the total business miles accumulated and divide by the total miles driven.

It’s important to keep accurate records: when, where, the purpose, the date—anything that’s helpful in establishing credibility for the deduction.

Home Office Deductions

Home office deductions can be a significant reducer of taxable income. For example, if you can legitimately claim $500 per month as a home office deduction, that lowers your taxable income by $6,000. That could potentially put you in a lower tax bracket.

Your home office has to be a space in your home that’s used exclusively for conducting business. So, it can’t be a bedroom or where you work from the dining room table. Typically, this deduction is meant for people who have a spare bedroom they turned into an office or a garage turned into an office or studio. You can take a deduction based on the square feet of your home. If your home is 1000 square feet and the mortgage is $2000, and your home office is 200 square feet, you can deduct $400 per month—a total of $4,800.

Keep in mind, there are some deductions that can be taken even if you don’t qualify for the home office deduction alone.

Partner with a tax expert like us to ensure you meet all of your legal tax obligations and keep as much money as you are entitled to.