TAX PLANNING FOR BUSINESSES
There is nothing wrong with a strategy to avoid the payment of taxes. The Internal Revenue Code doesn’t prevent that. – William H. Rehnquist
Myth #1 – All Accountants are Tax Planners
It is your legal right, and dare I say moral obligation, to you and your family to pay the least amount of taxes allowed by law so that you can better serve your stakeholders and position your company to grow.
Your accountant is a historian; they record what you have done. There is a belief that the act of recording historical data and then transferring that data to a tax return constitutes tax planning. Tax preparation, tax filing and accounting are important but don’t amount to proactive tax planning.
Some accountants may do minor reactive tax planning by offering advice such as “You should put more in your IRA.” Or they might say, “Last year, when you decided to take money out of your business to pay for that emergency…don’t do that again.”
To become certified as CPAs, accountants have to pass a rigorous two-day test – 14 hours of testing to be exact. While the CPA exam is valuable in helping accountants become more skilled in the trade of accounting, it has nothing to do with taxes. The CPA exam is focused on General Accepted Accounting Principles (GAAP), many of which do not relate to the entrepreneur or small business owner. If your accountant, bookkeeper, or tax preparer has not given you at least one idea that saves you at least $1000 in taxes EVERY YEAR, then you may have out grown your accountant. As in life, graduating from one phase of business to another is an essential path to growing your business and profit.
Revenue and profit are the primary fuels that feed a business. A $10,000 tax bill in a business that has a 10% profit margin means that you will have to earn $100,000 to pay the taxes. That is a lot of work to pay an ungrateful Uncle Sam. This is why you need to learn how to widen the gap between your profits and your taxes.
To better understand how to widen the gap between your profit and tax liability, let’s use the analogy of the Toll Bridge.
Think of the money you earn in your business as being on the San Francisco side. You pay a toll to cross the bridge. The toll is your income tax. If you want to get home to your family in Marin County, you have to pay the toll.
Visitors to the Bay area will pay the highest toll, they have to stop and pay the attendant in the booth. Locals have a toll tag; they breeze through and pay a reduced rate. Our goal here is to move you from a visitor paying the highest toll (tax) to becoming someone that is “in the know” and pays a reduced toll (tax).
Myth #2 – Small Business Owners Have a Higher Risk for Audit
What if you decide to take a proactive approach to your tax planning? Won’t that put you at risk for an audit? Whether you’ve been in business for a few months or several years, you’ve probably heard advice along these lines, “You don’t want to use this or that strategy with your taxes, it’ll create a ‘red flag’ with the IRS.”
To understand what a “red flag” looks like to the IRS, let’s use the analogy of traffic lights. In the traffic world, red means stop and green means go. When you see a red light, you must stop until you see the light turn green. When the light turns green, you are free to move through the intersection. A green light is not a “loophole” that creates a “red flag” and increases your probability of a ticket. The green light is part of the law that creates a managed flow of traffic through a busy intersection.
With taxes, however, many small business owners have come to see any strategy that helps them reduce their taxes as a “red flag” that will raise their risk of audit. This faulty logic is all based on rumors, “the way it has always been” syndrome or ignorance. Fortunately, we do know what is actually legal. It’s in the 70,000 pages of Internal Revenue Code (IRC). Anyone is welcome to read the IRC but most don’t (70,000 pages is a viable reason). I’ve made it easy for you here. I’ve demystified the 10 biggest tax myths into roughly twenty pages so you can master them too.
Here’s the skinny, less than five of those pages in the IRC are red lights or things to avoid if you don’t want to be audited. You make X, you multiply that by Y you have to pay Z. Simple, but EXPENSIVE.
Following this approach may be safe, like never moving anywhere at an intersection is safe. It may avoid the fictitious “red flag” but it’s an outdated approach. The accounting industry has been taught to sit at the red light and be ‘safe’, then follow the laws and use the green lights and allow for the free flow of traffic, and a more productive society. As it relates to taxes, it is more productive because you are keeping more of what you have earned. The tax code has over 70,000 pages of green lights. You probably already use the standard deduction green light and the mortgage interest green light. You may even use the charitable deduction green light for that bag of clothes you gave to the Salvation Army. Most people don’t worry about getting audited with these common “green light” strategies.
But, what about the less common “green lights,” such as writing off your swimming pool, renting your house to yourself, avoiding taxes on hundreds of thousands of dollars in income or expensing your vacation?
All of these are green lights listed in the Internal Revenue Code that you, as a small business owner, can use, legally! There are rules tied to their use, and most of the rules are surprisingly simple. One caveat is that some of the strategies will better serve you when you reach a certain threshold. We have found that you need to shift from DIY tax planning and hire a professional when you start to pay $20,000 in personal income taxes or make $100,000 gross income.
Following these strategies can easily save you thousands of dollars and not increase your risk for audit.
It’s a green light! Go!
When new clients come in to our offices, most of them have already lost money to over paid taxes. Our clients are thrilled when we save them tens of thousands in future taxes. This eBook is here to help prevent you from further loss or, if you are just getting started, to prevent you from losing money in the first place.