These tips are based on the United States’ tax system. Please talk to your accountant for specific tax advice.
As a small business, nothing is more important than the preservation of cash. Losing money to worthless expenses can literally sink a new company before it gets off the ground. Unfortunately, business taxes are one such expense that you are obligated by law to pay. Taxes can take up to 30% of your business’s revenue away, representing a huge threat to those who are not careful. Below are several strategies for reducing the amount of money you have to pay for taxes, and effective ways to make sure the money is available when the taxman comes knocking.
Know Your Corporate Structure
Before you save a dime of income for business taxes, you need to be absolutely certain of the structure of your business. When you filed your articles of incorporation and officially registered the business, you were asked to select a corporate tax structure (either a Sole Proprietorship, Partnership, Limited Liability Company, C-Corporation, or S-Corporation). Each structure has wildly different tax benefits and consequences and, depending on the needs of your business, may be either helpful or harmful come tax season.
As an example, if you own an S-Corp with single taxation, the business itself wont owe any money in taxes, but you and your shareholders will be responsible for claiming dividends on their personal income returns. Conversely, if you are registered as a C-Corp, you are taxed at both the corporate and personal levels, which is known as double taxation.
The best way to develop a logical, effective tax savings plan is to review the laws and procedures that apply to your corporate structure. The exact tax laws of each structure are too exhaustive to be covered here, but the IRS (for United States based businesses) offers several free resources on their website to help you stay in compliance. It is important to keep in mind that the structure of your business is not set in stone, and if you feel you chose the wrong one when you incorporated, you can always restructure at any point in time.
Using Deductions and Write-Offs To Your Advantage
You’ve probably heard the term “write-off” thrown around quite a bit in the business community, but it is important to understand exactly what it means. A business write-off, also known as a tax deduction, is an expense that reduces the total taxable income of the company at the end of the year. To illustrate this concept more clearly, let’s imagine that your business brings in $100,000 in a year, but you have $25,000 in write-offs. The amount of the write-offs are deducted from your total income, meaning you must only pay taxes on $75,000 now, resulting in a very significant savings.
There are many expenses that count as write-offs, including advertising costs, office rent, bad debt accounts, business travel, and more. You must be careful about what you claim to be a write-off, however, as claiming irrelevant and frivolous purchases can land you in serious trouble. To qualify, a write-off must be business related and necessary for the operation and betterment of the company. Office furniture is a classic example, as the IRS could never argue that you or your employees do not need desks to sit at and computers to operate on. On the other hand, a brand new yacht bought on company revenue is clearly meant for pleasure cruising and cannot be claimed as a write-off.
Save Over Time
Once you determine your corporate tax structure, and learn about the laws your business will be subject to, it is time to develop a savings plan that consists of regular, consistent contributions. Regardless of the amount of write-offs you may accumulate, or your projected revenues later in the year, saving for taxes little by little each month is the best and safest way to ensure that you don’t end up in financial trouble. Using your tax bracket, calculate how much you would be taxed each month and put that amount into a savings account that you do not use for any other purpose.
As an example, let’s imagine that your corporate structure and annual income level mean you fall under the 10% bracket. If your business brings in $40,000 in one month, take 10% ($4,000) and deposit it into your tax savings account. At the end of the year, add up your write-offs and use the savings to pay your taxes. If there is any savings left over, you can choose to invest it, take it as a bonus, or keep it there for next year.
Invest The Savings
Of course, it is a shame to watch a company account accumulating money and not helping the business in any other way than keeping the IRS off its back. Thankfully, there is a way to put your tax savings to work for your business while it’s just sitting there. By putting the account into low-risk investments such as mutual funds and T-bills, you can earn interest on your money over the course of the year. This practice effectively reduces the amount of money you lose to taxes by that amount.
Think about it like this — if you paid the IRS $50,000 in taxes, but investing that money over the course of the preceding year earned you $8,000 in interest, you only truly lost $42,000. Be careful not to invest in high-risk stocks hoping to make a quick killing before tax season hits. If the investment tanks, you’ll be out your tax savings and still owe the IRS money the company now doesn’t have.
Set Up an Approved Retirement Accounts
You probably already know that retirement savings are an important consideration for a financially responsible life, but now they can actually help your business out too. Contributions to IRS approved retirement accounts count as business write-offs and can reduce your company’s total income that is subject to taxation. Every founder in your company should open an Independent Retirement Account (IRA) and receive regular savings contributions from the company. This is a great way for the founders to receive a tangible benefit from money that would otherwise be sent off to the IRS. At the end of the year, total up these retirement contributions, save your records for bookkeeping purposes, and deduct the total from your taxes.
Credit Cards Now Accepted (US Specific)
As of earlier this year, the IRS has begun allowing business owners to pay their business taxes with a credit card, which is good news for small businesses that need to preserve and nurture their precious operating capital. Often times entrepreneurs or their investors have the means to qualify for a business credit card to get up and running, and this piece of plastic can be a true life saver come tax season. Let’s say you were diligent about saving, but experienced a lack of qualified write-offs and a sudden increase in income toward the end of the year that pushes your taxes up higher than you were prepared for.
You can now put the difference on credit and pay it off in instalments like any other monthly bill. Keep in mind that this debt will accumulate interest and should never be considered a total alternative to responsible savings, but it is important to know that the option is there should you find your business in a pinch.