Minimizing your business taxes isn't magic, but it does require a plan. Here are four areas to look at more closely.
Editor's Note: This article is for informational purposes and is not intended to replace professional advice. Please consult with a tax professional to determine what is best for your business and for your individual needs.
When is the last time your business tax preparer called and said, "Hey, I have some ideas on how to lower your taxes."
If you're like most business owners, the answer to that question is probably "Never." A tax preparer is certainly a critical part of your team and probably does a great job of keeping you in the good graces of the IRS. But they're usually not trained to help you plan ahead to minimize your taxes in future years.
In other words, when it comes to business taxes, we can't look through the rearview mirror. We have to look through the windshield and down the road as well.
That's the message from author and "Tax Coach System" creator Ed Lyon, who works with CPAs and other advisors nationally to create tax plans for businesses. According to Lyon, there are four general areas a business owner can address to minimize their taxes.
Timing: Know when and how to use tax laws to your advantage.
"A tax deferred is a tax minimized," says Lyon. Your income as a business owner is probably higher now than it will be in retirement, so your first goal regarding timing is to push taxable dollars into future, lower tax years. One example is a company retirement plan such as a 401K, SIMPLE IRA or SEP IRA. You can then deduct those retirement dollars in the current year and pay taxes on them later when you'll most likely be in a lower tax bracket.
Related to that is the concept of the time value of money, the idea that money available at the present time is worth more than the identical sum in the future, due to the fact that it will be invested and will grow. Put that money to work now in tax-advantaged financial vehicles. You'll not only save on present-day taxes, you'll grow your nest egg.
Shifting: Move money to areas of the business that provide the best tax advantage.
With timing, you're diverting money to a different tax year. With shifting, you're diverting money to someone or something that is in a lower tax bracket. Lyon gives one example: "If you're a business owner and you have kids under 18 but over the age of seven, you might hire them to work for your business."
Lyon continues, "If I pay my 12-year-old to work in my business and then use his wages to pay his school tuition, I'm essentially deducting that tuition. Instead of paying taxes on it at my dad rate and then giving it to the school, I'm paying it to him and writing off those wages. He works for it, he pays tax on it at his rate – which is probably zero – and then I can put it in a custodial account and later send it along to the school."
Code: Understand the tax code to leverage current tax law efficiently.
Lyon points out that the tax code makes clear a long list of things on which you don't have to pay taxes. "There's really no mystery to it, other than just understanding what's in the tax code," says Lyon. "You have to be willing to do a little digging."
Qualified retirement plans are one obvious example, allowing you to defer income taxes on money contributed and on the growth of that money. A key there, of course, is fitting the right type of retirement plan to your business.
Products: Utilize the individual financial strategies that are most tax advantageous.
One tax-friendly financial strategy that is underutilized by many business owners is permanent life insurance, such as whole life or universal life. These plans allow a business owner to sock away funds in amounts that can be far beyond the maximum amounts the IRS allows for IRA or 401K plans. That money grows tax-deferred and can be accessed tax-free for any reason whatsoever, even retirement income.
Whereas a Roth IRA, for example, has both income limits and contribution limits, permanent life insurance does not, nor does it include IRS-mandated taxes and penalties for withdrawals before age 59 1/2.
Lyon points out that there are strategies that fall into more than one of these four categories. "[A] 401K is allowed by the tax code," explains Lyon, "and it's also a timing strategy, and you can also say it's a product strategy as well."
One more important thing: A plan will only work if it's executed. It's common knowledge that many business plans and marketing plans, once written, end up collecting dust on the shelf. Therefore, with the help of an experienced advisor, a business owner must commit to executing their tax plan to enjoy its full benefit. The advice here is that the execution of the plan is scheduled and carefully mapped out before the plan is complete.
Survey after survey indicates that minimizing exposure to taxes is one of the biggest concerns business owners have. With the right plan, and with proper execution, business taxes can be one less thing for you to worry about.