Tax Strategies for Small Businesses
Paying taxes is something we all have to do (for the most part), so building your business's tax strategies is important way to ensure you keep as much of your small business profit as possible.
In the first few years of a business, there may be Net Losses due to the expenses that were needed to ramp up the business. This is a benefit since a "Tax Loss Carryforward" reduces future years' tax liabilities.
But, at some point, the business is going to be making a profit and taxes will need to be paid. Limiting your tax exposure is the name of the game.
Below are some simple tax strategies to employ to help reduce the overall tax liability.
One of your first steps would be to adopt expenses that grow margin in your business and are not part of your current business model.
A good example of this is hiring the appropriate staff to run a solid accounting department. Too many times I have seen small to mid sized businesses with just a bookkeeper doing all of their accounting.
Bookkeepers, in general, are not accountants. They usually are doing simple data entry into the books. The problem is that there are usually no month end process to create actual financial statements that help you understand how your business is performing. And, more often than not, the financials are not correct due to the inexperience of the bookkeeper.
Furthermore, an accounting department should, in and of itself, help create more margin because the expenses are being analyzed monthly and there is usually quite a bit of over spending that can be cut out.
Another expense that can be increased, which is directly tied to income, is advertising.
As long as your advertising campaigns are effective and there is extra profit to work with, increasing this cost will help increase revenue while also creating a matching expense. Now, this may actually create an increase in overall taxable income, but you are finding out how much margin is being built by the extra advertising which can help you model out future performance. If the advertising doesn't work as well as you would like, you know to move away from that type of cost and try another advertising method. Ultimately, you are experimenting with tax dollars to find out how far you can push advertising all the while reducing the tax liability.
Payroll is yet another area that can be an added expense to decrease the small business's tax liability.
Similar to accounting and advertising, this expense has the ability to increase overall net income. You are trying to understand how much labor is needed to create a certain revenue result and, at the same time, flush as much expense through the bottom line as possible.
In the examples above, you are not only using this tax strategy to lower income tax, but also finding out what legitimate business expenses can contribute to a higher net income. It is a win/win situation.
One other monthly process I would like to mention here is to make sure you are calculating what your year to date income tax is. A simple way to do this is to take your year to date Net Income and multiply it by 20%. That amount should be an accrued liability on your Balance Sheet and the money set aside in another account so it is not spent. If there is a Net Loss for the time period, $0 is accrued or saved.
Implementing this process will help keep you out of a year end panic because you don't have enough money saved to pay the income tax.
There are several ways that a small business can manage its taxes and I suggest that you and your accountant use various tax strategies to reduce your overall tax debt. Here are some other thoughts on reducing taxable income that you can put in your toolbox!
Blue Collar CFO