Tax Planning 101 for Business Owners
/Author: Stoy Hall, CFP
Even though tax season may be over, it’s never too early to start planning for next year. But what does that mean for entrepreneurs and small business owners?
In simple terms, tax planning is the process of figuring out what you have done in the past, what you currently are doing, and what you’ll be doing 18 months from now – and it’s a process best guided by a trained tax professional and financial planner.
For effective planning, you must be willing to share your entire financial picture with this person. Just like a medical doctor can’t fully assess a situation without full knowledge of your health history, a financial planner needs access to all the intimate financial details of your business.
Getting started
To begin, a business owner must provide a minimum of their last two business returns, your profit and loss (P&L) statement, and your balance sheet. This allows planners to do an immediate deep dive into your situation and find ways to possibly reduce your tax burden. This could include simple write-offs like cellphones, office space, marketing materials, advertising, vehicles, employee benefits, and even your own retirement. These are all simple adjustments that are made before digging into more complex concepts.
The second step is implementation of different strategies your planner recommends, like shifting the payroll and bookkeeping duties to an accountant, for example. Once this is done, there are two critical times in the year that you should meet with your tax planning team, well before the tax filing season. This way, you won’t be surprised in March or April of the following year!
The first meeting will be in the summer, typically between June and July. This meeting will be a check-in on your annual projections and to determine if any adjustments need to be made to your tax planning.
The second meeting should be in November or December to finalize numbers, review all that has been implemented, and make any last-minute minor tweaks. At this stage, you’ll know your tax refund or bill and – thanks to tax planning! – will have saved/planned accordingly throughout the year.
The final step is to file your return and get it signed. Then the process begins again for the following tax year.
Common tax planning techniques
Now that you understand the process at a high level, let’s look at five common tax planning techniques. Keep in mind that these are just examples and may not apply to all businesses – some of these may be different depending on whether or not your business has other employees.
Fully utilizing your employee benefits
We could spend days on this topic, but I’ll just stick to the high points. Business owners have a plethora of options for reducing their tax burden by adding benefits to their business (regardless of whether or not they have employees). Some of these benefits are:
Self- Directed Accounts
SIMPLE IRA
401(k)
Solo 401(k)
HAS
HRA
Life Insurance
Disability Insurance
Student Loan plans
Bonuses
These options may seem simple but can be effective in helping you access more tax deductions.
For example, we have a client who owns a firm and makes about $600k a year gross. We signed him up for a supplemental retirement plan utilizing leverage from a bank to fund an indexed universal life insurance policy (IUL). This loan has interest payments that are tax-deductible for 10 years. At the end of those 10 years (and once the note was paid off in year 13), this client will receive $290k in tax-free income from this plan – a huge deduction for a huge benefit!
We also can do that same plan for the spouse, children or key employees. What an awesome perk to offer to employees!
For another client, we utilized a Self-Directed Solo 401(k), or a 401(k) for the self-employed. This client maxed out his contributions and added his wife, adding a combined total $110k to their plan. Now that it is inside the self-directed option, we were able to purchase commercial real estate or another business with money from that same Solo 401(k). He invested in a building that initially sold for $1.5 million and is now worth $4.5 million, in just little over five years. Now that is growth within someone’s retirement that we love to see!
A last example to explore is the health savings account, or HSA. We have a client who added a health plan to his business and maxes out his HSA as well as his employee’s HSA. For a family that maximum contribution is $7k – a huge benefit to the employee, and another deduction for the business. He coupled that with an impressive insurance plan that has a family deductible of $4k, so that means in any year the family can max out their deductible and still be ahead $3k – money that can be used invest every year until they retire AND have another account for retirement! Assuming a 7 percent growth rate over 30 years, net the deductible, this account could be about $283,382.35 of tax-free money (if used properly in retirement). Count me in!
What’s utilized for business and what’s not?
Here is a list of 10 business expenses that many forget to write off (some may apply to in home businesses) at tax time.
Utilities (internet, water, gas, electricity, etc.)
Cell phone
Vehicle
Portion of your mortgage
Advertising (simple sponsorships)
Donations
Education
Meals (modified for new tax code)
Travel
Professional Fees (CPA, Financial Planner (CFP®), Attorney, etc.)
Hiring a Financial Planner (CFP®), focused on Business Owners
Having a planner on your team can help ensure accountability to the tax planning process as well as your financial plan – both personally and for your business.
A planner who focuses on business owners will know the techniques I mentioned above and will be able to separate your personal and your business finances. Most of the time business owners believe they are one and the same, but they’re not. You are an employee of your business (with added perks) and therefore you need to run your life as if you are an employee – which means dealing with the business as a separate issue as much as possible.
Your planner will be your best friend and coach for the all aspects of the financial plan. As a coach, we hold you accountable to the plans; as your friend we’ll help you navigating the sometimes-emotional highs and lows during execution of the plan.
As an added bonus, CFP services are tax deductible! As long as they are not directly tied to your investments, find a planner who is paid on a retainer that your business directly pays for – then those services are considered a business expense.
Structuring your business
This is another area where there are a lot of variables at play, so for the purposes of this article I’ll keep it simple and focus on the high-level differences between an S Corp, C Corp, and an LLC.
If you make an income of at least $25k it often is the trigger to becoming an S Corp. As an S Corp, you’re eligible for more deductions, have greater abilities to offer employee benefits, and a little more protection than just a schedule c/1099 business owner. (Note: Money & Mimosas recommends waiting until $70K to become an S Corp.)
A majority of us will fall under the S Corp status; a C Corp may be more appropriate for those with international focused businesses, or businesses that need/want to raise capital more easily.
Defining your role
As business owners, we inherently want to be in control or know everything that is going on in and around our business. To a point this is okay; however, the most successful businesses have different roles and responsibilities – i.e., CEO, CFO, COO, etc. You need to determine which role(s) you want to play. Focus on what you’re good at and what drives the most revenue for your business.
We all became business owners because we wanted to be independent and saw a need to help others – one of the things I love most about being a business owner. Our downfall comes when we lose focus on the initial mission and vision for our company. As each business transitions out of the infancy stage to something bigger, it’s up to the owner to take the lead on guiding the business through that transition: hiring partners, staff, or outside businesses to help take you from a hobby to a fully operational business.
If you can define your role quickly and precisely, it will cost you less money and allow you to be more successful.
Stoy Hall, CFP: Born and raised in Omaha, Nebraska, I grew up in a family that was not financial independent. I realized at a young age that my path to independence would be through sports and chose to go to Drake University to play football (my subconscious was telling me to get an education). At Drake I earned my degree in Finance with concentrations in business law and insurance, and experienced one of the most important events in my life: meeting my wife. While in college I worked at the Boys & Girls Club of Central Iowa, where I narrowed in on what I wanted to do in my career. After witnessing the effects of financial illiteracy on families, I became passionate about giving individuals and families the tools to become more financial empowered which lead me into the world of financial services and the work I do today. I live with my wife Michelle and our two boys (Lincoln, 4 and Croix almost 2) in Ankeny, Iowa. Find me on LinkedIn, Facebook, Twitter, and Instagram.
