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Whether your business is incorporated determines what tax planning strategies are available to you. When your business is incorporated, it becomes a separate entity for tax purposes. The downside is more tax compliance and extra paperwork for you and your accountant, but it’s worth the upside of more opportunities for corporate tax planning.
For example, once you’re incorporated you can pay yourself wages rather than living off the profits of your business like you do when you’re a proprietor. But how do you know how much to pay yourself or even if you should? That’s where tax planning comes in.
You’ve likely heard about tax planning and tax compliance before, but what do these terms mean?
Tax Compliance Explained
Tax compliance is following the rules laid out by the Internal Revenue Service (IRS) and other tax authorities that enforce the rules for state and local taxes. This isn’t just income tax, but also includes sales taxes and even property taxes. Tax compliance encompasses following the tax laws and filing your paperwork relating to tax laws on time.
In order to be compliant with your taxes, you need to know the rules. This can be tricky, considering there are numerous tax laws, and they change all the time. The government can adjust tax laws whenever they see fit. A number of tax incentives were implemented in 2020 to help businesses with the burdens felt during the Covid-19 pandemic.
When you’re busy running a business, trying to stay on top of all the tax updates and announcements is practically impossible. That’s why it’s important to find a CPA who will monitor those things for you and let you know when there’s a change that will impact your tax situation.
How Tax Planning Works
Tax planning is developing strategies that make the most sense for you and your business. Often, this will include a plan that results in you paying less tax in your corporation. To save the most tax, look for a CPA or tax advisor who will go beyond compliance work and proactively plan the best tax strategies for you.
One of the first considerations a business owner often faces is whether an S-Corp or a C-Corp is the better way to go for their business. The answer requires careful consideration of your individual situation. These two types of corporations are formed differently, are taxed differently, and have different ownership restrictions.
A C-Corp is taxed at the corporate tax rate and has no restrictions on who owns shares. With an S-Corp, income is taxed on the owners’ personal tax returns. Ownership is limited to 100 shareholders with an S-Corp.
When tax planning, your accountant will usually look at your personal taxes in addition to your corporate taxes to get a sense of your overall tax picture. Your accountant will analyze various scenarios to determine which one is the best for you given the stage of your business.
In the introduction, we mentioned wages. While the flexibility to pay yourself wages is one tax planning strategy, there are many other strategies worth considering.
Some tax deductions are discretionary. This means you don’t have to use them if it’s not to your advantage. There are also multiple ways to calculate the same thing. Vehicle expenses are one example of this. The business use of your car can be calculated using a standard mileage rate or using actual vehicle expenses paid.
When there are options involved in how you file your taxes, there will also be criteria you must meet in order to file using a certain method. Your accountant will consider things like this during a tax planning session to make sure you are saving the most tax possible while staying compliant.
The Difference Between Tax Compliance and Tax Planning
Tax compliance is following the guidelines set out in the Internal Revenue Code to file your tax returns in accordance with the law, and by the deadline set by the IRS. What compliance doesn’t include is an analysis regarding the best way to file. That’s where tax planning comes in. With tax planning, various scenarios are considered to determine the best way to file your taxes.
Accountants that offer tax planning services will go over estimates they’ve created using various scenarios. Together, you and your accountant will determine which scenario meets your needs best. This also involves considering your business and personal goals for the future, such as when you plan to retire and whether you plan to sell your business or keep it and remain an inactive shareholder.
In the United States, we have a self-reporting tax system. This means it’s up to the taxpayer to claim all the deductions and credits they’re eligible for. The IRS won’t tell you when you’ve missed something unless it means more money in their pocket. They don’t care about saving you the most tax, but your accountant does.
How Tax Planning Saves You Money
If you pay less tax, you’ll save more money. Corporate and personal tax planning directly affects the amount of tax you pay. It’s worth it to have your accountant prepare some tax plans for you.
Both personal and corporate tax laws include various deductions and tax credits you may be eligible for. Deductions reduce your taxable income and credits directly reduce your tax bill. The deductions and credits available to your business depend on your industry. The personal tax credits available to you will depend on your life situation—whether you are single or married, if you have children, your age, etc.
Tax compliance and tax planning are equally important, and they go hand-in-hand to ensure you are filing your taxes with the best strategy for your situation. Whether you’ve been in business for years, or you’re just getting started, you can always benefit from money saving strategies.
At Brook Bay Consulting, PC, we monitor your tax situation to provide proactive advice. Contact us to learn more about our compliance and tax planning services.