But first things first:
What exactly is tax planning?
Tax planning is basically forecasting your business’s tax liability for a forthcoming year using the financial records and then creating circumstances and ways to reduce it.
What are the different types of taxes small business owners have to pay?
Small business owners have to pay:
- Income Tax– It is calculated based on a business’s net profit.
- Self Employment Tax– Also known as Medicare and Social Security taxes, all business owners that earn $400 or more a month are required by the IRS to pay self employment tax.
- Employment Taxes– These taxes are paid by businesses for each employee on its team.
- Sales Tax– Currently only five states in the U.S are sales tax free. These include Alaska, Delaware, New Hampshire, Oregon and Montana.
- Local Taxes– These include real estate and personal property taxes.
There is also excise tax; however, excise tax is only imposed on certain businesses that manufacture or sell certain products or use certain kinds of equipment.
Now to the main question:
Why is tax planning important anyway?
Let’s be honest, no business owner likes to see their profits reduced. Tax bills do exactly that; they reduce your profits by increasing your expenses. Thankfully, though, there are ways to lower your tax bills. But for that, you need to strategize. And that’s where tax planning comes in. With tax planning, you focus on different deductions, credits and provisions legally available to you to save on taxes. Here, one must not confuse tax planning with tax evasion as the latter includes forms which use tax laws in ways not intended by the government. Tax planning is a legal practice while tax evasion is illegal.
Small businesses in the U.S generally have a poor reputation of mismanaging tax savings. According to one study, more than 60% of small businesses don’t avail tax deductions at all even when they are eligible for it. This is all because of lack of tax planning, without which, business owners are simply not aware of the many opportunities available to them that can help them save on their tax bills.
In addition to helping businesses lower their tax bills, tax planning is also important from tax preparation perspective.
Most business owners don’t prepare their tax paperwork until the last months of the tax filing season. Some start doing it just weeks before the deadline. In haste, they then file incomplete records or make mistakes which results in penalties. In extreme cases, some businesses even miss out on the deadline and end up having the IRS knocking at their door.
With tax planning, you can keep your books updated and have everything ready in store as you enter the tax season. You don’t have to worry about the last minute scramble, incomplete records or staying back after office hours just to get everything sorted. Plus, you’re also able to identify any potential issues in your books in advance and correct them promptly.
Tax planning is not a luxury practice; it’s a necessary one for all small businesses.
This then begs the question:
What are the steps entailing tax planning?
Tax planning entails following steps:
- Create a calendar. Mark every important date and tax-related deadline on it.
- Create an activity schedule based on the dates and deadlines marked in step (1). The activities should focus on getting the documents organized in one place for each corresponding tax date or deadline.
- Hire a tax specialist. Sit down with them, assess your tax liabilities and discuss where and how they can be reduced. Refer to the documents you’ve collected for help.
- Create a risk profile associated with the return you want to achieve.
- Make a decision best suited for your business.
This brings us to the end of the article; we hope you found the read helpful.
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