Okay, you just purchased the most expensive tax preparation software on the market. It’s got all the bells and whistles. It’s comprehensive, detailed and will work for just about any business. It will produce more schedules than you could ever imagine. To think a silly little business tax return could require 100 forms. And it’s easy to use; a few simple entries and voila, you’ve got a tax return that looks like it was prepared by a high powered CPA firm. The problem is, you don’t know the first thing about taxes. Remember the old adage: “garbage in, garbage out?” The same thing applies with your tax planning strategy. Unless you have a thorough knowledge of the tax code, tax preparation software can be useless without a tax planning strategy.
Your tax planning strategy might include some of the following:
1. Business formation, sole proprietorship, partnership or corporation?
2. How do you value your inventory?
3. Should you be on a cash basis or accrual method of accounting?
4. Should you operate under a calendar year or fiscal year?
5. How do you pay yourself, salary, draws or dividends?
6. Should you use straight line depreciation or accelerated under section 179?
Every business is different. Each has different business cycles, trends and problems. Some businesses are profitable from the get-go and others take awhile. Matching income and expenses should always be a top priority with any tax planning strategy; otherwise you might be wasting expenses against nonexistent income. Your business structure should also match your individual needs. Corporations are wonderful when you need to limit your liabilities but as a tax planning strategy, they can be expensive. Have you ever heard of double taxation? This occurs because corporations can’t deduct dividends paid on retained earnings and yet shareholders (like you) who receive dividends, must include the dividends received as income. Yuk!!!
Your tax planning strategy might also benefit from a fiscal year-end, as opposed to a calendar year-end For example, if your business is a corporation with a fiscal year-end of January 31, the corporation can pay you large year-end bonuses on its profit on the last day of its year (January 31,) but as an individual, since you’re on a calendar year, because you received the bonus in January, you won’t have to report it as income for another 15 months, on April 15th of the following tax year.
Another important tax planning strategy should include setting up the best accounting method. Should you use the accrual method or cash-basis method for reporting your income and expenses. With the accrual method, you can deduct an expense as long as you’ve received an invoice. Imagine the tax planning possibilities! But don’t forget, the same rule applies to income. You must report income when you invoice a customer even thought you haven’t actually received payment. As a cash basis taxpayer, you record income when it’s received and expenses when they’re actually paid. A good accountant can have a field day helping you develop a tax planning strategy to help determine when, and when-not to recognize income and expenses.
Your tax planning strategy should begin long before you’re ready to file your taxes. You see, by reading this article you might have been able to save the enormous cost of that expensive tax preparation software. It’s like a cook who’s been given the most expensive kitchen in the world, with the best tools, and appliances, but the shelves are stocked with Top Raman.