It's been a tough winter, but for some businesses, a tougher season has just begun-tax season. Many small business owners know all too well that tax deadlines can come at a time when cash isn't exactly flowing. When businesses don't plan appropriately, cash flow can look like a head-on collision. For those who do plan, it will be a smooth trip with no surprises waiting at the end.
A tax advisor or accountant-typically a Certified Public Accountant (CPA), Enrolled Agent (EA) or other qualified professional-preparing the necessary tax forms and schedules is only one part of the equation. Tax planning services can be particularly valuable to the small business owner by providing business reinvestment opportunities, tax credit information and cash flow projections.
Tax planning can also prevent the surprises most of us have experienced at least once.
Effective Tax Planning
Tax planning is a preliminary review of your current year's income, deductions, credits and payments before the end of your tax year. If you file your business taxes in March or April, you would perform your tax planning between October and mid-December.
Good tax planning requires good record keeping. Even though you may hire a tax professional to prepare your tax return, you are ultimately responsible for the return's completeness, reporting information and tax obligation. If you have complete and accurate records, your tax planning calculations and preparation will be more effective and efficient.
Good tax planning also requires an understanding of business accounting methods. Are you a cash- or accrual-method taxpayer? Cash and accrual accounting methods use different rules to determine when and how income and deductions are reported. Using the cash method, income is reported the year it is received and expenses are reported the year you pay. There are exceptions, such as depreciation and prepaid expenses. Using the accrual method, income is reported when the sale occurs (even if actual payment comes later) and expenses are reported when incurred (even if you pay them later).
Most individuals and small businesses can use the cash method of accounting if gross receipts do not exceed $1 million. However, there are exceptions. Understanding your tax method will help you understand your tax planning calculations.
Tax Deduction vs. Tax Credit
Good tax planning offers taxpayers an understanding of the tax deductions and credits that apply to them as individuals and as business owners. A tax deduction is an expense paid by a business or individual that then qualifies as a deduction to reduce taxable income. Typically, 100 percent of the paid expense reduces taxable income, with some exceptions. For example, meals and vehicle expenses may have deduction limits.
Prior to and after 2010, self-employed health insurance premiums could be deducted only from federal income taxes. But during 2010, the self-employed health insurance premium could also be deducted from self-employment taxes. This change allowed self-employed taxpayers an additional 15.3 percent in tax savings.
A tax credit is a specific tax benefit that reduces the amount of federal income tax owed. Some credits are refundable and some credits can reduce federal income tax to zero. A few examples of tax credits are the health coverage tax credit and the work opportunity tax credit.
Estimated Tax Payments
Tax planning can also mean more accurate estimated tax payments, which self-employed taxpayers must pay quarterly. These payments must include both self-employment tax (Social Security and Medicare) and federal income tax.
Generally, taxpayers must make estimated tax payments if they will owe at least $1,000 when filing their annual Form 1040. Taxpayers must pay the smaller of 90 percent of the tax for the current year, or 100 percent of the tax for the prior taxable year. The exception is if the taxpayer's adjusted gross income (AGI) for the prior year exceeds $150,000 ($75,000 if married filing separately). The taxpayer must then pay 110 percent of the prior year tax or 100 percent of the current year tax. Penalty and interest assessments can apply for noncompliance.
If a small business owner files Form 1040, Schedule C, Profit or Loss from Business, or Form 1065, U.S. Return of Partnership Income, they are required to include both self-employment tax and federal income tax when making their estimated tax payments.
For 2011, the Social Security tax rate is 10.4 percent, up to $106,800 earned, and the Medicare tax is 2.9 percent for a total of 13.3 percent. Income tax is calculated based on taxable income according to the IRS tax schedules, which vary by filing status and income level.
If a small business owner files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation, individual estimated tax payments may be required for the federal income tax generated by the corporation.
Generally, small business taxpayers filing Form 1120, U.S. Corporation Income Tax return, are required to pay corporate estimated tax payments if the annual tax liability is expected to be more than $500.
From a tax perspective, these steps will help you to develop or expand your small business.
Linda Snow, CPA, is the sole member of Snow Consulting & Tax, PLLC in Concord, providing financial and tax services for more than 20 years. She can be reached at Linda@SnowConsultingandTax.com.
Current Issue - May 2024