One of our clients, Donna, from Development and Training Resources, LLC, gave us a great topic to write about. Remember when we said we would answer your questions? She asked:
“What are the best ways to retain income for future business development required for the following year operating needs without substantial taxes?”
Donna wants to know how to have income that is not considered income to the IRS. First, let me say that Uncle Sam almost always finds a way to get his share. We did come up with a few ways to have legit expenses on the books without a real cash outflow, in turn making profits lower for the IRS than real cash profits. They are:
- Mileage Expense can be reimbursed to you from your business at the federal mileage rate. Often this book expense will be more than it actually cost you in cash.
- Depreciation on a property or goods that qualify allows you to take the expense over the course of years. This allows you to post an expense on your books where no cash was actually spent that year. (However in the year of purchase you are not able to take the whole cost as a book expense, having the reverse effect: less book expense where more cash has been spent.)
The list may not be definite or exhaustive, but as you can see, there are not many ways to shield income from taxes. From a tax perspective, the best way to keep cash in your business from year to year is to make your tax bill as small as (honestly) possible. Here are a few ways to do so:
- Get educated and stay informed about credits and deductions offered to your business and figure out if you qualify or how you could qualify. Do you use part of your home for a work office? Are your cell phone and internet bills deductible? What business meals and entertainment are deductible? Go here to read a good article on business deductions.
This is a good place to remind you that making an expense just because it affords you a deduction is stupid math. Do not spend $1 for $.35 or less off your tax bill. Only spend cash for your business if the expense stands on it’s own legs.
- Keep good records of your expenses and deductions. We had a client who kept track of every cent paid in sales tax. She was able to take a sales tax deduction much larger than the estimate table number. (This case applies to an itemized deduction for an individual, not a business, but it illustrates our point!)
- Keep business and personal expenses separate to avoid losing any business expenses in your personal accounts. We can testify that when people mix business expenses with personal, they not only lose some, but it is time consuming and costly to fish them back out.
- Business structure influences the tax bill. For example, a corporation has to pay what is known as double taxation, which means the company pays taxes and then the shareholders pay taxes on the dividends handed out (and besides salary, that is how money makes it back to business owners). Partnerships and LLCs are taxed only once. Read more about how to choose business structure here.
- Salary vs. distributions is a trick of the trade and we advise you consult a CPA before doing so. A business owner does not have to take all he/she wants to be compensated in the form of salary, which automatically triggers payroll taxes. In partnerships and LLCs, some compensation may come as distributions, which triggers no payroll taxes.
- Use your loss by carrying forward or carrying back your Net Operating Loss. Did you have a year when business wasn’t so hot and you had a loss? Your loss can be used to offset future or past net income, minimizing taxes in those years. Note: this is only available to sole proprietorships, individuals, and corporations (not S Corps) and should be done with the help of a CPA. Read more about it here.
Having said all that, do you want to know my opinion of the best way to be able to have leftover cash from year to year for business growth without having to pay large chunks in taxes? Be careful of who you send to Congress!
Did I miss anything? Have any other good ideas? Feel free to share them in the comments!