Most businesses start out with a growth phase where they are not profitable for the first few years. Sometimes they've been profitable but market conditions such as the recession from a few years ago sets them back. In either case, there's a struggle to get ahead and find the light at the end of the tunnel. However, if the business owner isn't careful, that light at the end of the tunnel could be a train full of taxes coming to run them over.
An outsider might look at a business and ask why the owner isn't planning for taxes when they've become profitable. One answer to this question is the owner may not even realize they're profitable. Consider the owner who, in becoming more profitable, pays off loans, credit cards and other debts. Many business owners don't understand that paying off debt principal is not a deductible expense. It does however use up cash necessary to pay taxes. Another situation is the building up of inventory in a retail or manufacturing business. This inventory is not deductible until it is sold. This inventory buildup again is using cash generated by the profits of the company which could be set aside for taxes. There are other scenarios which can drain cash necessary to properly plan for the tax impact of a company's profits. Obviously the owner's lifestyle can contribute to this also.
The key for any business owner is to have conversations with a qualified accountant or advisor before year-end. A good accountant can analyze the owner's financial statements, and explain in understandable terms what the financial condition of the company is. With that information the accountant can make recommendations for the business owner to reduce the tax impact of the profits, or to free cash necessary to pay the tax.
Steps in reducing the company tax can include buying certain types of equipment that can be fully depreciated (written off) in the first year, contributing to a retirement plan, or restructuring the business to a more tax-friendly entity.
The owner can plan for the taxes they will need to pay by setting aside a percentage of each day's receipts. These funds can be used to pay the taxes due following the year-end, when the tax return is done or prepaid as estimated tax payments to minimize the final tax bill.
If the owner gets in a position where thy simply don't have the funds to pay the taxes, they can and should be proactive in establishing a payment agreement with whichever tax authority they are behind with, federal or state. These agreements require the business to remain current with all future tax payments as well as the payment agreement itself. This forces the business owner to plan for both current and future taxes.
Obviously every business is different, and the options provided in this article are general in nature. The business owner needs to have in depth discussions with their accountant in order to develop a solid tax management plan which takes into consideration the cash flow needs of their particular business. Such a plan will ensure the business owner pays the least possible tax both in the current year and in future years, and has the cash available to do it.
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By Kurt Heling CPA of Alberts & Heling CPA's LLC