As we begin another year of uncertainty, it is more important than ever to devise a budget, understand cash flow and build a tax plan.
Everyone is familiar with tax preparation, the act of preparing your tax returns and filing them with local, state, and federal governments. However, companies often fail to tax plan.
What is Tax Planning?
Tax planning is the act of considering every aspect of your finances and building a strategy to minimize your tax burden and take advantage of tax credits and deductions. Building a solid plan includes building and reviewing items such as:
- Budget
- Cashflow—past and future projections
- Tax Credits and Deductions
Budget
Having a quality budget is extremely important. It is beneficial to both tax planning as well as day to day operations. For example, if you build a budget and review it against actual numbers and find variances, you can adjust, learn from past mistakes, and identify growth opportunities.
A quality budget includes considerations like:
- What drives our growth?
- What will it take to achieve goals?
- Who will oversee those goals?
- How do we measure progress as the year progresses?
- With limited resources, what areas are worth tackling, what items are worth purchasing?
- Percentage vs. absolute dollar.
- Comparison of budget to actual numbers.
Often the above items are not included when building a budget. Many companies make common, yet critical mistakes, such as:
- Last year’s revenue plus 5%
- Projections based on gut feeling
- Failure to compare budget projections to actual numbers
- No real plan to execute
Cashflow
To have a quality budget, you need to ensure it reflects real cash flow. This means taking into consideration:
- Accounts Payable and Accounts Receivable
- Inventory
- Debt Payments
- Forecasted Balance Sheet
Tax Credits and Deductions
In addition to utilizing budget and cashflow for tax planning, it is imperative that a business is aware of all tax credits and deductions for which it may be eligible. * In order to have a true tax plan, a business needs to know not only what it may or may not qualify for, but also timing, limits, etc. in order to take full advantage of these programs.
Below are just a few examples of business tax credits and deductions that businesses often overlook:
- Research and Development Credit
- Not only the material, but also the wages
- Recurring credit you can get every year
- First year you can also amend backwards, so often huge first year cash flow
- Not everyone will qualify, but it’s a very short phone call to determine if it’s worth really looking into
- Example: Electrical contractor – able to use foreman and project manager time for the credit
- Employee Retention Credit (ERC)
- If your income is down compared to the prior year, worth looking into
- Adds up very quickly, you don’t need a lot of employees to see a significant credit
- Will not last forever, but may qualify for multiple quarters
- Ex) Client with 5 employees received $30k
- Ex) Client with 50 employees received credit approaching $2m
- Cost Segregation
- Typically seen when buying/building/owning own building for business use
- A study is performed by engineers to break down the components of your building
- Default depreciation life of real estate as much as 39 years, significant portions can be written off immediately
- Better line up tax deductions with otherwise nondeductible expenditures, such as large down payments or buildout expenses in addition to original acquisition cost
- One-time tax deferral per building acquired, but very powerful
- Could be useful for you or possibly something to mention to your customers that are buying/renovating as it may free up some of their budget in the process (recommend they consult with their tax advisor, avoid giving tax advice)
- Qualified Business Income (QBI)
- 20% of QBI taken as a deduction
- Not all businesses will qualify, review on case-by-case basis
- Limitations may not apply until certain income level reached
Summary
To take full advantage of tax planning, it is advisable to work with a financial services firm or virtual CFO. Though the main purpose is to reduce tax liabilities, proper tax planning can help a business:
- Take advantage of tax credits and deductions
- Plan for both growth and lean times
- Guide decision making
- Aid with overall financial health
- Uncover whether or not the right type of business entity is being used
If you need assistance with tax planning or have questions about whether or not you qualify for certain tax credits or deductions, schedule a consultation.
*It is important to remember that tax credits reduce the amount of tax you owe and are usually dollar for dollar. A deduction reduces how much of your income is taxable.
