Tax planning strategies are commonly addressed in December as small business owners and other taxpayers start to freak out about bringing in the New Year. However, tax planning is an ongoing and fluid dynamic, and it should be performed methodically throughout the year. Sure, we can slam things together on December 31, but that is operating in crisis mode. Rather, operating in planning mode throughout the year allows for better decisions and better tax savings.
Tax Plans
As mentioned earlier, tax planning starts with the tax return, and from there we have some fun. Let’s put aside small business tax deductions and other tax reduction strategies for a moment. Tax Plans, the actual deliverable, are fairly basic, but are super critical. We don’t mind telling you bad news in August, but you shouldn’t be surprised by it in April. There are worse things, but one of the challenges of small business owners is having money in the bank and not knowing how much is theirs. Can I buy a new car, or should I look around for a used one? Your level of frugal-ness is commonly tethered to how much cash you have. Not always. Not dollar for dollar. But certainly influential.
When WCG prepares a tax return we automatically prepare a Tax Plan for the follow year. From there we tweak it and stress-test it again in June and July, and again in November and December (provided there is a greater than 10% change in income from the current tax projection). A quick word; tax planning and Tax Plans do not require NASA precision, however, they do require slightly above bar napkin quality too. Far too often we entertain conversations from taxpayers and small business owners who created elaborate spreadsheets with fancy formulas and color-coded cell references. We smile, and say, “Neat.” The proof is in the tax return pudding… let’s fire up the beaters shall we?
As such all our Tax Plans end in creating mock tax returns. Again, tax returns are the ultimate measure of tax obligation using current tax rates, tax law, tax deductions, tax credits and all the other things you’d expect on an actual tax return.
Business Tax Deductions
We don’t want to spend a lot of time on business tax deductions in this blog post. We have written a whole chapter in our Taxpayer’s Comprehensive Guide to LLCs and S Corps on business deductions. We have other blog posts on buying automobiles, home office deductions, maximizing 401k or defined benefits pension contributions, adding your spouse to payroll, Accountable Plan reimbursements, Sutter Rule and all kinds of other cool things.
But we need you to keep a few things in mind. First, you buy stuff for operational need (or for fun). If we can make your expenditure a tax deduction or a tax credit, then awesomesauce all around. But! Do not spend money just for the tax deduction. If your marginal tax rate is 24%, spending $10,000 saves you $2,400, sure, but you still have $7,600 in cash leaving your body.
Far too often we hear “but it’s a business write-off” at a cocktail party… just because it is a business tax deduction doesn’t mean the cash isn’t real. Houses are green and hotels are red in Monopoly, but your cash is still your cash.
Second big consideration is this… at times we run out of bullets in tax planning gun. The quickest way to reduce your tax bill is to make less or spend more. Both of those options sound silly. Again… same cocktail party… different crazy person… and we hear, “I don’t want to make too much money because it’ll just be taxed.” Nonsense. The highest marginal tax rate is 37% which means for every dollar you earn you still take home 63 cents. We understand your effort might not be worth 63 cents… and that is a personal thing… but 63 cents isn’t 91 cents.
91 cents?! In 1965, the marginal tax rate at $400,000 was 91%. Sure, $400,000 is a crapton of dough… and sure… it might have made sense to stop working in October if you are only taking home 9 cents on the dollar. Today, that thinking might be short-sighted. According to Investopedia in an October 2019 article, the U.S. ranks 21st in terms of effective tax rates for married people with Turkey, Denmark, Finland, Netherlands and Norway rounding out the top 5 highest tax rates.
The trick with small business tax deductions is to find dollars that are already leaving your body and that you are comfortable with spending from a budget perspective, and attempt to find a business connection. Was that meal with an associate who might also be a friend a business meal tax deduction? Could I justify a home office and reduce my non-deductible commuting expenses? I need a new car, can it be a business car?
