For many business owners, tax time equals stress. It’s not only added work in the first quarter but also added anxiety wondering whether cash will be due to the federal government on April 15. Here are six tax strategies to think about this year that could reduce future tax payments for any business owner.
1. Choose the Appropriate Tax Structure
While you cannot change business structure to affect 2021 taxes, you can think about your business strategy for the future as it relates to potential tax implications. Business organization structure is especially important if you plan to sell your business. For example, if your succession plan involves private equity, a C-corporation may be the best option.
Most business owners choose a flow-through entity because there is one level of taxation with a qualified business income deduction, which can give business owners up to a 20% deduction on their flow-through business income.
2. Separate Personal Finances from the Business
Our business is a niche loan services company. Too often, we see business owners run personal expenses through their business. Their goal is to, in effect, have no or lower income tax to pay at the corporate level. However, if owners need to borrow money, the books show reduced cash flow and net profit. This makes lenders hesitate as they consider the risks related to a potential loan approval.
This strategy also can impact a business’ valuation during a merger or acquisition. If you’re running personal expenses through your books and the buyer looks at your business health, seeing zero or low income, can negatively impact a possible sale and sales price.
3. Take Distributions Instead of a Salary
Instead of running personal expenses through business accounts, taking distributions for salary payments can equal huge savings. Some owners pay themselves a salary above what they necessarily need, rather than taking as needed distributions to get the cash into their pockets. Reclassifying salary payments as distributions typically means they are payroll-tax free.
4. Participate in a Cost Segregation Study
Another great tax strategy is a cost segregation study. This study divides a property into distinct components and allows owners to depreciate the property assets at various rates by separating components into different categories. The result is an accelerated depreciation schedule, which can reduce the amount of taxable income and increase the after-tax cash flow considerably.
5. Contribute to a Donor-Advised Fund
Philanthropic business owners have options for making donations that are advantageous to their taxes each year. One of those options is a donor-advised fund, which acts as a public granting organization. A donor-advised fund creates an account to make charitable donations to chosen non-profit organizations. The fund allows you to manage the distributions at your discretion as part of an overall tax strategy.
6. Find partners who understand your business
A key strategy to implementing the best tax practices for your business is finding consultants who are very familiar with your industry and your risk tolerance. The tax code is far and wide, and it is challenging for one person to be an expert in every industry. The right consultants will help to ensure you are taking advantage of all the tax provisions that may apply to you.
A closing thought to consider: Business owners often take a wait and see strategy to make decisions. As a former CPA and current business owner at a lending institution, my best piece of advice is do not pause business decisions based on pending legislation. Continue business as usual along with these tax strategies to benefit your company and lifestyle.
Remember these tips are for informational purposes only. Always consult with your attorney and CPA directly on these strategies.
Rick Dennen is the founder, president & CEO of Indianapolis-based Oak Street Funding, a First Financial Bank company with customized loan products and services for specialty lines of business including certified public accountants, registered investment advisors and insurance agents nationwide.