When it comes to handling tax planning, most people behave reactively. Unfortunately, most businesses handle their taxes like most people.
Perhaps this vignette sounds familiar. For these reactive people and entities, the tax year starts in January and tends to go like this:
- Scramble to put together all necessary documentation on time in order to send to your accountant (or enter into the computer program).
- Wait and see what the result is and how much you owe, hoping that you haven’t underpaid by too much.
- Pay what you owe and grumble the whole time, promising yourself to meet with your CPA after tax season.
- Go about the year, do your work. Get into firefighting mode, get distracted, put off calling your CPA.
- Arrive at the end of the year, thankful for a break and to enjoy the holidays.
- Repeat from step one.
In case you haven’t guessed it already – that’s the wrong approach. Think about your own life, if you’ve reached any level of personal or professional success when has “wait and see” ever really paid off?
Proactivity is where the high returns are. You go after clients (or attract them to you), ask for the sale and actively improve your product. In your personal life, maybe you worked hard to attract your mate or to buy your dream house in a fantastic city.
Rarely does a successful person merely “wait and see.” Proactivity is how gains are made, how people get what they want out of life.
So how about proactively working out a tax strategy? With a plan (and a professional) you can look ahead and save a ton of money. Rather than getting surprised by the tax bill at the end of the year, you can make purposeful decisions that help you keep more of your money.
Why Should You be Proactive About Tax Planning?
There are a few key advantages to proactive tax planning, but it starts by helping you avoid surprises. This means you’re looking ahead and know what’s coming before it gets there.
By implementing proper tax planning, you’re able to estimate in advance what you’ll owe in taxes. This way you’re sure to have the cash set aside and you can avoid fees generated by late payments.
But that’s just the tip of the tax planning iceberg. The real advantage of proactive vs. reactive tax planning is making sure that you’re taking all possible deductions and not overpaying.
What could proactive tax planning look like for you?
Reactive Tax Planning
First, let’s start with what proactive tax planning isn’t.
Perhaps you’ve already got a tax team, either in-house or you hire an external service. Unfortunately, just having a tax team doesn’t mean you’re tackling taxes head-on. At the outset of this article, we illustrated a good example of how not to handle your taxes. While clearly an uncomfortable situation for the business owner, the cycle doesn’t even touch on the fact that this business is probably paying way more taxes than necessary.
Reactive tax planning tends to not be more than simple number crunching and repetitive data processing. It’s often about scrambling to meet deadlines and frantically scrounging up the cash when the quarterly payments are due – if the payments are on time at all.
Further, while meeting regulatory and compliance requirements is critical for startups and mature businesses alike, that can’t be the end of the story. Proactive tax planning is more than compliance-only filings.
Proactive Tax Planning
So how could this look at your company? What does proactive mean?
Webster defines it as “acting in anticipation of future problems, needs or changes.” At its core, that’s what proactive tax planning boils down to: anticipating and steering tax issues based on the needs of the business.
More concretely, that could mean:
- Timing expenses and income (if your accounting system allows it) around the year-end to adapt to changing tax laws or business projections.
- Defining how much cash to set aside each month for your quarterly tax payments, based on your annual budget planning process.
- Identifying tax credits available to the business (this is a good one).
- Looking ahead to changes inside the firm or to the market as a whole.
- Anticipating audit and tax risks – giving you time to prepare and implement corrective measures.
The list could go on, but a comprehensive and proactive approach to taxes is more than just looking ahead. It’s also being strategic. For example, in some cases when planning for capital purchases a business can elect to take an accelerated or special depreciation. This could create a smaller tax burden in the years of the purchase. There might also be the option to take the de minimis deduction and immediately write off smaller purchases (normally <$2,500).
Innovative and Thorough
There’s an old joke about creative accountants ending up in jail. But while the laws are clear, that’s a little bit dark. Modern tax codes are full of exceptions, loopholes and special situations. Because of these nuances, it’s not realistic to expect the CEO to have a working knowledge of the ins and outs of tax planning. Indeed, too much creativity in an accountant could be dangerous. However, a good tax professional needs to be innovative while staying inside the law of course.
For example, did you know that different legal entities are taxed differently? Choosing the correct legal entity can have a dramatic effect on how the business’ income is taxed. A CPA who offers tax planning services would know that moving a Schedule-C business to an LLC or S-Corporation could drastically reduce taxes.
Depending on the niche in which your business operates, there could also be special strategies to maximize your deductions – thereby reducing your tax burdens. Often, federal, state, and local governments give tax credits to businesses to encourage them to operate in certain locations or to reward them for “going green”. The best part about credits is that unlike deductions, which reduce your taxable income, credits reduce your tax bill directly.
A proactive tax plan built by collaborating with an innovative and thorough tax professional can help you minimize your tax burden. They know what to look for, the right questions to ask and how to help you make the best decisions for your business.
Reactive tax planning tends to rely on accepting things as they are. Plug the numbers into the system and pay the amount it says is owed at the end of every quarter, never asking questions.
But a proactive approach recognizes that tax planning is far more complex and far more valuable than simply crunching the numbers.
The Bottom Line
If you haven’t been thinking about your taxes proactively in the past, you’re not alone. Most people like to avoid thinking about tax as much as possible, but they’re reactive and not proactive.
But now’s the time to change that. “Wait and see” doesn’t work. A professional can help you adjust your approach, and get more proactive when thinking about your taxes.
Rather of getting surprised by your tax bill at the end of every year, Pasquesi Partners can help you define and set up the most tax efficient business structure. We’ll also make sure you’re maximizing deductions in order to minimize your tax burden and keep more cash in your pockets.