Very little in business is guaranteed. Even a well-planned marketing and sales campaign cannot guarantee results. But those businesses that take tax planning seriously are almost always guaranteed to pay less in taxes than those businesses that don’t take it seriously.
A good business owner has systems and reports to manage everything from prospect conversion to product returns. But these same managers often fail to even consider managing their income tax liability. When income tax is one of the biggest business expenses, after material and labor, why don’t they?
Most business owners rely on their tax preparers to make sure they are paying the lowest income tax possible. What normally happens is they drop their tax information off with their CPA, spend a few minutes saying hello, go over any big items that may have changed from the prior year, and then forget about it until they are called to pick up the finished return. Then they pick up the return, see what they owe, write the check, and complain about how high income taxes are. They believe that the tax preparer will let them know if there is anything they can do to reduce taxes.
And this is a big mistake!
When most tax preparers are preparing your return, we are mainly concentrating on compliance. In other words, we are working to correctly report on the income tax return what has already happened in the prior year while following the tax law and all IRS rules and regulations. We may notice a few big items and discuss them with you. But at that time, our focus isn’t on tax reduction. Any good tax preparer is so busy that they really don’t have time to think about tax cutting during tax season.
That is why it is so important for a business owner to find a tax preparer who takes the time after their busy season to sit with them and design a customized plan to reduce their income tax.
Now I’m not saying that you, the business owner, must become a tax expert. But you must at least have a basic understanding of the rules of how the tax game is played.
Remember the last time you took someone to a baseball, football, basketball, or hockey game, and they didn’t know anything about the game? If no one takes the time to explain the rules of the game, they will quickly become bored and lose interest in the game. It is really hard to enjoy watching or playing any game when you don’t understand what is going on, how the game is won, or what the rules are. Winning at the “tax game”, which I define as paying the lowest liability legally possible, is also impossible for the business owner who doesn’t take the time to learn the basics of how the “tax game” is played.
Now being an informed sports fan does not mean that you would know enough to coach a pro team or even a youth team. That takes a level of understanding and expertise far above that of the normal fan. You are not trying to become a tax expert, and if you have a business with any complexity, it is foolish to try to prepare your own return without help. You most likely will never match the expertise and experience of a preparer who has prepared thousands of business tax returns in their career.
But you are not trying to become an expert. You are only trying to obtain a basic understanding of the tax system that will allow you understand how and when the tax system affects your everyday business and personal life, and to know when you should call your tax advisor for help and advice.
But I’m Too Busy to Worry About Tax Planning! That’s Why I Hire a Good CPA!
I hear this very often from business owners, particularly from those business owners that owe more in taxes this year than they expected. What they fail to understand is that there are substantially fewer things we can recommend that they do to cut taxes once the year ends!
A smart business owner understands this, and lets their tax advisor help them. Let me illustrate this with two real examples from this last tax season.
Business Owner A dropped off his income tax information in March as usual. His business increased grew that year, so when we prepare the return, he owes $25,000—more than he has ever owed in the past. He gets angry, grabs his stuff, tells me I’m not doing my job, and storms out. What he forgot was that the year was already history! There is nothing I can do now to change what actually happened.
Business Owner B also has a good year with an increase in sales and profits. But he calls me in October before year-end and tells me this. I do a quick estimate and tell him that he is going to owe about $90,000 in taxes. I recommend tax planning, which he agrees to. Now my fee for intensive one-on-one coaching is not cheap. But when we are done, I am able to present him with a plan that is estimated to reduce his taxes to about $25,000. When I do his return, he owes $28,000. (Remember, I prepared an “estimate”. Even the best crystal ball isn’t perfect.) He pays it with no drama and thinks I’m a genius for helping him save $60,000. Not a bad return for my $2,500 fee!
So How Much Can I Save?
At this point in the conversation with a business owner I am often asked, “Is tax planning really worth my time?” Well, let me share with you a few real-life examples of how much business owners have actually saved working with me on intensive tax planning in the last couple of years:
- A manufacturing company reduced their taxable income from $591,000 to $230,000 and saved $125,000 in income tax.
- A retail company cut their taxable income from $471,000 to $147,000 and saved $108,000 in income tax.
- A dentist reduced their taxable income from $299,000 to $234,000 and saved $22,000 in income tax.
- A consulting company cut their taxable income from $1,341,000 to $857,000 and saved $277,000 in income tax.
From these examples, we can see that 1) tax planning can reduce your tax liability no matter what kind of business you run, and 2) it is well worth the business owner’s time to be proactive rather than reactive when it comes to tax planning.
Let’s put these tax planning savings in a context that most business owners can better understand. For our example, let’s assume that the manufacturing company above had a profit margin of 10 percent (income before tax of $591,000 divided by total sales of $5,910,000). In order to for this company to increase their bottom line by the $125,000 in tax savings, they would have to increase sales by $1.25 million in order to attain the same increase in their bottom line ($1,250,000 times 10 percent = $125,000 in increased income). To put it simply: They would have to get $10 in sales for every $1 in tax savings.