Why Does Tax Planning Work?
Tax planning works because the business owner learns to appreciate that the tax law affects every aspect of their life and then learns how to plan their finances in a way that minimizes their tax liability.
When I say the income tax code affects every part of your life, I’m not kidding! Your income tax liability is affected by the birth of a child, having that child in a daycare, going to college, a marriage, a divorce, retirement, starting or closing a business, buying or selling a house, and many other “life events” that happen in the ordinary course of life. Even your death is a taxable event!
If you own a business, every transaction you do has a taxable event. How you structure it, time it, record it, and document it will have a tremendous effect on how much you end up owing in income tax.
So tax planning works when the business owner makes a proactive choice to learn how the “tax game” is won and constantly structures their business transactions in a way that minimizes income tax.
How Does It Work?
All tax advisors follow the same basic process when it comes to tax planning:
- Start with your company’s year-to-date income as of today.
- Estimate your sales and expenses from now until the end of the year.
- Make a tax projection based on this projected income for the year.
- Create a customized plan that lists the individual tax savings ideas and the tax savings that will result from each one.
While creating your plan, you need to pay particular attention to the savings in comparison to the cash expenditure required. Remember the following basic business rules:
- You don’t want to spend a dollar in order to save a quarter in income tax. Remember, a dollar deduction does not equal a dollar of tax saved! Even in the top 35 percent bracket, spending a dollar normally only saves you thirty-five cents.
- You should only buy equipment or consumable supply-type items if it is something you were planning on buying in the near future anyway.
- If in doubt, ask yourself: Does this expenditure help me increase sales, cut costs, or increase efficiency in my business? If not, you probably should not be spending the money just to cut your income tax bill.
Of course, no one can tell you how much tax planning will save you in advance. I often tell my clients that even if tax planning saved them nothing, at a bare minimum, they will know in November or December how much they will owe in taxes in March or April of the following year. My experience is that when a business owner knows they will owe $20,000 four to five months in advance, they will find a way to get the money. But they seem to get upset if you tell them on April 10th that they owe $20,000 by April 15th.
My experience is that you will save on taxes every time you take the time to do year-end tax planning and educate yourself on how to win the tax game!