By Ying Sa / Guest Column
I was at Starbucks on a recent morning, and saw a man putting his arm into the trash can and picking a receipt out of it. He saw me looking, and said, “I keep on forgetting this is a tax deduction – I need it!”
I smiled. Of course, it’s tax time. Who doesn’t need more receipts – especially if your tax person has already declared “no receipts, no deduction.”
What have you been doing to save on taxes for your business? Were you told to save all of your receipts for business-related expenses? Were you told to spend, spend, spend to reduce your taxable income? Are you concerned about paying too much on taxes? Have you literally borrowed money to pay taxes?
If you answer yes to the above questions, you could benefit from some three-dimensional tax-saving strategies. If you can master the concepts, you will no longer care about those Starbucks receipts, because you’ll already have gotten the tax savings you deserve.
The first ‘dimension’ is to determine the proper tax structure for your company. When starting a business, you must decide what form of business entity to establish. The most common forms of business are a sole proprietorship, a Limited Liability Company (LLC) or partnership, an S corporation or a C corporation. Having the right tax structure for your kind of business can bring huge tax savings to you.
For example, you and your partner are in business together. He has money, but no time; you have time, but no money. The correct tax structure will save your partner taxes when the business is in the startup stage, but it will also give you a tax refund and tax savings as the business takes off.
The second dimension is to choose the proper tax year for calculating taxes. Businesses have their own business cycles. You may choose a calendar year or fiscal year as your tax year. The calendar year begins Jan. 1 and ends Dec. 31. A fiscal year contains 12 consecutive months ending on the last day of any month except December.
Many businesses choose to operate on a calendar year, but seasonal businesses may see more of a benefit by ending their tax year in their slowest season. For example, if you own a construction company, you may make good money during the warm season, but not have a lot of income between the months of December and April. In this situation, you would set your year to end in April, as you will calculate taxable income at the time your income is at the lowest.
The third dimension is to choose the cash or accrual accounting method. There are two types of accounting methods that are mostly commonly used for tax filing: cash and accrual. Under the cash method, you include income in the tax year when you receive it and deduct expenses when they clear your bank account before year-end.
Under the accrual method, you generally include income for the tax year in which you have earned it, and deduct business expenses when the activities are performed.
For example, a doctor’s office would likely benefit from using the cash method so it doesn’t report income before it is received from the insurance company. Because of the insurance complication in the medical field, doctors normally do not know the exact amount they will get paid, making cash accounting a practical choice.
For retail businesses, accrual accounting is preferred, as businesses can reduce taxable income by deducting expenses such as inventories that were delivered and sold, but that have not yet been paid for.
These three dimensions combined can maximize your tax savings, and work magic for you and your business. The next time you have to borrow money to pay your taxes, you should ask yourself if you did your 3-D tax planning. Likewise, if you see the guy at Starbucks fishing receipts out of the trash, just tell him that he needs to think 3-D.
Ying Sa is the founder and principal certified public accountant at Community CPA & Associates Inc., with offices in Des Moines and Iowa City.