The Income Tax Impact – Tax Planning Strategies
Tax planning strategies range from the very simple to the excruciatingly complex, but they all have one thing in common: they seek to minimize your overall tax bill. There are dozens of means available to help you accomplish this goal, from gray areas to loopholes to income shifting to tax deferral. Most sound strategies use a combination of methods to keep income taxes to a bare minimum.
There are two major ways to cut down your tax bill: reduce your tax- able income, or reduce your tax rate. You can lower your taxable income by taking full advantage of allowable deductions, especially those that are deductible to businesses but not to individual taxpayers (company cars, for instance). While you can’t literally reduce your tax rate, you can do things that have the same effect, such as shifting income to the entity that will pay the lowest tax rate, or taking steps to minimize income that would be subject to self-employment tax in addition to income tax.
Loans and Leases
Some of the neatest tricks for getting money out of your business without incurring either double taxation or self-employment tax include loans and leases. While these two items may seem to have nothing in common, they do share one important factor: you need a legally binding contract to really make them work and to keep them from being reclassiﬁed by the IRS.
Loans are a great way to get money out of the company, whichever way the money goes initially. When you want to put money into the company without changing your equity standing, you can give it a loan and take back payments. This is especially beneﬁcial with C corporations, where you can’t get equity contributions back without invoking taxable dividends. If you need a lump sum of cash from the company coffers, treating it as a loan won’t set off any tax liability.
The key is to have a written legal loan agreement in place, and that has to include:
- Date of the loan
- Original loan amount
- Payment schedule
Yes, your loan has to include interest, at the current going rate. When you don’t charge interest, the IRS will, and in that case you’ll have to pay tax on that interest income even if you never actually got it.
Don’t confuse tax avoidance with tax evasion. Tax avoidance involves using 100 percent legal means to reduce your tax bill, which is some- thing you have every right to do. Tax evasion, on the other hand, employs illegal methods to get out of paying taxes.
Leases allow you to rent property to your company. That rental income will be taxable but won’t be subject to double taxation or self-employment tax. Any form of rent expense is deductible to the company. However, you cannot use this in connection with a home ofﬁce.
Get the Family Involved
When it comes to income shifting, paying family members in the lower tax brackets can be an excellent way to go. Get your kids involved in the business, and give them paychecks. This gives a beneﬁcial twist to just doling out allowances: your kids have some job responsibility, and your company gets an expense deduction.
In order for this plan to work, your kids have to actually work for the business in an age-appropriate capacity. You can hire your ﬁve-year-old to sweep up, your ten-year-old to do the ﬁling, and your ﬁfteen-year-old to work the register. Once they’re employees, you can even include them in your company’s retirement plan.