By: Matthew Andersen, CPA
Taxes are the largest expense you will face as an entrepreneur. They can be a major burden when you need capital to grow your infrastructure, team, and impact in the market. Cash is the precious resource that we all need to keep on hand. So, how do you keep your cash on hand and use it for fuel to grow your vision? It all starts with expense reduction. Reduce the expenses that do not have a measurable ROI to your business. Despite their significant ROI in our community, taxes have 0% measurable ROI for our businesses. Therefore, taxes are a good place to start.
The details for a thorough tax strategy are very complex and depend on the goals of the individual. We have found our team can easily work between 20-40 hours to design a plan to reduce taxes with measurable impact. That being said, there is a general framework that any entrepreneur can follow to reduce the burden on cash that taxes play.
There are three primary strategies to reduce your tax burden:
Defer Tax Liability
This is the easiest way to reduce taxes with minimal impact to cash – kick the can on paying taxes to next year or years from now by increasing expenses, making capital purchases, or saving for retirement. As the saying goes, a dollar today is more valuable than a dollar tomorrow; keep that cash on hand for now and worry about the taxes at a later date. Our objective in deferring tax liability is to find ways to increase expenses or decrease revenue in the current period. This will reduce the taxes you will be required to pay.
Change the Nature of Your Income
Did you know that not all income is taxed at the same rate? The money you earn in your paycheck is one of the highest taxed forms of income, and there are investments you can make where you’ll pay ZERO tax on the income. So, by changing the nature of the income you receive you can further reduce your tax burden.
Change Who Pays the Tax
That’s right, you don’t have to be the sucker on the hook for paying the tax! There are structures and methods available to reduce your liability by simply changing the taxpayer responsible for the tax. If done right you (the entrepreneur) can reduce your taxes and the taxpayer you transferred the responsibility to may pay at an even lower rate, or possibly ZERO!
We conclude with a warning!
There are two big red flag options that we see entrepreneurs pursue all the time in an effort to pay as little tax as possible.
- Do not spend money solely for the sake of NOT paying taxes. The worst, but most common example of this is buying an SUV or truck just to reduce taxes. This deduction has a NEGATIVE ROI, arguably WORSE than paying taxes.
- Do not take deductions that are not business related. As we will explain in a post later this month, this has more implications that just an IRS audit. For now just know that the IRS has strict deduction rules in place, and stretching them is the easiest way to get caught. Don’t take the risk!
In this post we have explored a basic framework and provided basic do’s and don’ts regarding tax strategy basics. This month we will be delving deeper to provide more examples and clear steps for you to take to jump-start your own tax plan. Come back later this month to read parts two and three of our Tax Strategy series!