By: Matthew Andersen, CPA
Thanks for joining us for the final installment of our month-long journey into strategic tax reduction. So far, we have explored the general framework we use for our clients, the risks of being too aggressive beyond an IRS audit, and today we complete our series by providing clear actionable ways to reduce your tax burden.
Before we jump in, it needs to be said that all tax reduction strategy requires cash. Without cash you cannot reduce you tax burden. That being said, the goal is to spend your cash in areas that will give you future ROI. Below we outline four actionable strategies within our general framework in the order of the timeframe in which your cash will be returned.
Defer the Taxes Until a Later Date
- Prepay business expenses: Each December pay all expenses that you can for the following month. This is the quickest and easiest way to increase your business expenses for the year and make the most out of your tax return.
- Make investments at year-end that will generate ROI in the next year: Marketing campaigns, training for you or your team, hiring consultants that can help you to build infrastructure, making new hires, etc. are all great investments that are sure to generate long term ROI. This allows you to defer tax by reducing income in the current period and make more money in the future from these investments.
- Buying equipment that will create more income: Purchase equipment or vehicles that meet the IRS’s rules on accelerated depreciation and generate positive ROI. We have mentioned in a previous post about how bad purchasing an SUV is for your business. Ultimately, the negative impact of buying an SUV comes when the purchase is made solely to avoid paying taxes, and the primary use of the vehicle is for the owner to drive it. It creates no future cash flow, the asset decreases in value, and it will cost you money to operate and maintain. However, a “good” vehicle purchase would be buying a vehicle that will be used by an employee to transport materials to a job site, or a piece of equipment that will increase production capacity. Making the right investment makes a difference!
- Retirement planning: You can defer between a few thousand dollars a year to hundreds of thousands of dollars depending on your retirement plan. Find what works for you and maximize the contribution.
Change the Nature of the Taxes to Lower Rates
- Municipal bond interest: This form of income has minimal (if any) tax burden. If done properly it may also have no state income tax burden.
- Capital gain: If you make investments in assets that go up in value and hold them for a year, you can reap a tax savings of 22% from the highest federal income tax bracket.
- Qualified dividends: Buy stock that pays a dividend that meets the IRS definition to qualify for the lower capital gains tax rate. For a definition of qualified dividends, refer to Publication 550, Investment Income and Expenses (PDF).
- Grow your business enterprise value: Your business is an asset that represents a significant portion of your net worth. Growing your company’s enterprise value increases your net worth, requires you to pay no tax on the growth, and will be mostly taxed at the capital gains rate when sold.
Change Who Pays the Tax
- Paying your kids: If your children are of legal working age, you follow child labor laws, and the children perform services for your company, their income tax bracket may be less than yours. How does this help lower your taxes? Since their tax bracket is likely lower, their income can be used to pay for their expense – with less tax paid. Their income is then taxed at a lower rate than yours, which, without paying them, would have come out of your higher tax bracket income.
- The structure of your business: Your business structure can change the impact of taxes. For example, C-corporations accumulate capital at a lower tax rate than other entities and S-Corporations can reduce self-employment taxes. Re-examine your structure to see if it is properly boosting your tax savings.
- Making happy employees: Share the success of your company with your employees! Again, we assume that your employees are taxed at a lower rate than you, the entrepreneur. Using financial incentives (i.e. paying bonuses), we believe we can reduce your taxable income, and by default your tax liability. The non-financial benefit can far exceed the cost as your investment is returned in the form of increased productivity, happier teams, and greater loyalty. Bonuses, benefits, time off, etc. may have no immediate measurable ROI but the non-financial impact can be huge!
- Charity: As an entrepreneur we all have dreams of leaving this world better than we found it. Making charitable donations can make that impact while also reducing your tax burden. There is no future benefit your business will receive, but amplifying your impact is immeasurable.
There you have it! We hope you have picked up some beneficial tips from our Tax Strategy series. Here at MD Andersen, CPA, PA we’re always looking out for ways to help our fellow entrepreneur, and these steps are a great place to start. If you want more guidance in expanding your personal tax plan, contact us today so we can help you to get back on track in making your tax return work for you.