Individuals and businesses alike are already starting to consider their tax preparations for next year. Small and medium sized business owners searching for advice about “paying too much in taxes,” will see thousands of results populate.
However, business size tends not to make as much of a difference as people think. Both big and small enterprises can, and likely will pay too much taxes because of improper optimization.
Before getting started on a major adjustment to your tax strategy, it is important to understand exactly how the legal structure of your company will shape the way taxes are assessed and even paid. Private businesses in the U.S. are typically one of the following: sole proprietorships, partnerships, C- and S-corporations, or limited liability companies – all of which have slightly different procedures.
Under a sole proprietorship, for example, an individual reports income and loss on their regular income tax return to the IRS, otherwise known as pass-through taxation. While they can deduct business expenses as they would on another tax return, they will also be liable for Medicare and Social Security taxes. These individuals may find that choosing to become a C-corporation instead might lower their tax obligations in dollars and cents – albeit with a tradeoff of a lack of simplicity that may be essential for certain types of ventures.
Additionally, improving your tax reporting is not the same thing as improving the business’s tax strategy through optimization. Instead, consider assessing the deductibility of your expenses, payroll and income tax obligations as well as any applicable deductions; working to reduce your taxes by maximizing credits, shifting income from high rates to low ones; and integrating your tax approach as part of a broader strategy to generate and sustain new sales, investments or wealth. Four strategies for doing so are recommended.
First, work with a skilled tax attorney to map out the company’s existing ownership and entity structures. This process will help the legal team identify exactly which changes can be made based on specific rules. Examples of this include registering a business in a different state for tax purposes, a procedure that will vary between the different tax structures, or reviewing S-corporation payroll taxes.
Second, carefully consider leakage points in your business strategy, such as poor cash flow that could be holding the business back both in assessing tax liability and in general growth terms. Doing so will also mean maximizing your net operating loss, or NOL, carrybacks. It also means reviewing tax rates at the state and local levels to assess whether you could be overpaying. One such example is one of your vendors mistakenly levying you on exempt items when those items travel across state lines.
Third, understand what changed both pre-COVID and post-COVID. The CARES Act in 2021 provided sometimes sweeping tax savings opportunities, including suspension of normal rules around excess business losses for individual taxpayers, providing special credits like the Employee Retention Credit, and changing the deduction of business interest expenses. The majority of these changes, however, were not permanent. With many pre-COVID changes from the Tax Cuts and Jobs Act sunsetting in 2025, next tax year will be one of the last times businesses can optimize the credits and specific programs they are using.
With this in mind, the fourth strategy is to understand – both short-term and long-term – how well your business is prepared for any eventualities and their tax implications. In a time of rising costs, labor market woes and fresh variants of the COVID-19 pandemic, businesses can expect to find themselves in continued tight squeezes, most likely without the same levels of outside support they received before. This is why working closely with a tax attorney now to successfully optimize your operation is an especially important priority.
Procedural errors, those that happen when forms are accidentally filled out wrong or contain omissions, occur that lead C-corporations and others to overpay. But more commonly, other companies do not have a tax strategy that effectively balances meeting the letter of the law with taking advantage of all the options available to them. This often happens over a longer period of time. If business owners sat down and did the math, they could find anywhere from tens of thousands to millions of dollars lost. The goal, instead, is to pay what you owe, and channel any savings back into your operations and long-term planning – a must in such uncertain times.
