How to ensure your small business is fulfilling tax requirements and maximizing cash flow
by Robert Lerose.
Every year brings new changes to the tax code that can have an impact on small businesses, and this year is no exception. For example, in 2013, new taxes on Medicare for earned and unearned income will come into play for the first time as part of President Obama's healthcare legislation. Amid the welter of changing regulations, there are some steps almost every business can take to ease the burden of tax planning and keep the cash flow moving in the year ahead.
Set aside a fix amount
Being responsible for your own taxes can be an unfamiliar and startling concept for those new to running a business. Some individuals who have been used to having taxes automatically deducted when they were salaried employees may not be prepared for paying quarterly taxes when they make the transition to business owner.
Perhaps the most common outcome of this circumstance for business owners is not putting money aside to pay estimated taxes every quarter. "I see this all the time," says Barbara Weltman of Big Ideas for Small Business and author of J.K. Lasser's Small Business Taxes 2013. "They get used to the idea that the money coming in is available to be spent," instead of dividing it accordingly.
Putting a fixed percentage of every dollar generated, such as 25 percent, in a separate account to meet ongoing tax obligations is a simple, practical solution. A business may also decide to incorporate to save on their taxes. Choosing the S corporation route lets shareholders pay tax at their personal income tax rate and sidestep the corporate rate.
Regardless of the structure a business chooses, keeping good records is essential. Weltman also recommends that small businesses get outside professional help for tax planning and preparation. In addition, small business owners who are knowledgeable themselves about changes in the tax code will be able to make informed decisions.
For example, Section 179—which covers deductions on new and used equipment—was expected to be reduced to $25,000 this year. However, due to the recently passed “fiscal cliff” deal—or, more formally, the American Taxpayer Relief Act—the limit was enhanced to $500,000 for both 2013 and, retroactively, for 2012. "There are certain tax provisions that many small business owners might want to take advantage of," Weltman explains. "For instance, if you're a contractor who needs cement mixers and expensive equipment, this might be the time to do it. Section 179 will go to $25,000 in 2014 unless Congress acts."
Know your business’s tax needs and opportunities
Getting referrals from trusted sources—such as bankers, attorneys, or other business owners—is a good first step in looking for a tax professional, Weltman says. As with any service provider, each advisor may offer different benefits. For example, John Beidle, the president of St. Louis-based 1040 Wealth Designs, represents taxpayers in front of the IRS. He also says he teaches business owners how to pay the least amount of tax legally possible.
Often his first step is to review past returns to understand the unique circumstances of a business before making suggestions. One problem he runs into often is when a business tries to do too many different things as a single business entity without realizing the various tax consequences for each activity.
"I run into Internet consultants and software people who might be publishing an ebook or selling an online membership—but they don't realize that they can categorize a percentage of that as passive income," he explains. "I find a lot of missed opportunities for business owners."
Besides looking for these hidden opportunities, small business owners can avail themselves of other ways to maximize their cash flow. "The best way is to situate yourself so you're getting paid immediately by taking cash, credit, PayPal, or any other payment form," Weltman says. If you have to invoice, try to get paid in increments as milestones in the transaction are reached. Finally, send invoices electronically and always follow up on late payers. "Accounts receivable are not fine wine," Weltman says. "They don't get better with age."
Tax accounting made simple
A little planning and a little discipline is all it takes to make tax planning just a regular part of running a business. Case in point: The Albany Distilling Company, a small micro-distillery that uses mostly New York State agriculture ingredients in the manufacture of its small-batch rum and whiskey products.
Founded in March of 2011, the two-man operation took prudent steps from the very beginning to deal with their tax requirements. "We have two accounts: our checking account and our money-to-pay-taxes account," says co-owner John Curtin. "Whenever we make a deposit or do a transaction, we make sure the taxes associated with that transaction immediately go to a separate account. We do not access it other than to pay taxes."
In addition to their standard corporate tax, Albany Distilling must also pay quarterly taxes to the federal and state government for the alcohol they produce, and sales tax for items sold in the retail section of their distilling operation—a total of four separate taxes.
"It's really important that we keep our tax money untouchable," Curtin explains. "We figure the taxes monthly and set the money aside and pay them when they're due." He and his partner use an accountant to handle their financial chores, freeing them to concentrate on producing product.
It's too early to predict sales for 2013, but Curtin hopes his start-up will hit at least $75,000 to $80,000 in revenue by year's end—enough to cover their expenses, including taxes, and a small stiped for living. “It's difficult for me to justify taking any sort of pay at this point because things are so tight." As for his company’s tax strategy, Curtin’s finds keeping it simple is the best approach: "I have no great advice about taxes, except just to pay them," Curtin says. Preferably followed by a stiff drink or two.
Disclaimer: Since the details of your situation are unique, you should always seek the services of a qualified financial planner and tax advisor.