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Avoid these tax strategy pitfalls
Tax and Financial News
August 2002
Avoid these tax strategy pitfalls
While many of the strategies available to small businesses for reducing their tax bills are relatively simple, some are much more complicated. That's why it's a good idea to consult a professional tax advisor about the tax implications of many operational and financial decisions. Here are four strategies that, while potentially advantageous, may require careful implementation to achieve the results you want.
Changing your business structure:
For both tax and nontax reasons, you may consider the limited liability company (LLC) or limited liability partnership (LLP) forms of ownership for your company. Both forms can provide protection for owners against company lawsuits and debts. Specific rules for these entity forms vary from state to state, but the Internal Revenue Service has its own ideas on how they should be structured to achieve certain tax benefits for its owners. Now matter what your state allows, you should check into the IRS's requirements.
Using independent contractors:
Contracting out work to independent contractors can produce financial savings, since there is no employer contribution to worker's compensation insurance or unemployment, no need to provide benefits such as health insurance, and no employer liability for Social Security and Medicare taxes. However, the distinction between independent contractors and employees can be fuzzy and the dangers of misclassification great. The IRS is always on the lookout for problems in this area.
Compensation for executive and owners:
This may seem straightforward. The business compensates executive and takes a deduction for it. However, the rule is that compensation can be deducted only if it is "reasonable". Historical criteria for deductibility include the role of the shareholder-employee in the company's success, the consistency of any bonus policy, and the general prevalence of certain business practices and benefits.
Employee's business travel and entertainment expenses:
If you do this correctly, you will not have to treat reimbursements as compensation, thus avoiding paying employment taxes on them. You can simply deduct these expenses, as far as allowable, as company business expenses. However, to do this, you must have an "accountable plan," which involves specific procedures to be followed by your employees and your company. The requirements aren't arduous but you will want to get the specifics from your tax professional.
Small changes in the way you operate your business can sometimes make significant differences in your tax bill. Keep an eye open for opportunities and use a tax professional to help you with your planning.
Changing your business structure:
For both tax and nontax reasons, you may consider the limited liability company (LLC) or limited liability partnership (LLP) forms of ownership for your company. Both forms can provide protection for owners against company lawsuits and debts. Specific rules for these entity forms vary from state to state, but the Internal Revenue Service has its own ideas on how they should be structured to achieve certain tax benefits for its owners. Now matter what your state allows, you should check into the IRS's requirements.
Using independent contractors:
Contracting out work to independent contractors can produce financial savings, since there is no employer contribution to worker's compensation insurance or unemployment, no need to provide benefits such as health insurance, and no employer liability for Social Security and Medicare taxes. However, the distinction between independent contractors and employees can be fuzzy and the dangers of misclassification great. The IRS is always on the lookout for problems in this area.
Compensation for executive and owners:
This may seem straightforward. The business compensates executive and takes a deduction for it. However, the rule is that compensation can be deducted only if it is "reasonable". Historical criteria for deductibility include the role of the shareholder-employee in the company's success, the consistency of any bonus policy, and the general prevalence of certain business practices and benefits.
Employee's business travel and entertainment expenses:
If you do this correctly, you will not have to treat reimbursements as compensation, thus avoiding paying employment taxes on them. You can simply deduct these expenses, as far as allowable, as company business expenses. However, to do this, you must have an "accountable plan," which involves specific procedures to be followed by your employees and your company. The requirements aren't arduous but you will want to get the specifics from your tax professional.
Small changes in the way you operate your business can sometimes make significant differences in your tax bill. Keep an eye open for opportunities and use a tax professional to help you with your planning.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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