Tax Planning

Tax Reduction 40 Strategies for Reducing Your Businesses Taxable Income Looking to reduce your taxable income? Here’s 40 practical strategies that are sure to help.

Strategy – Engage on business tax planning throughout the tax year.

Tax planning refers to the process of trying to predict what the dollar amount of your business’ taxable income will be, and the makeup of your business’ tax returns that created the taxable income. One approach to handling your business’ taxes is to wait until the end of the tax year, collect all relevant tax information and have your business income tax returns prepared. The problem with this approach is that you have virtually no control over what your business tax liability will be, and
you will have to take your tax bill as it comes. By far the better way to deal with business taxes is to engage in year-round “Tax Planning”. Tax planning, to be truly useful, must continue on a monthly, or at least quarterly, basis throughout the tax year.

Implement the following three steps to achieve tax advantaged status for your business:
Step #l: Review of previous years’ tax returns.
Step #2: Develop and implement a tax plan.
Step #3: Acquire strategy-based and IRS code-based tax return preparation.

Strategy – Decrease your business’ taxable income by shifting income and expenses into the most favorable tax year.

Under certain circumstances, it may be advantageous for you to consider shifting some of your business income and/or expense items from one tax year to another. Although it isn’t always possible to do so, you should consider taking this action if you are able to reduce the combined tax liability for the two years in question. Even if all you do is defer tax due until the following year, this strategy is worth implementing.

This strategy is only applicable to your business if it’s on a “Cash Basis” of accounting. One of the most useful applications of income and expense shifting is to defer income and accelerate expenses in a combined effort to shift taxable income from the current tax year to the next, assuming that your business tax rate is not expected to be higher next year, to the degree that higher taxes due next year increase your business total taxes due between the two years in question.

Conversely, if your business’ total tax liability is better served by keeping its taxable dollars in the current tax year, your business could attempt to shift taxable income back from next year to the current year.

Depending on whether you are shifting forward or back, you will use the following approaches:

Shifting Forward:

Delay cash receipts (by delaying billing);
Accelerate cash payments (by paying all legitimate current year expenses before the end of the current tax year).

Shifting Back:

Accelerate cash receipts;
Delay cash payments.

Expenditures that qualify for accelerating or deferring include, but are not limited to the following: advertising, legal fees, accounting fees and insurance. The IRS can disallow deductions that are clearly attributable to another tax year, and/or income that is not recognized in the proper tax year.

Strategy – Calculate your business “Tax Savings” as a function of the amount of the deduction, and your business marginal tax rate.

The greater the amount of your business tax deduction, the greater the tax savings. The higher your business’ “Marginal Tax Rate” (the tax rate applicable to the last dollar of taxable income) the greater the tax savings.

Strategy – Purchase a “Net Operating Loss” (NOL) in the process of buying another business entity.

You can obtain a Net Operating Loss by buying someone Else’s corporation, a corporation that has created a Net Operating Loss for itself. Tax law allows someone else to buy this corporation and enjoy the tax benefits of owning a Net Operating Loss. If you buy a corporation with a Net Operating Loss, you must be careful not to
inherit unexpected corporate liabilities, especially unpaid payroll taxes.

You must insist that a full “due diligence” search be performed by a corporate lawyer to avoid your inheriting these unexpected corporate liabilities that would become yours along with the corporation, and its Net Operating Loss.

Although the danger of these unexpected liabilities is always present, it may be well worth the effort and expense to search for these “hidden liabilities,” because tax law allows you to use this Net Operating Loss to shelter future income this corporation may generate for you up to the extent of the dollar amount of this Net Operating Loss.

You can use a Net Operating Loss to shelter prior years income. This can be accomplished by filing amended tax returns for the applicable prior year(s) (up to three years back “The Statute of Limitations” for income tax returns) (Forms 1040-X and 1120-x are designed to be used to amend prior year’s tax returns.)

Strategy – Use a Net Operating Loss to shelter otherwise taxable business income.

If your corporation has a Net Operating Loss (NOL), you should look into using the NOL as soon as possible, due to the 3-year statute of limitations the IRS imposes on all taxable entities: the entity can only go back up to three years to make any changes in a previous years tax due. If your corporation paid taxes in any of these three previous years, you can apply this NOL (or any portion of the NOL) to any of these three previous tax years that were profitable, beginning with the
least current and working forward. In doing so, you will be able to offset (to the extent of the NOL) any taxable income of these three years going back.

If you cannot carry your NOL back (there isn’t any taxable income going back, or after you have carried the NOL back there remains an unused balance of NOL), you can then carry the unused NOL balance forward up to 15 years to offset (to the extent of the remaining NOL) any future taxable business income that this corporation may generate during that 15 year period.

Recognize any applicable capital gains at any time. Since the Revenue Reconciliation Act of 1993 failed to include a reduction in the capital gains tax rate, there is no reason to defer recognizing capital gains until a later date, unless you believe that your personal marginal income tax rate – the rate that is applicable to the last dollars of taxable income you have in a given tax year will be less in the future than it is now.

In fact, the current 28% capital gains tax rate is still much lower than the maximum income tax rate on ordinary income of 39.6%.

Strategy – As a sole proprietorship, take your business “Statutory Deductions” on Schedule “C”.

As a Sole Proprietorship, you are obliged to file a Schedule “C” form, along with all appropriate accompanying forms. Statutory Deductions include any deductions that would “otherwise be allowed”. Statutory Deductions, such as your personal tax expenditures that you incur as business expenses, should be taken as business tax deductions on your business Schedule “C”, instead of as an itemized deduction on your Individual 1040 Tax Return (either of which is an allowable way to write
-off a statutory deduction). The logic behind taking this statutory deduction on your business Schedule “C” is that any deductions taken on the Schedule “C” reduce your exposure to Self-Employment tax at 15.3%.

Reimburse yourself from your business immediately for any and all out-of-pocket business expenditures.

Go back through the current tax year and add up all the receipts for which you have not been reimbursed.

Your business can expense these during the current tax year.

Strategy – Adjust any business related estimated taxes, and/or your W-4 relating to any W-2 wages you receive, for the current tax year to avoid additional tax due, or large refunds on your individual income tax return.

If your business’ form of organization is either a Sole Proprietorship, an “S” Corporation or a Partnership, the combination of your W-2 wages federal tax withholding and any business-related estimated tax payments should be designed to equal your anticipated total personal tax liability.

Strategy – Take the appropriate approach in bringing previously owned assets into your business.

The most favorable approach to bringing previously owned assets into your business is a function of your business form of organization. If your business is Sole Proprietorship, you merely show these assets on the books of the business by simultaneously increasing

The cost of the assets and
The owner’s equity section – to reflect either the assets fair market value, or its original cost whichever is less.

If your business is a Corporation, you must show the asset transfer as an “Asset Sale.” You must actually sell these assets to your corporation – by simultaneously increasing:

The cost of assets and
The owners equity section to reflect either the assets fair market value, or its original cost, whichever is less.

Strategy – Take advantage of the deductions created by your business unwanted inventory.

Donate your business inactive inventory to a qualified nonprofit organization and take a tax deduction.

A Regular “C” Corporation may deduct the cost of the inventory donated, plus half of the difference between cost and fair market value. Deductions may be up to twice the cost of the inventory.

Write-off obsolete or damaged inventory to reduce your gross profit andbusiness taxes accordingly. Often businesses carry the cost of inventory on the business’ books long after the inventory has become unsalable. You can write-off the full cost of this inventory, and reduce your business’ tax liability.

Strategy – Write off your business’ “Bad Debts” to reduce taxable income.

Bad debts are noncollectable accounts receivables – dollars which you have decided your business will never actually collect. Bad debts only officially occur when your business is on an “accrual basis” for accounting purposes. When your business is on an accrual basis, the sales figure includes all credit sales, as well as cash sales. The credit sales immediately create accounts receivables, and are treated as sales. If any of these accounts receivables become noncollectable, this dollar amount owed is written off as a bad debt. In this process, both sales and taxable income are reduced by an amount equal to the total dollar amount of accounts receivables written off. Only credit sales previously reported as income (generating accounts receivables) can be written off.

If your business is on a “cash basis,” only cash received represents sales, and therefore there are no accounts receivables. This means there can be no “bad debt” write-off. The closest thing to writing off a bad debt on a cash basis occurs when your business receives a customer’s check, and later, after the check has been deposited into your business checking account, the bank returns the check to your business. If these funds are never collected, this would trigger a bad debt write-off “of sorts” when you reduce the business’ checking account balance and its sales figure by the amount of this returned check.

Strategy – Consider purchasing your business’ fixed assets early to increase the current tax year’s fixed asset-based deductions.

You should consider acquiring (either by purchase or by conversion of personal assets) fixed assets for your business prior to the end of the tax year, if both of the following circumstances exist:

Your business will be needing these fixed assets (to use in the operating of the business) within the next few months. and
Your business is better served by reducing this years taxable income as opposed to deferring the tax impact of these proposed fixed asset acquisitions until the following tax year.

After your business acquires these fixed assets, your business will potentially benefit from the following two sources of business tax deductions available for the current tax year:

Depreciation expense on all fixed assets placed into service by your business during the current tax year. and
Section “179″ asset expensing on all fixed assets that are both: “Purchased and Placed” into service by your business, during the current tax year.

Strategy – If you are a Sole Proprietor, Take a tax deduction on your personal income tax return (Form 1040) for one half of the “Self Employment Tax” due on your business’ profit.

All the profits from a Sole Proprietorship (Schedule “C”) and from a Partnership (Schedule K-l, 1065) are considered “Self-Employment Income”, and therefore are subject to self-employment tax.

15.3 % on all self-employment income up to and including to $87,900 per tax year.
2.9 % on all self-employment income over $87,900.

The total amount of self-employment tax due is calculated using a Schedule SE (Self-Employment Tax), and then is transferred to your Form 1040. By doing this, you are giving yourself the same tax deduction as an employer gets when they deduct the matching portion of self-employment tax liability.

Strategy – Defer Income Tax due from the sale of your business by selling on an “Installment Sale” basis.

An installment sale occurs in the sale of business assets, where business assets are sold at least partially in exchange for a “Note” Payable. Under the terms of the note, one or more payments that are due the seller from the sale of the property are to be paid after the close of the tax year in which the sale or disposition occurs. Contained in each of these future payments is a portion of the taxable “Capital Gains” from the sale. The portion of the total capital gains received each year, by the seller, will generate an income tax liability to the seller, for each year, based on the dollar amount of the capital gains dollars received during each tax year.

The purpose of implementing the “Installment Sale” Method in the sale of business assets is:

To defer a major portion of the tax liability generated by capital gains from the sale of business assets. and
To reduce the overall tax liability by spreading the taxable gain over several years, in an attempt to have the capital gains dollars taxed at lower tax rates.

Strategy – Turn business losses into “earned income credit” eligibility.

Since business losses can be used to offset other income, business losses will have the effect of reducing your personal “Adjusted Gross Income” (AGI). If this AGI dips below certain threshold amounts, you may qualify for an “Earned Income Credit”. This credit creates a flow of tax dollars from the IRS back to you, in many instances, this credit creates a flow of dollars to you even when you didn’t have sufficient with-holdings to justify this amount of tax refund.

There are two methods by which you can qualify for Earned Income Credit (EIC):

Method 1. Claiming the “EIC” with qualifying children:

Have earned income, such as wages and self-employment earnings of under $25,080 if you have one qualifying child, or under $28,490 if you have two or more qualifying children.
A qualifying child is your son, daughter, adopted child, grandchild, stepchild, or foster child who at the end of the tax year was under age 19, or under age 24 and a full-time student, or any age if permanently and totally disabled.
Have a qualifying child who lived with you in your main home in the U.S. for more than six months during the tax year.
File a joint return – if married.
Use Schedule EIC whether you file Form 1040 or Form 1040A.

Method 2. Claiming the “EIC” without qualifying children:

Have earned income, such as wages and self-employment earnings of under $ 9,500, and also Adjusted Gross Income (AGI) under $ 9,500.
Have your main home in the U.S. for more than six months in the tax year.
Be at least 25 but under age 65 (If filing a joint return, either you or your spouse must satisfy this age test).
File a joint return if married.
Not be a dependent of another taxpayer.
Not be a qualifying child of another taxpayer.

Strategy – Deduct Losses on the sale, exchange or worthlessness of “Small Business” stock.

An individual can deduct, as an ordinary loss, losses that are realized on the sale, exchange or worthlessness of Section “1244″ stock.

The loss is available to the original owner of the stock, and is limited to the dollar amount originally invested by an individual. Section 1244 is an election that the owner of a corporation must make for the corporation’s stock to be designated as Section “1244″ stock. In order to qualify as Section “1244″ Stock, the following conditions must have been met:

The corporation must be a U.S. Corporation that receives less than $1 million in cash and property for their stock.
The stock must be issued for money or property (other than stock or securities).
At the time the cash and property was received, more than 50% of the corporation’s gross income for the past 5 years had to have been from normal business operations, and not from passive income such as rents, royalties, dividends, interest, annuities, or gains from the sales or exchanges of stock or securities.

Ordinary losses are limited to $50,000 per individual income tax return (Form 1040) or $100,000 per joint return.

Strategy – Avoid double income tax liability on corporate income.

The payment of “Dividends” by a corporation to its stockholders generates a “Double Tax” liability situation if the Corporation is a “C” Corporation. Since dividends are not tax deductible to the corporation and are considered taxable income to the stockholder, these same dividend dollars are taxed first as corporate income (at the Corporate income tax Rate of 15%), then they are taxed a second time as taxable income to the stockholder (at the stockholder’s Personal Income Tax Rate
of 15%).

The best way to avoid “Double Taxation” is NOT TO PAY DIVIDENDS AT ALL! Pay wages to stockholders (when the stockholder works in the business) instead of dividends. These wages are tax deductible to the Corporation (whereas dividends are not) and therefore these wages reduce the corporation’s taxable income by an amount exactly equal to the dollar amount of the wages paid. This deduction of wages paid to stockholders eliminates entirely the “1st Income Tax Due” figure. This
leaves only the “2nd Income Tax Due,” at the stockholder’s personal income tax rate. This applies to “C” Corporations only; “S” Corporations pay no corporate income tax because all income or loss flows through to its owner(s)’personal income tax return (Form 1040) where it is taxed for the 1st and only time at the owner(s)’ applicable personal income tax rate.

Strategy – Avoid Federal Tax Compliance Problems by adhering to Internal Revenue Service Rules and Regulations.

As a business owner you are required to adhere to the numerous Internal Revenue Service (IRS) tax reporting requirements that apply to businesses. Ignorance is no excuse, and failure to comply is met by IRS imposed penalties and interest. If you failed to comply, the lump sum tax due, plus penalties and interest could be more than your business could withstand financially. Therefore, you must adhere to IRS requirements, particularly in the areas of:

On time tax payments
Avoiding the taking of improper tax deductions
Meeting all tax reporting deadlines
Reporting all taxable income.

Strategy – Run your Business like a “business”, not a hobby.

The Internal Revenue Service uses as a guideline, a working rule that if your business shows a “profit” on its federal income tax return three out of five consecutive tax years, the IRS will assume your business is being operated as a “business”, and not a hobby. However, if your business fails to show a profit three out of five consecutive tax years, the IRS will then look further for evidence that your business is being run as a business. If the IRS fails to find this evidence, they will
conclude that this operation is not a business, but is in fact a “hobby” and they will riot allow you to use any business losses to shelter any of your other taxable income. If you can show that you conducted your activity in a “business like manner”, and intended to make a profit, you can have losses for many years.

The key, therefore, is to in fact run your business in a “business like” manner with the objective of making a profit.

Strategy – Take all necessary steps to bring your business into full compliance with all applicable federal and state requirements regarding employee payroll taxes.

Adhere to the following steps to achieve employee payroll tax compliance:

Step #l:
Your employees must complete IRS W-4 forms (Employees Withholding Allowance Certificate), and return them to your business. These forms indicate the number of withholding allowances each employee wishes to claim. On this form the employee can also indicate any additional dollar federal income tax withholding they wish to have deducted from their pay.

Step #2:
Each employee must have a payroll card on which you keep their cumulative payroll information: Gross pay, all tax and other with-holdings and net pay. You should create a new payroll card for each employee every year.

Step #3:
Calculate each employee’s gross pay for each payroll period by either dividing their annual gross pay by the number of pay periods in the year, or by multiplying their hourly wage rate by the number of hours they worked during the pay period in question.

Step #4:
Determine the dollar amounts of Federal Income Tax to be withheld from each employee’s pay. You must also be certain to comply with any state
tax withholding requirements.

Step #5:
Calculate the annual Social Security (FICA) withholding required by multiplying the portion of each employee’s annual pay, $87,900 and under, by 15.3%, and adding to this dollar amount 2.9% of any dollars over $87,900.

Step #6:
Identify any other deductions such as retirement or child support.

Step #7:
Calculate net pay.

Step #8:
Write the payroll check for the “net pay” amount.

Step #9:
Make any and all applicable federal payroll tax deposits for this pay period. Review Form 8109-B Deposit Coupon to see how to make your applicable Federal payroll tax deposits. Fill in the following items on deposit coupon:

Tax year month (1-12)
Dollar / cents amount
Employer Federal ID #
Name (of business)
Address (of business)
Telephone # (of business)
Type of Tax
Color in tax period (Quarter)

Once you have completed Form 8109-B, write a check for the total dollar amount of this required Federal payroll tax deposit, and make the check payable to “your bank,” put your business’ tax ID # on the check, along with the payroll tax period of the deposit, and then take the coupon and the check to your bank and make the deposit there. (Don’t forget to get a receipt). The reason you make the deposit at your bank is that your bank, as member of the Federal Reserve, is a collector of Federal tax deposits.

Step #10:
File IRS Form 941 (employer’s quarterly federal tax return). This is due on the last day of the month following the end of each calendar quarter. Form 941 summarizes all your business payroll activities for the quarter. Mail the completed Form 941, along with any tax dollars due (make any check payable to IRS, and put your employer ID#, along with the quarter to which it applies, on the check) to the appropriate address, depending on the location of your principal place of business.

Step #11:
By the due date of the Form 941, you must also make any applicable 940 (federal unemployment tax, FUTA) deposits. The amount of FUTA deposits due equals .8% of any employees gross pay under the $7,000 limit. This deposit is also made at your bank using the Form 8109-B (Federal Tax Deposit Coupon). The coupon should be filled in just as it was from the 941 deposits, except this time you should color in 940 instead.

Step #12:
File any applicable state unemployment tax reports and pay any tax due directly to the state.

Step #13:
File all applicable year-end forms.At the end of the calender year (and all due by January 31st, following the end of the calender year), your business is required to provide the following three tax forms:

Form W-2: wages and tax statement (copies to employees, a copy kept with the employer, and a copy sent to the IRS, along with Form W-3).
Form W-3: Transmittal for W-2s.
Form 940: Federal Unemployment Tax form – send it in with a check for the total FUTA tax due (less) any 940 deposits made to date.

If you use contract labor, you will need to issue Form 1099 – miscellaneous income, for any dollars paid to individual contract laborers who received payment in excess of $600 per calendar year. A copy of each 1099 form must be provided to each contract laborer by January 31st – following the calender year. Also due to the Social Security Administration by January 31st is Form 1096 (Annual Summary and Transmittal of U.S. Information Returns) along with a copy of each 1099
form. The employer must keep a copy of each 1099 form and the 1096 form for their files. Mail the 1096 form and all 1099 forms to the Social Security Administration.

Strategy – Set up a special business checking account for payroll taxes and sales taxes.

If your business has employees and/or your business is liable for sales tax (if your business is obliged to charge sales tax on its sales), collect the tax from its customers at the time of each sale, and transmit these sales tax dollars to your state on a routine (often monthly basis). It’s a good idea to set up a separate checking account in which to store these “Trust Fund Dollars.” These dollars include:

Amounts withheld from employee payroll checks: Federal income tax withheld + FICA tax withheld Note: Ideally, your business should deposit the employers matching portion of FICA into the account at the same time.
Sales tax dollars collected from your customers on behalf of the state. If these “Trust Fund Dollars” are kept in a separate business checking account, your business is far less likely to spend these dollars for some other business purpose before they are due to the federal and/or state governments, respectively.

Strategy – Minimize your Business State Unemployment Employer Experience Rate.

If an unemployment claim is granted to a previous employee of your business, this claim goes against your business account at your state’s unemployment office. This will cause your business unemployment experience rate to increase, which in turn can cause your business unemployment tax rate to increase, thereby increasing the unemployment tax due.

The following two steps are designed to reduce the likelihood of your rate being increased:

Step#l:
Insist that all new employees be subject to a mandatory 90-day” probationary period.” This 90-day time period is consistent with state unemployment laws – in that any new employee can be terminated without cause, for any reason, within a 90-day probationary period. Any employee terminated within this 90-day period cannot file an unemployment claim with the state against your business.

Step #2:
Contest all invalid unemployment claims against your business.

Strategy – Order a Federal Tax Identification Number When Required.

The IRS requires that you have a Federal ID # under the following conditions:

When you have employees.
When you create an artificial business entity – such as a corporation or a partnership.

Note: If you are operating your business as a Sole Proprietorship and have no employees, you can use your own social security number as your business tax identification number. However, for personal security reasons, it’s not an ideal situation for other individuals to know your Social Security number as they could obtain copies of your personal financial information (such as your credit report) once they know this number. If you use a Federal ID#, instead of your Social Security number, you can avoid this kind of potential exposure of your personal information.

As a direct result of the IRS requirement, your local bank will also require that your business have a Federal Tax Identification number, in order for you to open up a business checking account. There are two methods of obtaining a Federal Tax ID# for your business:

By completing and signing an SS-4 Form, and mailing it directly to the appropriate IRS Service Center.and/or
By contacting the IRS by telephone, you can be assigned your Federal ID# on the spot. You are required to read aloud the information shown on the completed SS-4 Form. When the IRS verbally assigns your Federal ID#, you should write this number on the top right-hand corner of the SS-4 Form, and mail this completed and signed SS-4 Form to the appropriate IRS Service Center.

Note: Under both of the above methods, the IRS will mail your business a written confirmation of its Federal ID#.

Strategy – Obtain a State “Sales Tax Number” (an “Exempt” number) for your business if it is required to collect State Sales Tax, or purchase goods for resale.

If your business is located in a state that has state sales tax, there are two issues to address:

If you are required to charge sales tax on all taxable sales made by your business, then your business must pass through all collected sales tax dollars to the state, when due.
If your business purchases goods (inventory) for resale, it can avoid paying sales tax on these inventory items, when your business purchases them, by obtaining a sales tax exempt number from the state and showing this number to your inventory suppliers. This exempt number is a sales tax number. This means that your business is “exempt” from paying sales tax on the inventory it purchases because it will charge, collect, and remit to the state, sales tax on the items it sells to its customers.

Strategy – Determine the required timing of your payroll tax deposits -based on total dollar amount of payroll tax deposits due.

Each quarter your business is required to file a Form 941 (Employer’s Quarterly Federal Tax Return), documenting your business payroll and payroll tax information for the applicable calender year quarter. In advance of filing this return, employers are required to make deposits which include:

Federal Income Tax withheld
Social Security Taxes withheld .
The employer’s matching portion of Social Security Tax due

In an effort to increase employer’s compliance, the IRS has greatly simplified the rules for depositing payroll taxes. Previously, deposits could have been required as many as eight times each month, and the schedule could change several times in one month. Under the new regulations, employers deposit withheld payroll taxes, and the employer’s matching portion of Social Security Tax due, on either a monthly or weekly basis. The determination as to which schedule applies should be made by looking back at the employment taxes reported for a 12 month look-back period, July 1st through June 30th of the prior year. The IRS will tell employers by November each year which schedule they will be required to follow for the coming calender tax year.

All new employers will be monthly depositors. Employers who reported $50,000 or less in payroll tax liability during the “look-back” period will be monthly depositors. The deposits must be made by the 14th day of the following month. Approximately 75% of all businesses will qualify for this deposit requirement category. Those employers who reported over $50,000 in payroll tax liability during the 12-month look-back period will be required to deposit weekly. For paydays on Wednesday, Thursday or Friday, the deposit will be due by the Wednesday after the payday. For all other paydays, the deposit will be due by the
Friday following the payday. This allows at least three (3) banking days between payday and the deposit due date.

The exception to this rule will be for employers who accumulate $100,000 in payroll tax liability during a period. Taxes due of this amount must be deposited the next banking day.

Employers accumulating less than $500 in payroll tax liability during a quarter may skip deposits altogether, and send full payment along with their quarterly employment tax returns (Form 941). If your business follows these rules, it will make all required tax deposits on a timelybasis, and will avoid penalties and interest on under-deposited taxes due. You will also stay current, and not get behind, where it could be difficult to come up with a large amount of tax deposit dollars, at one
time.

Strategy – Withhold payroll taxes on all commission dollars paid.

Commissions represent tax deductible dollars that are paid out to individuals based directly on their performance. These include Sales Commissions, based on the value of sales revenue generated, and Piece Rate Commissions, based on manufacturing units produced. Although commissions are usually variable in nature, they nevertheless represent wages or salaries to the individuals to whom they are paid. For this reason, your business must treat commissions paid as “Payroll”, and
deduct payroll taxes as applicable, pay employer’s matching portion of social security (up to the applicable limits), pay federal and state unemployment (up to the applicable limits), and all other payroll tax related costs.

Strategy – Keep a federal tax forms due date schedule handy as a guide to timely tax filing.

Some of the federal taxes for which a Sole Proprietorship, a Corporation or a Partnership may be liable are listed below on the “Federal Tax Form(s) Due Date Schedule” included for your use. If a due date falls on a Saturday, Sunday, or legal holiday, it is postponed until the next day that is not a Saturday, Sunday or legal holiday (a statewide legal holiday delays a due date only if the IRS office where you are required to file is located in that state.)

You may be liable for:

Income Tax
Self-employment Tax
Estimated Tax
Annual Return of Income
Social Security (FICA) Tax and Withholding of Income Tax
Providing information on Social Security (FICA) Tax and the withholding of income tax Federal Unemployment (FUTA) Tax

Strategy – Make all required Federal “Estimated Tax Payments”

The rationale behind the Internal Revenue Service’s (IRS) rules regarding estimated tax payments is their desire to provide a vehicle for the current payments of federal income and self-employment taxes, not collected through withholding. In general, estimated tax payments equal the dollar amount of income and self-employment tax that it is estimated will have to be paid, in excess of any outstanding tax credits from previous tax years, plus current withholding’s.

The requirements for making “estimated tax payments” fall into two categories:
1. Individuals -Note: The rules for individuals include:

Sole Proprietors
“S” Corporation Shareholders, and
Partners in a Partnership

This is true because under each of the above forms of business ownership, the business’ profit or (loss) flows directly to each owners “individual” income tax return. There is no “business entity” tax liability for a Sole Proprietorship, an “S” Corporation, or a Partnership.

2. “C” (Regular) Corporations

Each of these two categories will be discussed in turn.

1. Individuals:
No penalty for failure to pay estimated tax will apply to an individual (business owner) who qualifies under one of the following exemptions:

Exemption # 1:
If the tax due for the current year, after any applicable tax credits and withholding, is less than $500. or

Exemption # 2:
If the taxpayer has no ($0) tax liability for the preceding tax year provided that the preceding tax year was a 12-month period. Individuals who do not qualify for either of these two above exemptions may avoid the penalty for failure to pay estimated tax under the following two scenarios, by paying:

At least 90% of the total tax liability shown on the current year’s tax return. or
100% of the total tax liability shown on the prior year’s tax return.

Note: A “Special Rule” applies to individuals with “Adjusted Gross Income” (AGI)for the previous tax year equal to, or in excess of $150,000 ($75,000 for married individuals filing separately). In order for these high income individuals to qualify for “prior year safe harbor” thereby avoiding any penalty for failure to pay estimated tax they must pay the lesser of…

At least 90% of the total tax liability shown on the current year’s tax return. or
10% of the total tax liability shown on the previous year’s tax return instead of the 100% required of other individual taxpayers.

All required tax payments may be made either through withholding, or estimated tax payments. The due dates for individual estimated tax payments are:
Installment     Due Date
1st                          April 15th
2nd                          June 15th
3rd                   September 15th
4th                             January 15th (of the following year)

If this due date falls on a weekend, or Federal holiday, the payment is due on the first following business day. The 4th Installment for a tax year need not be made, if the taxpayer files his or her Form 1040 tax return, and pays the balance of the tax due on or before January 31st of the following year.

For the payment of estimated taxes, an individual is to attach the appropriate payment to a Form 1040-ES Voucher (one for each estimated tax payment [installment] due.)

2. “C” (Regular) Corporations
If it is anticipated that your “C” Corporation will have a current year-end Federal income tax liability (a bill) of $500 or more, this corporation must estimate its Federal income tax liability for the current year, and pay four quarterly “estimated tax installments” (using Form 8109-B) during that current tax year.

“C” Corporations may avoid a penalty if each estimated tax installment equals at least 25% of the lesser of:

100% of the total tax liability shown on the corporation’s current year’s income tax return or
100% of the total tax liability shown on the corporation’s income tax return for the previous tax year, (provided: A positive tax liability was shown and the previous tax year consisted of 12 months)

Strategy – Keep IRS records for three years – five years if payroll tax information.

You are required to keep business tax records for three years from the due date of your business’ tax return, or from the date the return was filed, whichever is the later. This three year requirement coincides with the IRS’s statute of limitations on tax returns. You are required to keep payroll records five years.

Once your business passes the three year statute of limitations (5 years for payroll tax returns), it is immune from IRS audit, unless:

Your business understated its income by more than 25% in which case, the statute of limitations is extended to six (6) years. or
You committed tax fraud, in which case a statute of limitations is not applicable.

You are prohibited from filing an amended tax return after the statute of limitations has expired.

Your business records include, but are not limited to the following:

TAX RECORDS: Tax returns, financial statements, any financial papers/bank statements, check stubs/canceled checks, sales invoices, purchase invoices and expenditure receipts (checks and cash).
PAYROLL TAX RECORDS: Payroll records (such as time sheets) and payroll tax forms.

Strategy – Avoid creating unintentional taxable business income.

Avoid “Constructive Receipt” of income. One way to implement tax planning for your business is to delay billing your customers, but you must have a “defensible business reason” to do this (other than tax planning) or the IRS will claim your business had constructive receipt of the income during the current tax year, even though these dollars were not actually received until the following tax year. Furthermore, if your business received a check on the last day of the tax year, but
held it over until the next “tax year” for deposit, the IRS would consider that your business had “constructively received” the income during the current tax year.

Avoid imputed interest on loans your business owners make to your business and/or loans from your business to its owners.

If you fail to indicate a reasonable interest rate on any of these business-related loans, the IRS will “impute”, or assign an interest rate to the loan. This means the individual or entity who makes the loan could have income tax liability on interest that was never received, but rather was imputed by the IRS, in order to create taxable income.

Do not show investment income on a Schedule “C”. Investment income, such as interest, dividend, and/or capital gains income is not subject to self-employment tax. All Schedule “C” (Sole Proprietorship) income is subject to self-employment tax unless it is received in the course of your trade or business income as a dealer in stocks or other securities.

If you showed this investment income on a Schedule “C”, you would be paying self-employment tax on income that is normally not subject to the tax. Use Schedule “B” instead.

Strategy – Avoid “Reciprocal Entertainment Arrangements” between business associates.

The IRS prohibits the expensing of entertainment and food expenditures on the basis of a prearranged and continuing “rotating lunch, or entertainment” relationship between you and another business associate. “I’ll take you to lunch, then you’ll take me to lunch (or to an entertainment event) so we can write-off these expenditures as business-related” is not allowed to create tax deductions for yours and your associates businesses. The best way to avoid this prohibition is to vary your entertainment and food routines to include numerous business associates not just one or two. Entertainment and/or food is only deductible if you can establish that it is directly related to your business. You must have more than a general expectation of deriving income, or some other specific business benefit from the entertainment and/or food.

Strategy – Avoid the contract labor trap.

Quite often the motivation behind considering treating an individual as a contract laborer (Independent Contractor) comes from the individuals themselves. You may have an individual say something to the effect of; “I’ll take care of my own taxes”. This may sound great at first, as it eliminates the need for you to do all the paperwork required when you have employees. Also, if a person is truly a contract laborer, you will save the costs associated with:

The matching portion of Social Security
Federal Unemployment
State Unemployment
Workers’ Compensation
Health Insurance
Disability Insurance
Life Insurance
Nonproductive Hours
Vacation Hours
Sick Pay
A reduction in your business potential exposure to negligence lawsuits
Exposure to employee lawsuits

However, you must be careful about treating an individual as contract labor. If you treat someone as an Independent Contractor, and later the IRS (or the state unemployment office) finds that this individual was “in fact” an employee, and should have been treated as one all along, you may be liable for back employee-related taxes. Moreover, the IRS could charge you, personally, a penalty on back Social Security taxes not deposited with the IRS. Since you wouldn’t want that to happen, and neither would the IRS, they have developed 20 factors indicating whether an individual is an employee or an Independent Contractor.

Instructions: An employee must comply with instructions about when, where and how to work. Even if no instructions are given, the control factor is present if the employer has the right to give instructions.
Training: An employee is trained to perform services in a particular manner. Independent contractors ordinarily use their own methods, and receive no training from the purchasers of their services.
Integration: An employee’s services are integrated into the business operations because the services are important to the success or continuation of the business. This shows that the employee is subject to direction and control.
Services Rendered Personally: An employee renders services personally. This shows that the employer is interested in the methods as well as the results.
Hiring Assistants: An employee works for an employer who hires, supervises, and pays assistants. An independent contractor hires, supervises, and pays assistants under a contract that requires him or her to provide materials and labor, and to be responsible only for the result.
Continuing Relationship: An employee has a continuing relationship with an employer. A continuing relationship may exist where work is performed at frequently recurring, although irregular, intervals.
Set Hours of Work: An employee has set hours of work established by an employer. An independent contractor is the master of his or her own time.
Full-Time Work: An employee normally works full time for an employer. An independent contractor can work for whom he or she chooses.
Work Done on Premises: An employee works on the premises of an employer, or works on a route, or at a location designated by an employer.
Order or Sequence Set: An employee must perform services in the order or sequence set by an employer. This shows that the employee is subject to direction and control.
Reports: An employee submits reports to an employer. This shows that the employee must account to the employer for his or her actions.
Payments: An employee is paid at regular intervals – such as by the hour, week or month.
Expenses: An employee’s business and travel expenses are paid by an employer. This shows that the employee is subject to regulation and control.
Tools and Materials: An employee is furnished significant tools, materials, and other equipment by an employer.
Investment: An independent contractor has a significant investment in the facilities he or she uses in performing services for someone else.
Profit or Loss: An independent contractor can make a profit or suffer a loss.
Works For More Than One Person or Firm: An independent contractor gives his or her services to two or more unrelated persons or businesses at the same time.
Offers Services to General Public: An independent contractor makes his or her services available to the general public.
Right to Fire: An employee can be fired by an employer. An independent contractor cannot be fired as long as he or she produces a result that meets the specifications of the contract.
Right to Quit: An employee can quit his or her job at any time without incurring liability.

An independent contractor usually agrees to complete a specific job, and is responsible for its satisfactory completion, or is legally obligated to make good for failure to complete it. If you are uncertain whether or not an individual should be classified as an employee, and you want the IRS to determine it for you, contact the IRS; file a Form SS-8 (Information For Use in Determining whether a Worker is an Employee for Purposes of Federal Employment Taxes and Income Tax Purposes), and
file it with your IRS District Director.

Strategy – Watch out for changes in corporation tax filing status: “S” Corporation:

The following shows the results of potential changes in your “S” Corporation’s tax return filing status: Changes additional actions required File an “extension of time to file” your “S” Corporation tax return – by filing Form 7004Amend a prior year’s “S” Corporate Income Tax Return (Form 1UO-S)

You will also be required to file extensions of time to file – for any owner(s) individual Federal tax returns (Federal Tax Form 4868) You will also be required to amend all owner(s) individual income tax returns as well (Form 1040)

Note: The above changes and results automatically extend the statute of limitations on all affected returns. These actions extend the period of time during which the IRS can scrutinize these specific returns, and therefore should not be done without first determining the total financial impact of the changes and results. Be careful not to let your corporate charter lapse. If your business’ corporate charter lapses, the IRS may be able to hold all directors and/or officers responsible for the entire corporate debt for employment and unemployment taxes if state law renders them personally liable for corporate debt – upon lapse of the corporate charter.

Strategy – Avoid Internal Revenue Service “Audit Flags”.

There are certain types of expenditures, business transactions and/or lines on tax returns that tend to receive more attention form the IRS than others. It is in these areas that you must be particularly careful. The list below includes some major audit flags:

Gross receipts in excess of $100,000 on a Schedule “C” (Sole Proprietorship).
Regular corporations whose total assets exceed $5,000,000.
Excessively high travel, meals and entertainment expenses, relative to the level of gross sales.
Schedule “C” (Sole Proprietorship) net profit of zero and or continued losses over several years.
A continuous flow of monies into and out of the business involving the owner(s).
Zero or minimal cash deposits in a business that receives cash.
Excessively high cost of sales in a business without inventory.
Token or zero owner(s) wages paid out of an “S” Corporation.
Inadequate inventory records.
Higher depreciation expense than might normally be expected in your type of business.
Excessively high vehicle mileage.
Mathematical and clerical errors on the tax return.
Failing to report all income.
Tax Shelters, or high partnership losses.
A large amount of UN-reimbursed medical expenses.
A large amount of undocumented charitable deductions.

If you can avoid these “audit flags” while at the same time alerting yourself to other potential flags that may pertain more specifically to your business, you will have taken major steps toward avoiding much of the audit-related scrutiny from IRS.

Note: Apply the “repetitive audit relief rule to continuous IRS audit activity.

If your business has been audited in either of the last two years, on a particular issue, and the audit resulted in “no change” in your tax bill, you can request – on behalf of your business – that it not be audited on the same issue.

Note: This applies only to non-corporate tax returns.

Strategy – Avoid Internal Revenue Service Penalties.

The IRS will charge your business a penalty for every violation of the tax codes. The way to avoid these penalties is to comply with all IRS requirements. That’s easy to say, but of course, before you can adhere to tax law, you need to be aware of tax law as it applies to your business. To assist you in a better understanding of your potential exposure to IRS penalties, a few of the more troublesome penalties the IRS is authorized to charge have been itemized below, along with the applicable penalty for each violation. These penalties are calculated on a “percentage (%} of the Total Tax Owed” basis.

PENALTY % OF TOTAL TAX OWED
Underpayment………………………………………………………. -1/2 of 1% per month
Late Payment…………………………………………………………. -1/2 of 1% per month
Failure to Pay…………………………………………………………………… -1% per month
Late Deposit…………………………………………………………………………… – 2% -15%
Accuracy-related Penalty……………………………………………………………… – 20%
Failure to Report Large Cash Payments……………………………………………. -10%
Substantial Understatement of Tax Liability ……………………………………. -20%
Failure to File…………………………………………………. -8% per month (Max. 25%)
Fraud …………………………………………………………………………………………….. -75%

Note: The current interest rate the IRS charges on uncollected tax dollars is 9%.

Strategy – Avoid personally receiving a “Trust Fund Recovery Penalty from the IRS for nonpayment of business trust fund taxes.

Trust Fund Taxes consist of those taxes your business withholds from its employee(s) wages:

Federal Income Tax withheld, plus
Social Security (PICA) and Medicare Tax withheld

As a Sole Proprietor, or a Partner in a Business Partnership, you are potentially personally liable for any and all debts of the business. Alternatively, as a shareholder in your Corporation, generally you cannot be held personally liable for corporate debts, unless you have personally guaranteed the debt. However, if you are responsible for making the decisions as to whether or not your business pays its Trust Fund Taxes, you will be personally liable for any of these trust fund taxes that go unpaid. The extent of this personal liability is that you will be liable for “100%” of the unpaid trust fund taxes plus interest and normal applicable IRS penalties for failure to pay. The best way to avoid liability for these trust fund taxes is to make all payroll tax deposits in full and on time, and file all required employment tax forms when due. If you do not do so, then the only way to avoid a 100% penalty for failure to make trust fund payments is for you to prove that you had no knowledge that the trust fund taxes were not being paid, and that someone else was, in fact, authorized to make the payroll tax deposits and filing decisions, and other payment decisions.

Strategy – Beware of the “Nominee Lien” when moving from your old corporation to a new one.

Sometimes when your old corporation is in trouble with the Internal Revenue Service, you may be tempted, and/or advised, to “fold” (close) this old corporation, and move your business and its assets into a brand new corporation in an effort to avoid paying the taxes due on the old corporation. Be aware that if you do this, and the IRS is able to prove that you created the new corporation for the sole purpose of avoiding paying the tax due on the old corporation, and you have essentially the same business operation in the new corporation as you did the old, the IRS can place a “Nominee Lien” on your new corporation. This means that your new corporation has just been assessed the tax liability of the old corporation.

When you consult with your legal adviser, the best way to avoid the Nominee Lien, if the taxes owed by the old corporation are substantial may be, in some cases, for your old corporation to declare bankruptcy. Declaring bankruptcy forces the IRS to “get in line” along with all the old corporation’s other creditors. This action prohibits the IRS from actively soliciting payment from the old corporation, except under terms handed down by the bankruptcy judge.

Note: Bankruptcy, however does not usually discharge trust fund liability.

Strategy – Keep Internal Revenue Service Telephone Numbers Handy

Much of what the IRS does, or is set up to do, can be done over the telephone. However, if you do have telephone conversations with the IRS, it’s essential that you follow up your conversations with a letter or memo to the appropriate IRS contact – confirming the subject matter discussed over the phone. Be certain to document the details of the call, as well as any applicable tax information, ID numbers, the purpose of the call, etc. on this correspondence, and of course always make reference the specific individual with whom you had the telephone conversation.

Your local IRS office may also be useful. However, most IRS issues involving telephone conversation initiate at the Regional or District IRS office. Quite often, if the conversation gets to the local IRS level, you have likely waited too long to respond to previous IRS correspondences and/or telephone calls on a collection or an audit related issue. With this in mind, you should respond immediately to any and all IRS contacts with you and/or your business. To facilitate this, it’s best if you keep a list of IRS telephone numbers handy. Some of the more useful numbers are listed below:

Taxpayer Assistance Order (TAO)

To suspend IRS actions, ask for the “problem resolution officer” who will review your request.
Call: 1-800-829-1040
Forms & Publications: Call: 1-800-829-3676 (Form)
Tax & Return Information: Call: 1-800-829-4477

Develop your own list of IRS telephone numbers by:

Referring to your previous correspondence with the IRS
Looking in your local telephone directory
Calling your local telephone company’s directory assistance

NOTE: The best times to call the IRS are:
Mon-Fri, 8:00 a.m. – 9:30 a.m. or
Mon-Fri, 3:00 p.m. – 4:30 p.m.

Strategy – Know how to Obtain copies of your prior year’s Tax Returns.

If you need a copy of a prior year’s tax return, you can request one from the IRS. All you have to do is fill out a Form 4506 – “Request for copy of tax forms” and Pay a small fee Strategy – Be aware of the major steps in the IRS Tax Collection Process.

The major steps in the IRS collection process are:
Step #1: 1st notice and demand for unpaid tax
Step #2: Ten days later, The IRS Enforcement Authority
Step #3: The IRS will send a 30 day letter which describe the taxes due, and your opportunity to contest this deficiency.
Step #4: Up to three more notices will be sent, over a period of time, asking for payment.
Step #5: A notice of “Intent to Levy” –Final Notice Before Seizure is sent by certified mail.
Step #6: Thirty (30) days later: “Enforcement Action to Collect the Tax” begins, using the following three step process:

Lien: The IRS claim is legally placed “against” any assets your business owns.
Levy: The IRS positions itself to take any and all dollars your business has (up to the extent of the IRS claim). Note: this includes business checking and savings accounts, etc.
Seizure: This process allows the IRS to take possession of any and all business assets, including the actual business location and all its contents, in an effort to collect all taxes, plus any applicable penalty and interest due.

Strategy – Use “Problem Resolution” If you are unable to resolve an IRS Tax problem.

To offer assistance to taxpayers with problems that have not been resolved through normal channels, special addresses, phone and fax numbers are available for District and Service Center “Problem Resolution Offices (PRO)”. In emergency cases, you may forward documentation directly to these addresses, or you may call the Problem Resolution Office, directly. Some examples of “emergency cases” include:
(1) erroneous levy action, or (2) a major systemic problem involving a large number of taxpayers. In most cases, the preparer will need to submit copies of a Power of Attorney, and notices or prior correspondence, even if the taxpayer has submitted them previously.

Publication 1320, “Operation Link” contains further information on “PRO” services. Contact any PRO office to request a copy of the Operation Link publication.

You are certainly a candidate to benefit from “PRO” services under for example, the following types of circumstances:

If you have contacted the IRS regarding the status of a refund at least 90 days after filing an original or amended return, and a second inquiry is necessary.
If you have requested information or assistance more than 45 days earlier, and have received no acknowledgment, no final response, or have not received a response by the date promised in the acknowledgment.
If you previously responded to a billing notice and now have a third or subsequent notice indicating incorrect action by the IRS on your earlier response.
If you have tried the normal channels or procedures, but these haven’t worked in resolving your complaint or inquiry. In other words: “…If all else fails”.

Problem Resolution Contact List

Atlanta Service Center Problem Resolution Office
P O Box 48-459 Doraville, GA 30352 Stop 29A
Telephone & Fax Numbers (404) 455 – 2050 FAX: (404) 455-2527

Atlanta District Office Problem Resolution Office
401 West Peachtree St. N.W. Stop 202-D, Room 1520 Atlanta, GA 30365
Telephone & Fax Numbers (404) 331-5232 or 5233 FAX (404) 730-3438

Columbia District Office Problem Resolution Office
PO Box 17167 Plantation, FL33318
Telephone & Fax Numbers (803) 765-5939 FAX (803) 253-3910

Ft. Lauderdale District Office Problem Resolution Office
PO Box 17167 Plantation, FL33318
Telephone & Fax Numbers (305) 424-2388 FAX (305) 424-2483

Jacksonville District Office Problem Resolution Office
P O Box 35045 Jacksonville, FL 32202
Telephone & Fax Numbers
(904)791-3440 FAX (904) 791-2266

For other locations call: 1-800-829-1040

Strategy – Obtain competent advice from a professional whenever you and/or your business have a tax problem.

The more you know about the workings of the IRS, the better off you are, to a point. This is true as long as you remember that the purpose behind knowing more (about anything) is to know the relevant questions, not necessarily all the answers. When you have an IRS issue that you can’t easily resolve, you should immediately contact a professional; this will allow you to focus on your business’ activities, while you turn your IRS matters over to a professional.

Note: You may want to take yourself out of the communications loop with the IRS by granting your professional a (Limited) Power of Attorney to represent your interests directly with the IRS.

Remember: “Especially when it concerns Taxes… an ounce of prevention is worth a pound of cure”!!

If you will follow all the tax strategies I have outlined, you will be able to greatly reduce your tax liability with confidence. Make sure you take this new found money and apply it to your focus fund where it can do the most good!

Tagged as: Brad Gillies, Income Shifting, Income Taxes, Tax Planning, Tax Reduction

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