Tax planning is a process of looking at various tax options in order to determine when, whether, and how to conduct your business and personal transactions, so that taxes are eliminated or reduced. As an individual taxpayer and as a business owner, you will often have several different options as to how you want to complete a certain taxable transaction. The courts strongly back your right to choose the course of action that will result in the lowest legal tax liability.
However, tax evasion, the reduction of tax through deceit, subterfuge or concealment, is improper. IRS examiners will be on the lookout for the following four situations, among others, as pointing to possible fraud:
1. A failure to report substantial amounts of income;
2. A claim for fictitious or improper deductions on a return;
3. Accounting irregularities;
4. Allocation of income to a related taxpayer who is in a lower tax bracket.
A business owner may not reduce his or her income taxes by labeling a transaction as something it is not. Thus, if payments by a corporation to its stockholders are in fact dividends, calling them “interest” or otherwise attempting to disguise the payments as interest will not entitle the corporation to an interest deduction. It is the substance, not the form, of the transaction that determines its tax-ability.
There are countless tax planning strategies available to a small business owner. But regardless of how simple or how complex a tax strategy is, it will be based on structuring the transaction to accomplish one or more of these often overlapping goals:
1. Reducing the amount of income that is subject to tax;
2. Subject taxable income to the lowest possible tax rate;
3. Reducing the amount of the tax itself by claiming tax credits;
4. Controlling both time that the tax liability will arise and the time when it must be paid.
In order to plan effectively, you will need to estimate your personal and business income for the next few years. This is necessary because many tax planning strategies will save tax at one income level, but it will larger tax bill at other income levels. You will want to avoid having the “right” tax plan made “wrong” by erroneous income projections. Of course, you also need to estimate your sales volume, revenue, expenses, etc. for many other business purposes.
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