How Strategic Year-Round Tax Planning Can Benefit Your Business

When asked how important tax planning is to them, a typical business owner will say that they only prioritize it at the beginning of tax season, or at best, towards the end of the previous year. Once the taxes are filed, some contractors wait until the following year to find out whether they have a tax liability.

However, a competent tax planner knows that the best approach is to stay on top of your tax situation year-round. Proper tax planning includes tax projection based on the previous year’s numbers, which can affect the business (and personal) decisions made by the taxpayer. Even the IRS, perhaps counter-intuitively, acknowledges that paying closer attention to tax planning is beneficial to those who engage in it. It’s worth referencing IRS Publication 5349: Year-round Tax Planning is for Everyone.

Let’s take a deeper dive into how this strategy can benefit contractors.

Which Strategies When?

Contractors should always consider tax planning as an important part of their business strategy. A popular recommendation is to implement a tiered approach to tax planning, since there are specific strategies that should be used for businesses that show low profits versus higher projected profits. For example, in construction the numbers can increase quickly, but in such a volatile industry, a quick turn of events can have devastating effects on a company’s taxes.

When engaging in tax planning, a contractor should consult both their tax and financial professionals, as a financial advisor will provide the information a tax planner needs to develop the most effective strategy for the contractor.

Successful tax planning must begin with current and accurate financials. The old principle of “Garbage in, garbage out” applies here, meaning if decisions are made based on inaccuracies, then the analysis performed will result in poor recommendations that will not benefit the contractor’s business.

Several factors must be considered when making decisions on which tax strategies to implement, including, but not limited to:

• Accounts receivable. It is common for customers to have their own tax strategies, which may necessitate paying their outstanding invoices before the year's end. Receiving substantial payments at the end of the year can disrupt your tax planning.

• Working capital. This is a critical factor to consider when deciding on the tax strategy. While the goal is to minimize the tax liability, using funds needed for working capital can hurt the operations of a business and may lead to financial chaos.

• Financing needs. Eliminating all profits through tax strategy can hinder or even completely jeopardize the company’s chances of securing necessary financing in the near future.

Earlier and Later Stages

Again, contractors should have a tiered approach to tax planning. As companies go through different stages, their focus and objectives change. A tiered approach allows contractors to be proactive by customizing their tax planning strategies to accommodate the objectives specific to each stage.

A few common tax planning strategies used during the earlier stages of business life include:

• Maximizing deductions. Ensuring all expenses are accounted for and in some cases accelerating major purchases to minimize tax liability.

• Taking advantage of depreciation. While some depreciable assets like equipment can be fully depreciated in the year of purchase, consider extending the depreciation over the life of the asset if that approach will be more advantageous to the company and owners/shareholders.

• Retirement planning. Implementation of retirement plans such as a 401(k) can help contractors reduce their tax liability while allowing them to save for the future and improve employee morale.

As a company grows and is exposed to higher tax liabilities, consider implementing some of these strategies:

• Insurance. This will include more sophisticated insurance plans such as captive insurance which can improve the financial position of the company and its shareholders.

• Pension plans. Pension plans tailored to the company’s unique situation can help by reducing the tax liability, improving the company’s financial position and increasing the dedication of the employees and their long-term commitment to the company.

• Business Trusts. Trusts can help companies reduce their tax liability in several ways while providing other advantages such as flexibility by creating the trust in a manner that meets the specific goals of the company. Asset protection and Estate planning are some of the other potential advantages of a business trust.

It is important to note that tax planning involves creating a tailored strategy for each business and its shareholders. Creating a strategic plan sets business intentions and helps your tax planner minimize tax liability.

Effective communication between contractors and their tax planners is pivotal for optimizing these strategies. Regular reviews of the company’s financial performance can reveal opportunities to adjust tax planning methods, ensuring that they remain aligned with evolving business objectives. Staying informed about legislative changes and shifts in tax policies enables contractors to avoiding unexpected liabilities. 

Keeping up on your tax situation year-round and planning ahead so that tax season won’t catch you off guard will help maintain a stronger financial position for your business.