Tax planning is a necessity in the world of business because the IRS wants its money. However, businesses often focus on taxes so much that it can lead to failure or shape their decisions in a way that isn’t aligned with their goals.
It’s easy to get caught up in trying to reduce your tax burden to $0, and no less than 55 Fortune 500 companies paid no money in taxes.
Even Nike didn’t pay money in taxes, but these businesses often shelter their money and have investors that a small business owner cannot leverage.
If you’re trying to be like Nike, it’s important to consider the good and bad sides of tax planning.
5 Advantages of Tax Planning for SMBs
Tax planning can help make your business moves profitable, and it is a necessity for businesses of all sizes to some degree. The main advantages of tax planning are:
- Reduce your tax burden. Your business must find ways to keep costs low, and if you’re not tax planning, you’re not leveraging the tax code to reduce your tax burden. Owners that are planning for their taxes pay less money to the IRS.
- Free up investment money. When proper planning is done, you’ll free up investment money that can be used in other business areas. Knowing or projecting your tax liabilities allows you to earmark funds for certain investments that can help your business continue to grow.
- Peace of mind. Many small business owners don’t know their tax burden when they sit down with a tax professional. Knowing your tax liability is a part of proper tax planning and helps reduce the number of surprises at the end of the tax quarter.
- Budget for the quarter properly. Businesses need to know what changes are made to the tax code that can negatively impact their business. Tax planning helps identify critical changes and also allows for accurate budget planning.
- Better decision-making. Budgeting and decision-making are easier when you understand your tax burden. There may be years when your projections are higher-than-average, so this may be the right time to expand or invest in new business equipment.
If you’re not tax planning, you need to start. However, there is a dark side to tax planning, too.
3 Disadvantages of Tax Planning for SMBs
Tax planning is a good thing until it becomes obsessive. Many business owners want to save on business taxes, but at the extreme level, it’s a major disadvantage.
There are a few reasons.
- Reducing taxes often costs money. If you’re reducing your tax burden to extreme levels, you’re often spending money to do so. Some years, you may need to invest in your business to the point where your cash flow is low, but if you do this yearly, you may be positioning your business to not have the cash it needs to grow.
- Make rash decisions to lower the tax burden. When you’re caught up in only reducing your tax burden, you may make the wrong business decisions along the way. It’s not uncommon to release a product too early or hire employees that you really can’t utilize just to lower your business taxes.
- You’re taking on the tax burden yourself. Business owners wear many hats during the first few years of business, but being an accountant shouldn’t be one of them. Instead, you should work with a tax professional that can obsess over your taxes rather than doing it yourself.
Cash flow planning can be greatly impacted when you’re using all of your liquid assets as a way to lower your tax burden. In 2020, it was found that most small businesses can expect to pay an average effective tax rate of 19.8%. If you don’t like the sound of that percentage, then there are ways to manage it, but but be sure that your tax planning truly aligns with your business’s goals.
Work With a Tax Professional You Know and Trust
One important thing you can do for your business is work with a tax professional that you know and trust. The right professional will understand your business and your goals.
But how can you know whether a tax professional is someone you can trust? There are several things to consider when choosing a tax advisor, such as:
What is the Role of the Tax Professional?
One of the first things to consider is the tax professional’s role. For example, will they be working with your financial planner, attorney or other members of your team? Will your tax professional also have access to your accounting software? Will they be a CPA, or even further, will they be your CPA?
Understanding your tax professional’s role will make it much easier to find someone who meets your needs.
Do They Have the Right Experience?
Does the tax professional have the right kind of experience? Ultimately, you want to work with someone who has achieved the results you’re looking for with other clients. In addition, you want someone who knows your industry.
When talking to tax professionals, ask about their strategies. They may have achieved the results you are looking for, but at what cost? Do they use aggressive strategies that may cause some red flags? If so, it may be best to walk away.
Make sure that you check out any references you receive. Find out whether they have any experience with businesses in your industry. Someone who knows and understands your industry will be better equipped to meet your needs and find the right strategies to reach your goals.
Will They Be Available Year-Round?
Situations may arise throughout the year that require the help and guidance of a tax professional. Make sure that you work with someone who provides their service year-round. A reliable and trustworthy advisor will keep in touch throughout the year. They will offer you check ups throughout the year to make sure your business’s tax plan is current with the tax code and your goals, as both of those can change often.
If you want to set you and your business up for success, choosing a tax professional that you only meet with once a year likely isn’t best.
If your business is hyper-focused on tax planning, this can lead to you risking future growth, keeping dangerously low levels of cash flow and basing decisions on taxes alone.
Thoughtful planning helps your business save money, allows for healthy cash flow levels and only makes investments that align with your business goals.
When you’re trying to plan your taxes, work with a professional that can help analyze your finances and help you make prudent business decisions. The cost of hiring an accountant or tax advisor is also tax-deductible.Tax Planning