In the excitement of starting a new business, it’s easy to focus on your business ideas and ramp up your operation. But taking a step back and considering business tax planning from the outset is important.
This means considering which business structure you should create, how tax credit can affect your business, when to purchase assets, using tax-loss harvesting, and understanding which startup expenses are deductible.
Basics of Business Tax Planning
Business tax planning means strategically analyzing your business’s financial situation with a tax-centric lens. It’s a balance of ensuring you comply with tax obligations while taking full advantage of allowable deductions and credits.
Most importantly, you need to understand the unique tax implications facing your business structure. Your business will face different challenges depending on whether it’s a sole proprietorship, partnership, LLC, or corporation.
The first step towards effective tax planning is ensuring your entity structure aligns with your business needs. You should also familiarize yourself with potential deductions to ensure you’re not leaving any write-offs on the table, and you should make it a habit to keep comprehensive records and receipts.
Tax credits offer incentives for various business activities, such as research & development of new tech, hiring certain employees, and more. These credits can provide significant financial relief. However, complying with complex federal regulations is no easy task, so you should work with a tax advisor to avoid trouble with the IRS.
Proper tax planning accounts for all these areas and much more. Your unique needs will depend on the nature of your business, entity structure, and other factors, but these common themes usually apply universally.
The Best Business Tax Planning Strategies for Startups
There are several essential business tax planning strategies that you should consider for your startup.
Selecting the proper business entity structure is a strategic choice with significant implications for your legal liabilities and tax burdens. The type of structure you choose can affect your personal liability, dictate the amount and type of paperwork your business must regularly file, influence your ability to raise funds and impact your tax obligations.
A sole proprietorship is the simplest structure and does not require a separate tax return. But it exposes you to personal liability for business debts and might not be the most tax-efficient structure.
Forming a corporation shields your personal assets from business liabilities but introduces stricter regulatory and reporting requirements. A corporation will have to file a tax return. If you organize your business as a C-Corp, the business will pay taxes at the corporate level on any profit left in the business.
An S-Corp is a special type of corporation that avoids double taxation. The income flows through to shareholders, who report it on their personal tax returns. While an owner of an S-Corp is required to pay themselves a “reasonable salary,” which is subject to Social Security and Medicare taxes, any additional profits taken as distributions are not. This can translate to thousands of dollars in savings compared to a structure like a sole proprietorship or a general partnership where all income is subject to self-employment taxes.
A Limited Liability Company (LLC) combines a partnership’s flexibility with a corporation’s liability protection. This offers the right blend of simplicity and protection for many small businesses or startups.
Maximize Tax Credits
Unlike deductions, which reduce the amount of income subject to taxation, tax credits directly reduce the amount of tax you owe, dollar for dollar. If you’re in a 25% tax bracket, a $1,000 deduction would save you $250 in taxes, but a $1,000 tax credit would save you the total of $1,000.
The Research & Development (R&D) tax credit serves as a prime example of the substantial savings businesses can realize. Specifically designed to incentivize companies to invest in innovation, this tax credit can significantly reduce a company’s tax bill, depending on the scale of its R&D activities.
By understanding and maximizing tax credits, businesses boost their bottom line and gain more resources to reinvest, grow, and innovate.
Tax Loss Harvesting
Though most business owners focus on the profits they expect to make, losses are a part of many businesses (especially newly formed startups).
That’s where tax loss harvesting comes into play, offering a silver lining in such downturns. In essence, tax loss harvesting involves selling investments that are at a loss to offset taxable gains from other investments. By doing this, businesses can reduce their taxable income, subsequently lowering their tax liability.
In certain scenarios, “abandoning” a property or an investment, essentially relinquishing all rights and claims to it, can present even more significant tax benefits than simply selling it at a loss.
Over time, these tax savings can be substantial, demonstrating that there’s a potential strategy to soften the blow even in the face of investment setbacks.
Buy Assets at the End of the Year
One strategic maneuver to consider is the purchase of new or used assets. If your tax bill looks larger than anticipated, purchasing assets can become an effective tool to lower those liabilities.
Section 179 allows businesses to deduct the entire purchase price of qualifying equipment bought or financed during the tax year. It’s explicitly designed to encourage companies to purchase equipment and invest in themselves.
There is also an option to take bonus depreciation. This provides a different method of deducting a significant portion of the cost of new assets. Bonus depreciation began its phase-out in 2023. For 2023, the bonus depreciation rate is 80% and is scheduled to reduce by 20% each year until it reaches 0%.
Section 179 and bonus depreciation may change the taxability of an asset if you sell it in the future.
Remember that these assets in service before year-end are depreciable. It’s not enough to merely purchase the asset. It must be operational and used in your business by year-end. With the right timing and strategic acquisitions, businesses can harness these tax advantages. This optimizes their financial position as they transition into the new year.
Use Startup Deductions
Launching a new business venture comes with many expenses. Some expenses include: market research and legal fees to initial inventory costs. The tax code offers special provisions to alleviate some of this financial burden.
Startup businesses can deduct up to $5,000 in startup costs. They can deduct an additional $5,000 in organizational costs, provided the total startup expenses do not exceed $50,000. This means that new businesses can claim a combined deduction of $10,000 in their first year of operation. This helps offset some of the initial costs of getting a business off the ground.
There are some stipulations around these expenses. For startup expenses between $50,000 to $55,000, the $5,000 deduction is progressively reduced by the amount exceeding $50,000.
Any expense that’s not eligible for deduction in the first year must be capitalized and amortized over 15 years.
Closing Thoughts on Business Tax Planning
In the dynamic world of startups, where every penny counts and every decision can significantly impact the future, tax planning emerges as an indispensable component of business strategy.
Some of the most beneficial tax planning strategies for startups include picking the proper business structure, maximizing tax credits, strategically acquiring assets at the end of the year, leveraging the power of tax loss harvesting, and utilizing startup deductions to offset initial costs. Each of these tactics can provide substantial relief from tax burdens, ensuring that startups retain more of their hard-earned capital.
The importance of tax planning remains an essential part of your startup plans. Startups that prioritize and integrate these strategies today will realize long-term rewards.
Tax Hack Accounting specializes in innovative tax strategies for startups and enterprise businesses. Our veteran team of tax pros has decades of combined experience, and we’ve helped business like yours rack up millions in tax savings since we opened our doors. Connect with us today for a complimentary one-on-one strategy session with one of our talented tax pros.