What tax planning strategies do you employ for your organization? If you answered "none," you might be in trouble...
With tax season ending, now is the time for business owners to start thinking about next year.
- What is your approach to cash management?
- How do you plan to pay your taxes?
- How are you taking advantage of tax credits through your business structure?
These are just a few questions you may not know the answers to but should be thinking about as tax day approaches...
But, before you become too overwhelmed, keep in mind that there is a light at the end of the tunnel.
Tax preparation does not have to be an afterthought, and assistance is available.
I'll show you some of the most important tax planning strategies for business owners and some of the most common mistakes I see business owners make when it comes to tax planning. So let's get this party started.
Select a specific accounting method and stick to it.
All business owners can choose how they want to report expenses and income based on their business model.
As an agency owner, you must understand the distinction between the two main accounting methods: cash and accrual.
Even if you have an in-house CFO or a partner handling your financial reporting, it's critical to understand how each one works so that we can all collaborate to make the best bookkeeping decisions for your agency.
You can choose to report income and expenses on an accrual basis, which means waiting until the project is completed before reporting the funds, or on a cash basis, which means reporting funds as soon as they are received and paying taxes on them the same year.
Your option will impact your company's ability to schedule tax payments, so you must make an informed decision.
This comes at a high cost and necessitates owners to fill out numerous forms each time they attempt to make a change.
Expenses at the end of the year should be increased.
This strategy is for expenses you expect to benefit from at the start of the year.
Rather than paying when you need the product or service (say, in February), you can pay for it before or on December 31st.
This will provide you with a tax credit for the expense, deferring your liability for it by a year.
Locate and Use Tax Credits
Tax credits are typically given to employers to encourage positive behavior; however, from a business standpoint, they are simply a means of receiving cash back from the government.
Tax credits for providing education are one example, as credit for making energy-saving improvements to your business.
COMMON TAX PLANNING MISTAKES MADE BY AGENCIES
Now that you understand the fundamentals of tax planning, let's look at some of the most common mistakes agencies make regarding taxes.
1. Failure to Select the Appropriate Accounting Method
This is the "accrual vs. cash" debate we previously discussed.
If you don't establish a consistent method for reporting income and expenses, you'll miss out on many tax breaks.
As a best practice, project-based agencies should use the accrual method, while monthly retainer agencies should use cash basis reporting.
If your company performs both operations, you can structure your reporting as a hybrid of the two - accrual for projects and cash for monthly clients.
2. Selecting the Incorrect Business Structure
Many agencies do not consider business structuring until it is too late to structure in a tax-efficient manner.
Each of the four business structures has advantages and disadvantages, and conducting research before starting your business is the best way to avoid making a mistake. However, there are ways to correct mistakes, which is why tax planning services are beneficial.
3. Insufficient Cash in the Bank
The third point is that agencies must be aware of their cash flow to pay their taxes and keep their company bank account and finances in good working order.
You should always know how much money you can set aside for investments while covering expenses like payroll.
Your business may suffer if you take out too much.
On the other hand, not withdrawing enough from the bank frequently causes businesses to miss out on investment opportunities that could have increased their profit margins. This brings me to the next major cash flow planning mistake.
Many agency owners are taken aback by a sudden increase in company profitability. Managing cash flow and cash requirements throughout the year is critical when you're in a rapid growth phase.
4. Inadequate Cash Flow Planning
Because of the nature of the agency business, many agencies struggle with cash flow planning.
Project-based firms never know when the next big deal will come in, and monthly retainer-based firms may have clients whose contracts require them to pay on an ungodly pay schedule (net 90? Come on.) Alternatively, they may pay late or not at all.
It is critical to consider your obligations and determine how cash will be distributed after it has been deposited into your account. Even with proper cash flow planning, it can be difficult to predict when and where cash will be required.
However, without cash flow planning, an agency may find itself insolvent if a client pays late or breaches its contract.
How are you going to pay your office rent? What about your employees?
What about your taxes?
Predicting cash flow and planning how it should be used in advance is preferable to having no insight and spending on a whim. The only way to protect your business from unforeseen issues is to have a solid plan.
Now that you understand the goals, benefits, and common pitfalls of tax planning, you can see why organizing your organization to be more tax efficient is a win-win situation. And whether you choose to outsource tax planning or take on the project in-house, your agency will reap the benefits of this investment if done correctly.