Effective Tax Planning: Why & How?

There are so many changes to the tax laws each year that most people simply cannot keep up.  Without an awareness of the tax laws an individual or business can make some very big tax mistakes.  But by having an awareness of the tax law changes a person can really make some huge tax reductions.  You see, it is the awareness of the law changes and how to take advantage of those changes that makes or breaks a tax return. 

How does one do effective tax planning?  First, start with a tax projection using the prior year tax return data and project your taxable income for the current year and the next year.  Adjust the figures for changes in income or deductions that you already expect to happen.  This will give you a good idea of the income tax that you will be facing for the current year and the next year.

Second, compare the tax brackets for the two years to see if there is any difference.  If there is a difference, then look for ways to shift income and deductions between the two years to take advantage of lower tax brackets.

Third, if your taxes are more than you want to pay, then look for ways to reduce taxable income.  You can do this by indentifing ways to exclude taxable income or identifing additional tax deductions.  Generally, it is a good idea at this point to discuss the matter with a tax professional that can help you identify the options that suit your situation.

Actually, we have some basic tax planning strategies that are contained in a booklet (that is easy to read).  We go over the basis strategies in the booklet with our clients to see what works best for them.  Every client's situation is unique, so the strategies are designed on an individual basis.

Fourth, look for tax credits if your taxes are still too high.  There are many tax credits available that most people overlook or are unaware of.  Again, a tax professional can go over what tax credits may work for you.

Finally, check to see if you have paid enough in withholding and estimated tax payments to avoid late payment penalties.

Now that that is done, you will know that you are paying as little as legally possible in taxes.  Sweet dreams! 

Larry Holmes, CPA

    

What do I do if I forgot to file my business tax return extension request on March 15?

By Larry Holmes, CPA, MBT

First, don’t panic.  California is a “paperless” extension.  So California grants you an automatic extension to file even if you don’t file a paper extension with them.

Second, there is no penalty for filing late if there is no tax liability for Federal.  So go ahead and file the return late and you shouldn’t have a problem if there is no income tax liability.

Finally, the Federal penalty for filing a delinquent return is 5% for each month (or fraction thereof) up to 25%.  The penalty is computed only on the net amount of tax due, if any, on the return after credit has been given for amounts paid through estimated tax payments and any other credits.  So if the business has not tax due, then there is no late filing penalty.  If there is a balance due, the penalty can be avoided if there was “reasonable cause” for filing late.  The best thing to do is to speak to a tax professional quickly so that you can get help on possible reasonable cause defenses.

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Booking Credit Card Expenses in QuickBooks - the Right Way

By Larry Holmes, CPA, MBT

I frequently find new clients that have trouble handling credit cards in QuickBooks.  I thought the following article might be of help.

Are Credit Cards Expense Accounts?
No.  The most basic mistake that I see is that a business will treat a credit card like an expense account.  It is not an expense account.  It is a liability account because the credit card represents a borrowing of money prior to actual payment.  As a liability account it belongs on the balance sheet rather than on the profit and loss statement.

Buying something with a credit card is paying with borrowed money, and the money is borrowed from the credit card company.  That is why a proper accounting is to handle the credit card in QuickBooks as a liability account.

When Are Expenses Recorded?
The expense is recorded on the “Record Credit Card Charges” screen, in the “Expenses” tab.  When you use the Enter Credit Card Charges screen, you are recording the expense and you are also recording the borrowing from the credit card company at the same time.

For income tax purposes (and good accounting practices as well), the transaction date is the date that should be used in QuickBooks.  It is a mistake to use the credit card statement date or the check payment date as the date of the transaction in QuickBooks.

Are Credit Card Payments an Expense?
I cannot tell you how many times I have seen people record credit card payments as an expense.  Credit card payments are not an expense; instead they are payments on the amount borrowed from the credit card company.  In essence, credit card payments are payments of a debt rather than an expense.

I hope this is helpful to you.

Cash vs. Accrual

by Larry Holmes, CPA, MBT

Taxpayers have a lot of choice when it comes to how they maintain their books and records for income tax purposes.  Many service businesses keep their books on a “cash basis”.  Other types of business that have a lot of inventory keep their books on an “accrual basis”.   Very few people understand the differences between these.  So what are the definitions of each?

Income
Cash basis means that the business records their income at the time they receive the actual payments from their customers.  The payments can be in the form of cash, credit cards, wire transfers, checks, or ACH deposits.  We encourage business owners to deposit all receipts from their customers on the same day they receive the payments.  That way the bank deposit for the day shows the total of the income for the day.
 
Accrual basis means that the business records their income at the time the service or product is delivered to their customer.  This frequently happens before the payment is received from the customer as many businesses allow their customers time to make payments.

Deductions
Tax deductions for a cash basis taxpayer occur when the taxpayer pays their bills. 

Tax deductions for an accrual basis taxpayer do not occur when the payment is made, rather they occur when the service or supplies are received by the taxpayer.  Since many businesses purchasing services and supplies do not have to pay immediately upon receiving them, the accrual basis taxpayer will typically record tax deductions sooner than a cash basis taxpayer does.  However, it is possible for a cash basis taxpayer to send out payments before receiving the services or supplies, ie. prepaying rent.

Which method has the most advantages for you?  That depends on the type of business that you have.  There are many factors that one should consider in choosing their accounting method.  It is possible for a business to adopt “hybrid” methods of accounting, as well.  The factors can become complex in a hurry so it is best to have the experts at Holmes & Associates discuss your specific business needs.  All businesses are different and unique and the most advantageous methods are unique to each business.

Decisions, decisions...C Corp or S Corp?

by Larry Holmes, CPA, MBT

Recently, I have found a number of small business owners using S Corporations and LLCs rather than C Corporations. It appears that many tax professionals recommend the use of S Corporations or LLCs exclusively without considering the tax benefits of a C Corporation. I thought I had better let you know about the major tax benefits of a C Corporation compared to those other types of entities.

Avoiding the Double-Tax Dilemma
These tax professionals cannot seem to solve the problem of how to get the money out of the C Corporation without paying the "double-tax" that exists on corporations and individuals. Perhaps they are unaware of the many ways to access the money through the use of legally available, non-taxable fringe benefits. The list is almost endless and can be found in the tax code. It is not difficult if you know where to look.

The solution to the problem of the double-tax on corporations and individuals is to avoid it all together by careful tax planning. For most small businesses, paying the double-tax is simply an indication of a poor (or no) tax plan.

A Clever Strategy Using the C Corporation
A clever strategy for successful business owners is to leave money inside of the company at the end of the year rather than pay it out in bonuses. This money can work just like a retirement account; it can be left in the company, invested and allowed to grow.  When it reaches a sizable sum, the owners can access it in a variety of ways, i.e. borrowing it, paying for medical expenses, paying dividends (taxed at 15%) or liquidating it and paying capital gains at 15% or they can pass it along in a very favorable estate tax plan, if they so choose. Also, a nest egg left in the company can be used for a rainy day, business slowdowns, or expanding the company by investing in new lines of business.  It can also be used to fund another enterprise the owners start or become involved with at a later date.

Most of our small business clients are very talented people and the accumulation of money through cheap tax rates in a C Corporation is of great value to them over time. It enables them to get into some much bigger games in the future and they are glad to have the money available to play those bigger games.

Your “Custom” Fiscal Year
The other major tax difference is the availability of a fiscal year-end. A C Corporation can adopt a fiscal year end. The S Corporation and LLC are usually stuck with a calendar year end. I find that the tax savings from a fiscal year end can be huge. Bonuses can be paid out of the C Corporation in January rather than in December and that means the individuals don’t have to pay tax on those bonuses until the following year. Now if you do that every year (pay bonuses in January rather than December), you find that almost one full year of income tax disappears into the far distant future. Imagine skipping one year of tax until some far distant future date (30 to 40 years or even more)? It’s possible with good planning.

Not a “One-Size-Fits-All” Strategy
Despite the many tax benefits that exist for C Corporations, I don’t exclusively utilize C Corporations rather than S Corporations or LLCs. There are still many business situations and tax strategies that dictate the use of entities other than C Corporations. Real estate investments rarely make sense in C Corporations, for example. However, I find that the use of a C Corporation in conjunction with an S Corporation or LLC can really hit some home runs by taking full tax advantage of each type of entity. Using multiple entities can get complicated in a hurry, but in certain business situations that tax savings can be astonishing.

Anyway, next time you hear someone telling you about how S Corporations or LLCs are the only way to go, think twice. It is quite likely that the small business owner would find the C Corporation to be much more profitable and beneficial.

Another thought: why do you think that all the fortune 500 Companies are C Corporations? Sure, they have legal reasons for using C Corporations. But they also have the smartest and brightest tax guys in the world working out the best tax solutions by using C Corporations. Don’t you think the brightest minds in the world working for the richest companies in the world know something about what they are doing?

The above is simply a general overview of what I have seen and is not intended to be specific tax advice for anyone.  S Corps and LLCs do have their uses.  The purpose of this article is to make you more aware of the possible tax benefits rather than make a specific recommendation.

If you would like more information, please call me. I would love to help you with your particular situation.

Sincerely,
Larry Holmes, CPA, MBA
Holmes & Associates