Many entrepreneurs do not consider taxes when they set up a business until they owe a big tax bill.
But decisions made when starting a firm can greatly affect future tax liabilities. The following tips can help reduce taxes for start-up companies:
-Selection of tax entity. Let's consider a fictitious high-tech startup called GoTech. The first thing the owners must do is determine what type of company they want to operate. The most common are corporation (C or S), partnership, and limited liability company, also known as LLC. The IRS has devised various mechanisms to tax each of these entities and its owners.
S corporations, partnerships (general and limited), and LLCs are considered "flow-through" entities, which means that the owners are taxed on income.
In addition, LLCs and partnerships allow flexibility in the tax treatment of each owner. For instance, the big-money investor may want to deduct losses generated by the firm. If all parties agree, losses from GoTech could be allocated to that investor. If there is income, those amounts can be allocated evenly to the other partners or shareholders to share the tax load.
C corporations are subject to double taxation at the corporate level and at the shareholder level (if the company makes distributions). However, keep in mind that for publicly traded companies, the only entity of choice is the C corporation because S corporations are limited to 75 shareholders. (Many firms convert to C corporations prior to making initial public offerings.)
-Defer income and accelerate deductions. Small businesses (less than $10 million in gross receipts for the past five years) that do not have inventory should elect the cash method of accounting. This would allow a company like GoTech to defer year-end income by instructing customers to pay invoices after Dec. 31.
If the business has the financial wherewithal, it can also accelerate deductions by prepaying items like insurance, property taxes and rent. That way, GoTech could deduct these expenses under the cash method in the current year. Also, credit card charges are considered deductible in the period they are incurred.
-Expense reimbursement. Many startups utilize employees and their personal credit cards to pay for company expenses. GoTech could adopt an accountable plan, which allows the corporation to deduct those reimbursed expenses while leaving them off an employee's W-2. Otherwise, employees must report those reimbursed expenses as income and deduct them on their personal tax returns subject to limitations.
For reprint and licensing requests for this article, CLICK HERE.
Stories You May Also Be Interested In
- Economic Forecast & Trends 2018: Tax Reform - International Planning Considerations
- Custom Content: Top International Planning Opportunities for L.A.-based Tech & Manufacturing Businesses
- State of Accounting - Points of View from the Accounting Leaders' Desks: Entity Choice a Hot Topic After Tax Reform
- Economic Forecast & Trends 2019: Four Ways Tax Reform Will Affect 2019
- Tax Reform: Tax Cuts and Jobs Act - The New Favorable Deduction for Passthrough Entities
- Key Tax-Planning Opportunities for Food and Agribusiness Companies
- Tax Reform: Multinational Companies Should Start Preparing Now for Monumental Changes in New Tax Law
- The Business of Cannabis: Tax Planning for Cannabis Companies