Forward Tax Planning vs Viewing Taxes in the Rear-View Mirror
Anyone who has driven a vehicle understands that a quick check in the rear-view mirror regularly is a good thing but driving with your focus on that mirror will almost surely result in calamity. Taxation for the small business is a lot like that. Looking back at the year, the decisions you as a business owner made, and the many business transactions, is leaving you wide open to a collision with the IRS; and you will almost always come away with significant financial damage.
Today’s new automobiles are leaving the assembly line with forward collision avoidance systems. They either sound a warning when something is too close in front of the vehicle for the speed, slow or stop the vehicle, or both. These systems add some to the cost of the vehicle, but not nearly as much as the financial damage from over-taxation or a collision with the IRS. There is an equivalent in the business world; it is your accounting and tax professionals.
If you find yourself viewing your end-of-year income tax due and saying to your accountant “You mean I could have…,” it is too late. The thing about tax planning is that it is looking forward both short and long-term. And even then, changes in your business can and should result in changes in the tax plan.
One example could be changing the method of depreciation of an asset. There can be a valid business reason for doing so, but the IRS has some tight rules about it listed here. The page starts out with:
Generally, you must get IRS approval to change your method of accounting. You generally must file Form 3115, Application for Change in Accounting Method, to request a change in your method of accounting for depreciation.
Then there follows a long list of bullet points; nothing simple about the IRS. Perhaps the entire situation could have been avoided with a quick consult with your tax expert before the original depreciation decision. It gets a lot more complicated in the rear-view mirror.
Another example of the importance of planning in a business is when it is growing or expanding. The goal of almost every entrepreneur who starts a business is to grow it into something bigger than themselves. They may want to run it as long as they can, or they may have a plan to grow it to a point where they can sell it and retire with financial security. It is the growth itself that creates either challenges or opportunities when it comes to taxation.
In growing, the business will likely be hiring employees or using independent contractors, either decision becoming a consideration in planning ahead for the tax consequences or opportunities. Decisions like whether to hire family, what benefits the business can afford to offer and how to package them, and retirement plans for ownership are all things you want to be looking forward at, not in the rear-view mirror.
The best way to think about driving your business is to focus major decisions forward and only review how well they worked in the rear-view mirror. To do that, rely upon your accounting and tax team’s advice, as they are on top of not only recent IRS rule changes, but coming changes and their effective dates and consequences.