November 28, 2005
COMMENTARY: An all-year project | Individual and business tax planning shouldn't be relegated to the fourth quarter
By Jack Sullivan
Principal, Runyon Kersteen Ouellette, South Portland
In an annual ritual, sometime between the departure of the leaf peepers and the arrival of Thanksgiving, accountants, tax attorneys, financial planners, investment advisors and various publications bombard the electronic and written media with a plethora of articles about year-end tax planning. To the neophyte, tax planning would seem to be a once-a-year process accomplished in the last calendar quarter. However, tax planning should always be on the agenda.
Tax planning takes on an added dimension if we are also business owners. As we wind up our tax strategies for the current year, we also should be formulating our strategies for the coming year and, when feasible, the years beyond. Not only should we be focused on the annual income tax we expect to pay, but also on the legacy we expect to leave behind and the consequences of the estate taxes. Planning strategies for these two taxes are not always compatible, and one must be careful to navigate the best possible course between them.
Although most of us expect to pay taxes and feel morally responsible to pay for the running of our government, we are nonetheless human and hate to depart with a dollar before we have to, nor incur more than our fair share. Herein lies the motivation for tax planning: the postponement of taxes whenever legally possible, and the attainment of the lowest possible tax given the current tax regulations.
The latter presents a significant challenge, as Congress repeatedly sees fit to change the playing field by revising the rules, often retroactively, and in many cases discouraging behavior they had encouraged in the past, such as rewarding tax shelter investments, then not. Similarly, our state legislators of late have found it increasingly difficult to keep up with and pay for federal tax incentives; more frequently, they decide to decouple state tax policy from the federal laws, further complicating the process.
Tax deferral is a common goal, but it can not be undertaken in a vacuum. To do so without thought to the future can backfire if income is postponed to a later period in which an individual or a business is in a higher tax bracket. If there is a significant spread between tax brackets in adjoining years, the strategy normally is to plan such that the lowest overall tax is incurred between the years. Thus sometimes the strategy is reversed, and income is accelerated and expenses are deferred. With the lowest tax rates in years and much rhetoric being given to the blossoming deficits, there has recently been talk of bridging the budget gap. Could it be that we are looking at the lowest tax rates that we will see for a while?
It goes without saying that having up-to-date and accurate financial records is an integral ˆ and year-round ˆ part of the planning process. Over the past several years, technology, and the advent of neophyte-friendly software, has facilitated this objective and most small business (even those with no professional accounting or bookkeeping staff) can now have reasonably accurate financial records on a timely basis.
One of the best ways to defer taxes is to pay yourself in the form of disbursements that are currently deductible to the business but not currently taxable to you. Often heralded but frequently underutilized, retirement plans are win-win and, thus, a must-must. Many businesses have found that it is hard to recruit or keep employees unless some type of retirement plan is available, even if it is self-contributory with minimal employer contribution.
With this in mind, there is even a plan, the SEP-IRA, that can be implemented after year end and applied to the prior year, but for many it may prove prohibitively expensive to implement. Many small businesses change the type of plan they utilize as the business evolves, the income available to the owner changes, the owner ages, the number and compensation of employees' changes, family members come on the payroll, and disposable cash varies.
While some plans can be set up at the last moment and funding can be delayed until the due date of that year's tax return including extensions, the best plan for you and/or your business may be a 401(k) or a SIMPLE plan, which require prospective earnings and employee notifications before they can be implemented. For a significant number of businesses in Maine, the best fit may be such a voluntary deferral plan; thus, the end of the year may be too late to shelter any current year income.
So, you see, tax planning is a lot like Christmas shopping. You can wait until the last minute, but the choices may not be what you envisioned; you may be forced to take what is left, and at a price you did not plan on paying. Therefore, as you put the finishing touches on 2005, look to 2006 and beyond. Also take the time to look over other bridges you and your business will have to cross in the future ˆ business succession, insurance coverage, your will, estate plan, etc. ˆ to ensure your current plan is in sync with your long-term goals.
In an annual ritual, sometime between the departure of the leaf peepers and the arrival of Thanksgiving, accountants, tax attorneys, financial planners, investment advisors and various publications bombard the electronic and written media with a plethora of articles about year-end tax planning. To the neophyte, tax planning would seem to be a once-a-year process accomplished in the last calendar quarter. However, tax planning should always be on the agenda.
Tax planning takes on an added dimension if we are also business owners. As we wind up our tax strategies for the current year, we also should be formulating our strategies for the coming year and, when feasible, the years beyond. Not only should we be focused on the annual income tax we expect to pay, but also on the legacy we expect to leave behind and the consequences of the estate taxes. Planning strategies for these two taxes are not always compatible, and one must be careful to navigate the best possible course between them.
Although most of us expect to pay taxes and feel morally responsible to pay for the running of our government, we are nonetheless human and hate to depart with a dollar before we have to, nor incur more than our fair share. Herein lies the motivation for tax planning: the postponement of taxes whenever legally possible, and the attainment of the lowest possible tax given the current tax regulations.
The latter presents a significant challenge, as Congress repeatedly sees fit to change the playing field by revising the rules, often retroactively, and in many cases discouraging behavior they had encouraged in the past, such as rewarding tax shelter investments, then not. Similarly, our state legislators of late have found it increasingly difficult to keep up with and pay for federal tax incentives; more frequently, they decide to decouple state tax policy from the federal laws, further complicating the process.
Tax deferral is a common goal, but it can not be undertaken in a vacuum. To do so without thought to the future can backfire if income is postponed to a later period in which an individual or a business is in a higher tax bracket. If there is a significant spread between tax brackets in adjoining years, the strategy normally is to plan such that the lowest overall tax is incurred between the years. Thus sometimes the strategy is reversed, and income is accelerated and expenses are deferred. With the lowest tax rates in years and much rhetoric being given to the blossoming deficits, there has recently been talk of bridging the budget gap. Could it be that we are looking at the lowest tax rates that we will see for a while?
It goes without saying that having up-to-date and accurate financial records is an integral ˆ and year-round ˆ part of the planning process. Over the past several years, technology, and the advent of neophyte-friendly software, has facilitated this objective and most small business (even those with no professional accounting or bookkeeping staff) can now have reasonably accurate financial records on a timely basis.
One of the best ways to defer taxes is to pay yourself in the form of disbursements that are currently deductible to the business but not currently taxable to you. Often heralded but frequently underutilized, retirement plans are win-win and, thus, a must-must. Many businesses have found that it is hard to recruit or keep employees unless some type of retirement plan is available, even if it is self-contributory with minimal employer contribution.
With this in mind, there is even a plan, the SEP-IRA, that can be implemented after year end and applied to the prior year, but for many it may prove prohibitively expensive to implement. Many small businesses change the type of plan they utilize as the business evolves, the income available to the owner changes, the owner ages, the number and compensation of employees' changes, family members come on the payroll, and disposable cash varies.
While some plans can be set up at the last moment and funding can be delayed until the due date of that year's tax return including extensions, the best plan for you and/or your business may be a 401(k) or a SIMPLE plan, which require prospective earnings and employee notifications before they can be implemented. For a significant number of businesses in Maine, the best fit may be such a voluntary deferral plan; thus, the end of the year may be too late to shelter any current year income.
So, you see, tax planning is a lot like Christmas shopping. You can wait until the last minute, but the choices may not be what you envisioned; you may be forced to take what is left, and at a price you did not plan on paying. Therefore, as you put the finishing touches on 2005, look to 2006 and beyond. Also take the time to look over other bridges you and your business will have to cross in the future ˆ business succession, insurance coverage, your will, estate plan, etc. ˆ to ensure your current plan is in sync with your long-term goals.
Most Recent
Most Recent
Comments