Surviving—and Profiting From—the Economy: Part 2, Tax Savings

By Mark E. Battersby

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Surviving a shaky economy can be a lot easier for the business owner who takes full advantage of the helping hand provided by his or her operation’s not-so-silent partner, Uncle Sam. Yes, the Internal Revenue Service (IRS) is a partner in every business in the sense that a share of the operation’s profits, aka taxes, finds its way into the government’s coffers.
      Our tax laws underwrite the normal costs of doing business with tax deductions, and depreciation write-offs help the business recover the cost of equipment and other business property over time. However, taking full advantage of Uncle Sam’s tax laws begins with something very basic: how your business is operated, meaning its designated entity or form.

Business Entities

For tax purposes, the five predominant forms of business enterprise are:
1) The ‘C’ corporation. This entity is subject to the toughest tax bite. The earnings of an incorporated business are taxed twice: First when a corporate income tax is imposed on the operation’s net earnings, and second, after the earnings are distributed to shareholders as dividends and each shareholder must pay taxes separately on his or her share of the dividends.
2) The ‘S’ corporation and 3) The limited liability company (LLC). An S corporation is merely an incorporated beauty store business that has chosen to be treated as a partnership for tax purposes. It, along with the relatively new limited liability company or LLC, offers some appealing tax benefits while still providing its owners with the liability protection of a corporation. With an S corporation or with an LLC, income and losses are passed through to shareholders to be included on their individual tax returns. As a result, there is just one level of federal tax to pay.
4) A partnership. One of the major advantages of a partnership is the tax treatment it enjoys. A partnership does not pay tax on its income but “passes through” all profits or losses to the individual partners.
5) A sole proprietorship. The easiest structure is the sole proprietorship, which usually involves just one individual who owns and operates the business, as is the case with many beauty stores. The tax aspects of a sole proprietorship are especially appealing because income and expenses from the business are included on the sole proprietor’s personal income tax return.

Tax Laws

Just as the various types of business entities offer flexibility as to where—and at what rate—the income of a business will be taxed, our tax laws offer a degree of flexibility that permits business owners and managers to legitimately manipulate both income and deductions to achieve a consistently low tax bill.
Deferring or postponing the receipt of income in a tax year when profits are up often results in a lower tax bill for that year and in later years when income will, hopefully, be offset by a larger-than-usual amount of deductions. On the other hand, businesses damaged by a natural disaster often have an incentive not to claim deductions and thus report higher pre-catastrophe income. Higher pre-catastrophe income can lead to higher federal assistance and insurance settlements from damages due to loss of income.

A “like-kind” exchange of business assets and similar swaps such as trade-ins of business vehicles, will defer the gain on the disposition of any business asset. It is also possible to defer the gain on an asset destroyed in a casualty such as when the building housing your beauty products operation is destroyed by fire and insurance proceeds are used to build or buy a new one. Similar results are achieved where a building is condemned by a state or municipal government entity. Naturally, with like-kind exchanges any gain that results may be deferred, usually added to the book value or “basis” of the replacement property.
      Despite all of the attention focused on income taxes, property tax actually commands the greatest focus for most businesses. It’s also the most difficult tax to manage. According to the Council on State Taxation, a Washington, D.C. think-tank, American businesses shell out more for property taxes than for any other type of state or local taxes.
      It isn’t only those business owners who own their property who have been impacted by skyrocketing state and local property taxes; tenants, too, are feeling the bite. Regardless of whether property taxes are paid directly by a tenant, or are included in a lease, those taxes represent a significant cost.
In seeking to reduce or correct a property tax bill, any owner or manager can review their property's record in the tax assessor's office. Such records are public and, as such, available to everyone. And remember, a reduced assessment or a corrected property tax bill not only means less expense for your operation this year but also for years to come.

      In the bigger picture of surviving bad times, tax savings is only one strategy and may not even always be the smartest move. Taking advantage of accelerated depreciation write-offs or even the 50-percent “bonus” depreciation temporarily created under the “rebate” tax bill will be wasted in a tax year when taxable income is low. Postponing deductions wherever legitimately possible can mean larger write-offs in later, more profitable years.
      Taking advantage of tax deductions where—and when—they will do the most good, does not mean ignoring write-offs that help reduce the cost of doing business. We will delve into more substantial cost-cutting in our third and final installment.

Mark E. Battersby is a freelance writer based in Ardmore, PA.

Go to the previous web exclusive article on Surviving—and Profiting From—the Economy: Part 1