Tax time can be painful, especially if you don’t plan ahead. As a business owner, you will face many stresses if the tax deadline is the only time of year you consider taxes or their implications. You may be waiting with bated breath to find out about an unknown tax liability or worry about the accuracy of your books and how that could impact your tax situation. There are benefits of tax planning that can help the mad scramble many owners face during the annual tax deadline.
What we cover in this episode:
- 01:26 – Uncertainty of taxes
- 02:48 – The importance of tax planning
- 06:18 – Tax horror story – A case for tax planning
- 10:22 – Minimize the pain
- 19:00 – Benefits of proactive tax planning
Uncertainty of taxes
In looking at taxes in general, the biggest pain point boils down to uncertainty – the notion of not knowing what to expect, what’s going to happen, and wondering whether or not you will owe money. These unknowns can quickly lead to stress and anxiety. We may not speak for everyone, but most people would say they don’t enjoy writing a check to the IRS. However, if your business is making money, you’re going to have to pay taxes. We like to point out the alternative though, which would be a loss. If you are paying taxes, that means you are running a profitable business! There are things you can do to minimize the uncertainty though, so stick around to learn about the benefits of tax planning and other tips.
The importance of tax planning
We want to give you tools and ideas to minimize the stress and anxiety that often accompanies tax season. Tax planning and taking a proactive approach to your taxes is going to have the largest positive impact on you and your business. There are things that can be done in advance to mitigate potential taxes as you make decisions for your business. Most of these actions must be taken throughout the year though and cannot be retroactive. You can’t wait until a couple of months before taxes are due and then decide to get tax planning advice. While some changes may be made after the year comes to an end, most must be done proactively during the year. Neglecting to plan ahead could lead to missed tax-saving opportunities. Planning ahead also gives you time to ensure that you are recording things appropriately.
Relationship with your tax preparer
Tax preparation isn’t just the act of submitting the tax form. Having your taxes done correctly and planning appropriately is extremely important. There is much more to tax, which is one reason you want a good preparer who is accurate, detail oriented, knowledgeable in tax law, and has good experience. Many times this is a CPA, advisor, or virtual CFO. Having them as part of your team is great, but you also need to have a good relationship which means you need to speak with them regularly, rather than once a year during tax time. Speaking with your tax preparer regularly gives everyone constant awareness of what is happening in the business. You can avoid the build up of stress that comes with uncertainty. If your tax preparer isn’t proactively approaching you throughout the year, then you need to proactively approach them. We recommend scheduling routine meetings throughout the year for many reasons. Routine meetings are beneficial because you want to have a plan in place as the year progresses. If you need to write a check during the year, you will be able to put money aside so it doesn’t come as a shock. These regular meetings allow you to avoid extreme sticker shock at the end of the year when you see the official amount you owe for taxes.
Tax horror story – A case for tax planning
Imagine making a mistake worth $300k in your business… Katina Peters, one of our partners at PJS & Co. CPAs, shares a story to help all of us learn about some of the costly mistakes she has seen in the past when tax planning has not been a part of a business owners’ toolset. Disclaimer, we were not the actual tax preparers for this client. The client came to us after the fact with this situation and we were able to walk them through the process to fix the issue.
Background on the story
This client performed construction-related contracts and had what they refer to as work in process (WIP). Work in process, or WIP, is the work that is performed on a job but has not yet been billed, so no money has been collected. With this, there is a nuance in the law that requires filing under what is called percentage of completion. Basically when this happens, the work in process is claimed as income even though no money has been collected yet. So, this client was in a rough spot because they owed taxes on something they hadn’t been paid for yet. In this situation, this was a multimillion dollar contract and the work in process portion totalled approximately one million dollars. Our client hadn’t billed for this and they didn’t have the money for it, which was a huge tax liability that was accrued because they didn’t make the proper elections up front. In an ideal world, they would have elected previously to get cash in hand in order to be able to pay the taxes. Their election to be cash basis would have kept them from getting taxed until the cash from the job was in their bank account. They could have then taken some of that money and paid the tax. Instead, they had a $300,000 tax bill they couldn’t pay.
The solution and IRS audit
Ultimately, we were able to make the correct election and get rid of that large tax bill for this client, but that then triggered an audit. Katina explains that the audit occured “because now we’re reducing a large amount of income. The IRS wants to understand what’s going on.” We then got the client through the audit and there were many lessons learned. Unfortunately, they ended up spending money to straighten everything out, that they wouldn’t have spent if they planned ahead with a knowledgeable tax preparer. It was a very long, drawn out, stressful, and costly process that they had to go through.
This is why we are such big advocates of tax planning with a knowledgeable preparer. We have had to step in and clean up messes left behind by others and it takes time, money and mental space for the owners who have to deal with these costly mistakes. We would much rather help our clients handle things in a proactive manner so these mistakes can be avoided. Our best advice is to look for a CPA or CFO who will have consistent and regular meetings and discuss how you will be handling taxes and any necessary bills before they become a problem.
Minimize the pain
If you think you are hearing a broken record, you aren’t wrong. We say some things over and over, but we repeat them because they are important. Our hope is, the more you hear something, the more it will sink in. We are here to help you avoid stress and costly mistakes!
Maintain accurate books
It’s always necessary to have accurate accounting. Accurate books are especially needed when it comes to planning for taxes because those numbers will be used to make projections. If you don’t start with accurate numbers, your projections will be off, and your expectations will be off. Then, from that incorrect expectation you won’t have a correct tax scenario on which to base other decisions. Essentially, with inaccurate books it is a ripple effect that can cause damage to your finances.
It’s also very important to have timely books. If you have accurate books, but they are six months late, that’s a problem. Accurate, timely information is needed in order to accurately make projections, whether it’s for tax purposes, cashflow, etc. It’s nice to know what your cash flow is going to look like when it’s time to pay estimated taxes. With timely books you can make projections for each quarterly payment, as well as when it may be time to pony up the tax bill at the end of the year. The goal is to make sure you know the direction you are heading in advance so you can make adjustments as needed.
Having a system in place on a regular basis that promotes accurate and timely books is also helpful when you meet quarterly with your tax advisor. That’s right, we suggest meeting at least once per quarter with your tax advisor, virtual CFO, and other advisors on your team. It can be helpful to calendar out these meetings in advance to ensure they remain a priority. Devote the time to sit down and do some forward-thinking and planning to do things like put enough money away for taxes. Sometimes spending wisely to help your tax situation is needed. Other times it’s necessary to save up. Regardless, meet with your team and plan ahead to avoid unexpected tax bills.
Proactive communication can also serve everyone well, which is why it is one of our big core values we have as a company. By proactively communicating with your advisors about the decisions you’re considering, they can ask questions and help you decide the best plan of action. It is crucial to proactively communicate with your advisor about things like structural changes, admitting a new partner or parting ways with an existing partner. Decisions like this can have significant tax ramifications and your advisor may be able to help you find a different avenue to take that would suit you better, like a different structure, to minimize tax impacts. Another topic to proactively communicate with your advisor about is prior to making large purchases like equipment.
Don’t let your taxes dictate your life
Your CPA can help determine how to handle each decision so it works best for your tax situation. We aren’t saying you should live your life or run your business by your tax situation though! There are decisions you can make to benefit your tax situation that are actually a detriment to your business financially. But we do encourage you to consider the timing of any large purchases and step back to take a look at the big picture. You may think you need to buy something in October and after further discussion with your advisor, you realize waiting until January is a better option. Having a discussion about it allows you to determine if you are in dire need of the purchase or if it can hold off a few months. Your advisor can also help you consider any ramifications that can come into place.
Making timely decisions
As just mentioned, considering the timing of your decisions and purchases is also important. If you are engaging in dialogue with your advisor and keeping them up to speed with what’s going on with your business and things you’d like to do, they will be able to lead you in the right financial direction. If you aren’t being intentional and open with them, they won’t have any awareness or be able to provide guidance. Your advisor’s experience can be extremely valuable because they can share insight on what to think about when making a big decision. Their knowledge and different perspectives can really come in handy.
Benefits of proactive tax planning
If you take our advice and implement these proactive tips with tax planning, you’ll likely experience decreased anxiety, stress, and fear. In fact, those feelings may be replaced by confidence! When you know the direction you are heading and the plan to get you there, the unknown may not be as crippling. We’ve seen business owners who have shied away from planning ahead in business and with taxes because they feel they don’t have time. Yet, in the back of their mind they are thinking about the unknown or they spend sleepless nights thinking about the unknown. So what’s really happening is, instead of taking time and using some of that mental energy to make a plan, that mental energy is being used up in a way that isn’t beneficial to anyone; stress. Planning ahead lets you clear your mind to be present in your business and with your family.
Ancillary benefits of proactive planning also includes having accurate books, accurate tax returns, and staying on top of things. Plus, if you happen to get selected for an audit, you have good, clean records and you won’t have to worry.
Tax time is unavoidable and the time is here! We know it’s not always the most fun time of year, but after hearing today’s episode, hopefully some of the uncertainty can decrease. Communication with your advisor is key! Keep in contact with your advisor on a regular basis, talk to them about upcoming decisions, and let them work with you to get plans in place. Even if you haven’t planned well for this tax season, start implementing these tips now for next year’s tax season. As always, we want what’s best for you and your business. Putting a plan in place will improve your overall feelings about your business, feelings about your cash situation and feelings about where you’re headed with your tax situation.