Tax Planning for Small Business: A Dozen Helpful Strategies
Bjornson, Chris, Barney, Douglas K., The National Public Accountant
Recent changes (effective in 1997) in the Internal Revenue Code (IRC), and already existing IRC sections provide an opportunity for tax practitioners to give valuable advice to their clients, especially small business clients. These small businesses employ a significant percentage of the U.S. population and the federal government has numerous provisions in place that can assist small businesses; whether those businesses are just starting or have been in existence for some time. Some of the provisions were designed specifically for the purpose of encouraging small business activity in the U.S. This article provides an introduction to some of the income tax provisions that have the most wide-spread impact and provisions that can be most beneficial to small businesses. Tax practitioners may want to refer to specific sections of the Internal Revenue Code for more information on some of these provisions. The authors have cited relevant IRC and Treasury Regulation sections as appropriate for this purpose.
The article divides these 12 potential tax benefits for small businesses into three categories: those that directly benefit the firm, those that directly benefit the owners, and those that directly benefit the employees. For all three categories of items, however, the firm will also benefit. Any tax provisions that help the employees or owners will also indirectly help the firm.
Graduated Tax Brackets
One of the most obvious, yet underrated, provisions of the tax code favorable to small business is Internal Revenue Code (IRC) [section]11.(1) This section stipulates the tax rates applied to corporations. The current corporate tax rates start at 15% and increase to 35 percent. Section 11 provides brackets for taxation as follows:
Taxable Income Marginal Tax Rate $0-50,000 15% $50,000-75,000 25 $75,000-$10 million 34 Over $10 million 35
In addition, the IRC provides for a phaseout of the benefits of the lower tax brackets using "bubble" tax rates. For corporations with taxable income above $100,000 an additional 5% tax is due on the excess earnings above $100,000, up to a maximum additional tax of $11,750. For corporations with taxable income above $15,000,000 an additional 3% tax is due on the excess earnings above $15,000,000, up to a maximum additional tax of $100,000. The effect of these additional taxes is to eliminate the tax benefits of the lower tax brackets. Effectively, corporations with taxable incomes of greater than $335,000 are taxed at a flat tax rate of 34% and corporations with taxable incomes of greater than $48,333,333 are taxed at a flat tax rate of 35 percent. Section 11 therefore starts eliminating the greatest effects of the lower tax brackets when corporate taxable income reaches $100,000.
The tax rate of corporations varies considerably over a relatively short range. While corporations with taxable incomes of $50,000 are taxed at a flat rate of 15%, corporations with taxable incomes of $335,000 are taxed at a flat rate of 34 percent.(2) This is a range of 19% of taxable income and is a considerable difference in the portion of taxable incomes paid to the federal government. Numerous states also have graduated tax rates for their corporate taxpayers. Overall, this can be a tremendous advantage for small corporations.
For tax planning purposes, clients with highly fluctuating taxable incomes (high taxable income one year and low taxable income the next year) may wish to try to level out taxable income figures over years. One method that might help do this is the cash method of accounting.
Corporation B has an income of $20,000 in year 5 and $80,000 in year 6. This results in total tax over the two years of $18,450. If this income were evenly spread over the two years, the total tax would be $15,000; a tax savings of $3,450. …