Employees have little leeway when it comes to tax liability. Most get a W-2, which forces them to pay payroll taxes in addition to income taxes and limits their deductions. As ordinary income earners, employees also lack access to many of the tax shelters available to business owners.
But shifting from an employee to an owner doesn’t guarantee tax savings. Lowering tax exposure requires an investment in strategic finance.
“Most business owners overpay the IRS because they choose the wrong path for taking profits,” says Arron Bennett, founder of Bennett Financials. “When you take money the wrong way, such as a poorly structured salary, you risk throwing away thousands in unnecessary taxes. Addressing an owner’s compensation is a key step in strategic financial planning for business.”
Bennett Financials offers strategic financial planning to help businesses save substantial amounts through advanced tax strategies and access to strategic finance concepts typically reserved for ultra-high-net-worth individuals. Bennett Financials services include guiding clients on reinvesting tax savings into strategies that boost profitability and maximize business growth. To date, Bennett and his tax planning agency have helped clients save over $15 million in taxes.
“Strategic financial planning for business seeks to legally extract cash from your business without triggering unnecessary taxes,” Bennett explains. “And there are a number of ways to do it.”
The following are ways those who have established their businesses as a C corporation can legally access company profits while lowering their income tax obligations.
Tax-free money through owners’ loans
Owner’s loans, in which business owners borrow money from their companies, are one way to continue to draw money from a business while lowering your taxable income. Because loans aren’t legally considered income, they don’t trigger income reporting requirements. The loans also allow owners to avoid the added burden of payroll taxes.
However, business owners must be careful about the approach they use to take advantage of owner’s loans. The Internal Revenue Service (IRS) tends to look closely at loans from a company to the owner to ensure they aren’t a disguised distribution.
“Owner’s loans must be structured correctly,” Bennett warns. “Make sure there is a written agreement, set repayment terms, and reasonable interest.”
Tax-free money through reimbursements
Reimbursements for business expenses are a win-win, as they are generally tax-free for both the employee and the business. And they can be applied to a wide range of business activities, from travel expenses to office supplies to professional development.
“If you are paying for business expenses out of pocket, you are losing money,” Bennett says. “To start saving, you need to set up an accountable plan so your business reimbursements can be tax-free.”
An accountable plan establishes a legitimate business connection for the expenses. It also ensures there is adequate accounting, including the collection of business receipts and the creation of records showing that excess reimbursements are returned within a reasonable time. Business owners should review accountable plans regularly to ensure they comply with the latest IRS regulations.
Tax-free money through retirement contributions
Retirement contributions can provide a number of tax benefits. They can reduce a business owner’s taxable income by allowing for tax-deductible contributions. They can also allow money to grow tax-deferred.
Simplified Employee Pension IRAs (SEP IRAs) are one option that is easy to set up, allows for tax-deductible contributions, and provides tax-deferred growth. Solo 401(k)s, which are available to business owners with no employees other than a spouse, also allow for tax-deductible contributions and tax-deferred growth but have higher contribution limits than SEP IRAs. Solo 401(k)s can also be set up for Roth contributions, which are made after-tax but can be withdrawn in retirement tax-free.
Tax-free money with insurance plans
“High-income earners use specialized insurance policies to store and access wealth tax-free,” Bennett shares. “Whole life insurance is one type that can be used to shift income in a way that results in lower taxes.”
Whole life is a type of life insurance policy that provides a death benefit while building a cash value that grows over time. The tax benefits include tax-deferred growth on the cash value and the ability to obtain policy loans on the cash value. Loans drawn on whole life policies are generally tax-free.
The downside of whole life policies is that they are complex, have unique tax implications, and typically do not have tax-deductible premiums. Business owners interested in using whole life policies as part of their strategic finance efforts should seek guidance from a tax professional.
Strategic financial planning for business can dramatically lower a business owner’s tax exposure. The items explored above are some of the top ways owners can make strategic finance changes that allow them to take more money with less taxes.
“The bottom line is most business owners are overpaying on their taxes simply because they don’t have a strategy,” Bennett says. “The IRS wins when you don’t plan, so make sure you do.”
