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Four basic tax strategies for businesses

Posted by Jamie Downey  March 20, 2012 12:31 PM

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There is an infinite number of tax savings techniques that one can implement. However, most of these techniques fall into one of four basic categories, as follows:

Timing – This is probably the most commonly used and understood of the tax savings strategies. Most timing involves the postponement of paying the tax to future years. For example, by accelerating depreciation expense (via bonus depreciation or Section 179) you reduce your current year taxable income and postpone the payment of tax to a future time. Another common tactic is contributions to a 401(k) or SEP retirement plan. These allow you to defer income now and recognize it as taxable income in the future. Generally speaking, most feel that delaying the payment of tax to a future year is always the best course of action. However, there are times when you might also considering recognizing more taxable income in the current year. For example, in 2012 the top capital gains rate is 15 percent. In 2013, the top capital gains tax rate is set to increase to 20 percent (obviously this could change with Congressional action). Also in 2013, the Obamacare Medicare surcharge kicks in on investment income for higher income taxpayers. So the potential top tax bracket for capital gains in 2013 is 23.8%. If you are sitting on a capital gain, it may be beneficial to take the income in 2012 as opposed to 2013 where you would pay an 8.8 percent higher federal tax rate.

Splitting – This strategy involves taking income and spreading it between two or more entities. The splitting of income is beneficial if you can push some of the income into a lower tax bracket of a different entity. As an example, a sole proprietor makes $300,000 of income. He is in the 35% tax bracket. If he incorporates the business and pays himself $250,000 as a salary, then the corporation will have $50,000 of income, which will be taxed at the 15 percent rate (the lowest corporate tax bracket). This shifts $50,000 of income to a lower tax bracket. Like many strategies, this has its limitations. The income retained by the corporation is subject to dividend tax to the owner if distributed to him.

Conversion – Typically, conversion is the changing of operations such that a different category of income is created. One of the best conversions to execute is converting income which would be treated as ordinary income to lowed taxed capital gain income.

Creation – This involves creating the appropriate structure to take advantage of certain tax benefits or subsidies as well as moving operations to a lower jurisdiction to take advantage of these benefits. For example, Massachusetts has seen an increase in movie production in the last few years. Massachusetts provides various benefits to film producers, including exemption from sales tax, a payroll tax credit of 25 percent and a production tax credit of 25 percent. With the state of Massachusetts paying upwards of 25 percent of the cost to produce a movie, it is little wonder that the studios are increasing production and assets in Massachusetts. Another example; it is widely reported that Rose Kennedy was a resident Florida upon her passing. Florida’s is very tax friendly to estates. For significant estates, Massachusetts assesses a tax of up to 16 percent on the value of the estate . This move in residency probably saved the estate millions in potential state tax liabilities.

Most all the tax savings techniques you encounter will revolve around these four basic concepts and will allow you some ways to reduce your tax burden. Notice fraud is not included in this discussion, only legitimate tax savings opportunities. Liberty has a price. Aircraft carriers and tanks cost lots of money, and these tools protect our liberty. So fraud should not be considered. However, if the government provides for legitimate ways to reduce your tax bill, you should consider it without hesitation.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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Local finance professionals share insights and advice on issues such as budgeting, managing debt, and retirement planning.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of CardHub.com, a credit card and gift card marketplace, and WalletHub.com, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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