Taxation in the Budget Process

The Giersch Group recommends that companies using a calendar year should develop a budget. The key is to build a budget that correlates with the first year of the strategic plan.  We recommend the strategy be updated each September.

Proper tax planning in the budget process allows your company to hedge against unnecessary expense associated with poor planning.  It also allows you to benefit from tax minimization and better cash flow. In this resource, the Giersch Group explores some of the current issues and best practices related to budgeting for taxation in the New Year.

Tax Implications of (Small) Business Structures

A company pays taxes based on the company’s structure.  Sole Proprietorships, Partnerships, Limited Liability Companies (LLC), and S Corporations do not pay taxes on income. The owners include the company’s taxable income in their personal tax returns in order to pay the taxes on the profits of the company. The company will, however, distribute cash to the company owner in the amount needed to pay these taxes.  Thus, although it is often said that these companies do not pay taxes, as a practical matter they do. Therefore, the company’s budgets should include estimated taxes based on the budgeted income. 

A C corp is treated as a separate taxpaying entity from its shareholder. As an entity, a C corp is responsible for taxes on its earnings.  The shareholders of a C corp are also responsible for taxes on their individual earnings, creating double taxation. The shareholders pay their tax on the operating earnings when they are distributed in the form of dividends. Many times, C corps will use pay-out bonuses at the end of the year to minimize taxes to the company by reducing earnings.  While such bonuses are more tax efficient than having the company report the income, pay taxes, and then pay the balance to the shareholder in dividends who then pay dividend taxes, an S corp is far more efficient. For budgeting purposes the C corp needs to decide if it will report income or pay bonuses. If it reports income then the budget should show estimated taxes on the company’s earnings.

Tax Calendar for Estimated Taxes

The Tax Calendar for Small Businesses and Self-Employed -- Publication 1518 -- is available here.  Small businesses pay quarterly estimated tax payments, not annual. Tax on the first three months (January-March) results are to be paid by the 15th day of the following month, April 15. The next two months (April-May) are to be paid the 15th day of the following month, June 15.  The next three months (June-August) are to be paid the 15th day of following month, September 15. The final four months (September-December) are to be paid the 15th day of the following month, January 15.  States will generally follow this same pattern, but there are some exceptions.

In budgeting estimated taxes, there are several safe harbors, such as paying in the prior year’s taxes.  These should be reviewed as part of the budget process to see which might apply.

Publication 1518 has a 12-month calendar filled with information on other business taxes, IRS and Social Security Administration customer assistance, electronic filing and paying options, retirement plans, business publications and forms, and common tax filing dates.

Budgeting for Taxes Related to Capital Expenditures

A capital expense is an expenditure that has multiple year benefit and is sufficiently large that it is capitalized and depreciated over several years.  Depreciation is a key area of tax planning, because the US government encourages capital expenditures through acceleration of depreciation, thereby allowing for reduced taxes.  

The absolute amount of capital expenditures should be budgeted in a normal fashion based on the needs of the business and the available cash flows. It is the timing of capital expenses that involve most tax planning.  For example in the end of 2017, the political landscape suggests that tax rates will increase in 2018. Therefore, depreciation taken in 2013 will save more taxes than depreciation taken in 2017. As a result, an equipment purchase in December could be more tax advantaged by being deferred to January 2018. 

In addition, there can be bonus depreciation and regular accelerated depreciation on larger equipment purchases.  These rules have varied widely over the past and probably will in the future. Because of the tax law changes and the potential benefits, tax planning for capital expenditures can be quite useful.

Conclusion and Actions

Budgeting and financial control are the backbone of small business financing. Taxes and tax planning need to be part of the budgeting process. Recommended actions:

1. Complete the business budget.
2. Develop the capital expenditure plan for the next year.
3. Consider tax planning for the next year related to a) capital expenditure and b) bonus/compensation.
4. Based on the net income for the months, budget the estimated tax payments.

Additional Reading

1. Tax Foundation: 2013 State Business Tax Climate Index, gives information on the tax environment for 2013. http://taxfoundation.org/sites/taxfoundation.org/files/docs/2013_Index.pdf
2. US Small Business Administration: Guide to Budgeting For the Small Business, gives further basics on budgeting. http://archive.sba.gov/idc/groups/public/documents/sba_homepage/pub_fm8.pdf
3. Estimated taxes guidance. http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes

For more information, please visit the Giersch Group at http://www.gierschgroup.com/ or contact us at prosper@gierschgroup.com