Get the Skinny on Tax Management
All businesses are subject to taxes. While the concept is simple, the government takes a percentage of earnings as the cost of allowing a business to operate in its jurisdiction. How much that percentage actually is can vary considerably. Because the relevant tax code at both the federal and state level includes so many laws, exceptions, exemptions and reductions, a considerable amount of savings can occur with the right analysis and tax return filings. In this respect a business owner is well-served in understanding what triggers a business tax and how to reduce that liability as much as possible.
Taxes are Based on Business Net Income
Most business owners and managers understand that profit creates tax liabilities. In fact, the IRS is very clear on the matter than earned income is taxable. However, revenue and income are two different numbers. Revenue represents the gross amount a customer actually pays a business for goods or services. This is the amount of funds that come in prior to any expenses being applied against them. Net income represents the profit funds that are left over after legal business expenses paid to create that revenue are subtracted. The remainder is a positive figure representing taxable profit. If the number is negative, however, it becomes a business loss at the end of the tax period.
Ideally, every expense counted against revenue has a receipt behind it. This is called a paper trail. Saving these receipts can be very handy as they quickly add up and create a legal and powerful tax deduction against revenue collected. At tax time, when all expenses are accounted for as well as eligible tax credits, the remaining dollars are what are taxed. Further, if there ends up being a business loss, no taxes are owed and the business can possibly carry the loss forward to future business years as well.
Tax Credits vs. Tax Deductions
Understanding how deductions versus credits work is also a powerful tax issue for a business. Many tax credits exist, and businesses as well as individuals are eligible to use credits if they apply. However, tax credits are more valuable. A tax deduction reduces tax liability, but when all the math is done taxes are still a percentage of the money earned as a net profit. A tax credit, on the other hand, is a dollar for dollar tax reduction. It applies after expenses are taken and tax liability is calculated. Then the credits apply and reduce the taxes owed. For example, a tax deduction may reduce a $100 liability to $90 but 25% taxes still bite $22.50 of what’s earned. A tax credit of $20 can apply to $100 earned which creates a tax liability of $25 at 25%, but with the credit applied only $5 is owed. As a result, using credits where they apply should always be done. A business just needs to make sure it documents its eligibility for that given tax credit.
While the above may seem simple enough, it’s amazing the number of businesses that don’t pay attention to basic tax management with income. As a result, they rely blindly on accountants who many not have their best interests in mind. A smart business owner knows his or her tax basis and how to manage it just like he or she knows his or her revenue sources.