Written by: Marci Gietl, CPA
As you start and grow in your career or with a new business venture, it’s important to not only consider your tax compliance requirements but also tax planning to reduce your tax obligations.
As an employee, ensure that you have a full understanding of the benefits your employer offers and how you can utilize them as many lead to tax savings. As a business owner, consider these benefits to offer employees that may have maintenance costs associated with them but provide you not only with tax deductions but could have payroll tax savings as well. As a business owner looking to establish any of these plans, ensure you have proper documentation of the plan in compliance with IRS regulations.
- Cafeteria Plan: Typically cover health costs or dependent care benefits. Withheld pre-tax (before federal and state income tax) and also before FICA taxes.
- Education: Employers may establish plans to reimburse employees for education related expenses. Expenses for non-job related education up to $5,250 annually can be excluded from federal and state income taxes, FICA and FUTA taxes. Amounts that are job-related are not limited by IRS regulations.
- Retirement: Pre-tax accounts allow you to save federal and state taxes currently with funds being taxable upon distribution. (Caution: Early distributions may be subject to penalties.) After-tax accounts (Roths) are tax currently but grow tax-free and if proper terms are met, are distributed tax-free. Bonus to the employee may be matching dollars from the employer of part or all of your contributions and depending on your level of income, you may qualify for a retirement savings tax credit! Employer may benefit upon setting up the plan from a tax credit for doing so.
Retirement accounts may be viewed at times as just another source of savings to tap into when funds are needed. However, it’s important to understand the potential consequences of doing so and how some planning may reduce the effects of a distribution. For example, funds withdrawn from a 401(k) plan used for a first-time home purchase would be subjected to a 10% early withdrawal penalty as well as regular federal and state income taxes. A distribution from an IRA for the same purpose up to a maximum of $10,000 would still be subject to regular income taxes but would avoid the 10% penalty. There are other exceptions to the penalty that apply only to IRAs and not 401(k) withdrawals as well. One way to plan for this is to rollover any old 401(k) plans from previous jobs into IRAs before the need arises.
Additionally, consideration should be given to converting traditional IRAs into Roth IRAs either in a lump sum or over a number of years depending on your tax bracket and ability to pay the taxes. The benefits of then having these funds in the Roth are as mentioned earlier for the funds to grow tax-free and eventually be distributed as such. Tax planning can help you determine if this is the right move for you.
Tax planning as a new business owner should not just factor in federal and state income taxes, but should also consider other taxes that your business may generate: self-employment tax, payroll taxes, sales tax, excise tax, etc. The nature of your business will determine your tax obligations, but tax planning can help you understand the differences in these taxes and especially what income is subject to or expenses are deductible against each of these. Documenting all income and expenses thoroughly can allow for better planning to reduce these obligations but also to ensure proper compliance to avoid unnecessary penalties and interest.
Please contact us to further discuss any of this information.