Tax Planning, Part 2: Tax reduction options — fringe benefits and retirement plans
This is the second article in a three-part series on tax planning. Our first segment discussed ways to project your profit as the starting point for year-end tax planning. We all know the old saying, "You've got to give a little to get a little." Well, did you know that when you offer your employees fringe benefits it could improve your tax situation? In this segment we want to review employee fringe benefits, including retirement plans, as tax-reduction tools...
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This is the second article in a three-part series on tax planning. Our first segment discussed ways to project your profit as the starting point for year-end tax planning. It appeared in the fall eFitBiz by SNEWS®, and you can click here to access it. You can also see that first article in the SNEWS® Training Center by clicking on www.outsidebusinessjournal.com/training center. Once you have read that article and followed its advice, you’re ready for the next step — considering your tax reduction options.
By Jeff Taksey and Edward Neff
We all know the old saying, “You’ve got to give a little to get a little.” Well, did you know that when you offer your employees fringe benefits it could improve your tax situation? In this segment we want to review employee fringe benefits, including retirement plans, as tax-reduction tools. When you take advantage of fringe benefits, you can reduce payroll taxes, as well as individual and business income taxes. The best part is most business owners are employees of their own companies and can also participate in the retirement plans and possibly other fringe benefits. In fact, quite often the owner is the biggest beneficiary in the benefits.
Review employee fringe benefits offered. Employee fringe benefits are an excellent way to attract and retain key personnel. A fringe benefit is normally not taxable to the employee, and employer costs are fully deductible. Many fringe benefits can benefit the owners of a business and can also reduce the matching payroll taxes of the business. The following is a list of some of the most popular types of employee fringe benefits:
- Health insurance (*)
- Group term life insurance (*)
- Medical reimbursements
- Educational assistance
- Dependent care assistance (*)
- Adoption assistance
- Parking (*)
- Transit passes (*)
- Health savings accounts (*)
- Group term life insurance (*)
- Long term care insurance
- Retirement plans (*)
Most fringe benefits are subject to IRS regulations, which must be reviewed and understood before the fringe benefit program is implemented. Some fringe benefits are employee funded, some are employer funded, and some may be a combination of both. For example, these fringe benefits above marked by an asterisk (*) can be a benefit that is offered as part of a flexible spending plan (also known as a cafeteria plan) where employees will pretax these benefits and have the money deducted from their paychecks. A flexible spending plan has limited cost to an employer as the benefits are funded from the employee’s own paycheck. The number of employees and the type of business entity often dictate which fringe benefits should be offered.
Review state tax filing requirements. Each year the business should analyze and make a determination that the business is complying with all state tax filing and payment requirements. A business normally has a state income tax requirement in any state in which it has nexus. Having an office, warehouse or equipment in a particular state can create nexus. Having employees working in a state on a regular basis can also create nexus. Once nexus is established with a particular state, the state’s tax laws should be analyzed to determine the tax payment and filing requirements of that particular state
Be sure to analyze the business’ qualified retirement plan to determine if it is the best possible choice. Retirement plans have become the number one tax-savings vehicle for businesses and their owners. Contributions to a retirement plan are deductible by the business and tax deferred to the recipient individual. In maintaining a retirement plan, the business must bear the cost of employer contributions and administrative costs of the plan. There are many types of retirement plans available to the business owner. The following are three of the most popular types:
>> 401K/profit-sharing plan. This type of plan allows for both employee and employer contributions. The employer normally incurs professional fees for administration of the plan. Typically, any employee that works at least half-time is eligible for this type of plan after one year of employment. The employee is allowed to contribute up to $15,500 (2007 level) annually from his or her pay. In most cases (there is no requirement), the employer will make a matching contribution or a discretionary profit-sharing contribution to the plan of up to 25 percent of employee compensation with a maximum employee/employer combined contribution of $46,000 for 2007. Without an employer contribution to the plan, it is often difficult for the highly compensated employees of a business to make the maximum allowed 401K contributions of $15,500. Employees are 100 percent vested in their own contributions and typically vest in the employer contributions over a five-year period. These types of plans can be written to reward certain targeted employees and owners.
>> Simplified employee pensions. Also called a SEP, it is 100-percent employer funded. Employees become eligible after three years of service. For 2007, the maximum SEP contribution is 25 percent of an employee’s compensation up to a maximum of $46,000. An SEP requires little administration, and is very popular in businesses with fewer employees or very high turnover.
>> Simple IRA. Employers with fewer than 100 employees can adopt this type of plan. It allows for both employee and employer contributions. There is little or no administrative cost to this type of plan. Generally, any employee earning more than $5,000 that has been with the company more than two years is eligible. An employee can contribute up to $10,500 (2007 level) of compensation to the plan. The employer must provide either a 3-percent compensation matching contribution or a 2-percent contribution for all eligible employees. The advantage of this type of plan is that there is virtually no administration and the employer is normally able to keep the employee cost low. The disadvantage is that the owner/employee of the company cannot contribute near the $46,000 annually allowed with other plans.
The above is not an exhaustive list of retirement plans. There are other types and variations. A major component of income tax planning for a business is setting up a qualified retirement plan or reviewing the company’s existing retirement plan to determine if it should be modified.
In year-end tax planning, it’s also wise to review whether the business is using proper and advantageous methods of accounting.
Cash vs. Accrual Accounting Methods
The cash method of accounting recognizes income when revenue is collected and deductions when expenses are paid. The accrual method recognizes income when earned and deductions when incurred. Thus, the accrual method causes recognition of income and deductions earlier then the cash method.
With few exceptions, if your business stocks inventory for sale to the public, the IRS requires that you use the accrual method. However, portions of a business, not involved with inventory, may remain on a cash basis. Service departments may elect cash basis accounting while sales of inventory are on the accrual basis. The important factor for tax planning is to use allowable methods that mitigate or defer the taxable consequence.
For example, if your service department generally has more customer receivables than related expenses payable, the cash method would postpone recognition of the built-in profit until ultimately collected and paid. C corporation businesses with average annual gross receipts of greater than $5 million per year, must use the full accrual method of accounting.
Everyone has probably heard terms like LIFO, FIFO, Average Cost, etc. These are alternative methods for determining the order and thus cost for each widget you sold. However, not everyone is familiar with IRC Section 263A, which applies to taxpayers with gross revenue exceeding $10 million. This section requires somewhat complex cost accounting for applying warehousing direct and indirect costs between cost of goods sold and ending inventory. If the shoe fits, make sure you comply.
Our next segment, running in the SNEWS® Training Center Nov. 19, will wrap up our three-part tax and business planning series. In it, we will focus on business succession, reasonable compensation regulations, tax credits and other good stuff. In the meantime look hard at each of the above available fringe benefits and consider getting them established in your business. Many cost nothing and save everyone money. They are what we call “Why Not?” decisions. The retirement plan options are complex and require professional evaluation to maximize the desired result. Pick a reputable expert and get started before it is too late for 2007.
Taksey, Neff & Associates LLC was founded in 1977 by Jeffrey Taksey. The firm (www.tncpas.com) is located in the Washington, D.C., market and handles national and international clients, including numerous retail fitness dealers. Many dealers and manufacturers know Jeff Taksey from the 20 years he’s been attending various fitness industry trade shows, where he’s gained enormous insight on the market. To contact Taksey, email firstname.lastname@example.org.