How to Pay Less in Taxes

How to Pay Less in Taxes 

Norm Brodsky answers a reader’s question at Inc.:

To begin with, [the reader] needs to start his planning process early enough to allow him to end the year with as little cash profit as possible. That’s the idea if you have a young company using cash-basis accounting. I gave him a hypothetical — and oversimplified — example, just so he’d have a general idea of how it works. Let’s suppose that you finished last year with $20,000 in cash. If you end this year with $50,000 (not including new capital you may have added during the year), you’ll have a cash profit of $30,000 on which you’ll owe taxes — assuming, that is, you didn’t buy depreciable equipment or software.

With planning, however, you can reduce your taxable income by, say, paying in advance bills for expenses you’ve incurred this year but would normally pay next year. Conversely, you can scale back your efforts to collect receivables for a month or so. You’ll wind up with less cash at the end of December but more cash the following month.

In doing your planning, you need to be aware of some important nuances. Let’s say, for example, that you bought $25,000 in software or equipment during the year, and it gets amortized over five years. That means only $5,000 of the cost can be deducted this year. The remaining $20,000 is added back to your taxable cash balance, as in the example above. You may be able to offset that amount, however, by borrowing money and using it to prepay expenses you’ve incurred but not yet paid for. Any new capital you put into the business isn’t counted as taxable income.