Small and medium businesses have a tough task to deal with while running their ventures – ensuring uninterrupted working capital. In addition to facing competition from big corporations, they have to manage their affairs with limited resources. The scene gets aggravated as the tax filing season approaches.
3.3 lakh businesses qualify as small businesses (0.5% of all MSMEs) and just 0.05 lakh qualify as medium businesses (0.01% of all MSMEs). The rural areas consist of 324.9 lakh businesses, whereas urban areas have 309 lakh businesses.
Small and medium-sized enterprises feel financially pinched to pay taxes. Adjusting funds to pay for taxes becomes extremely difficult. So, are there tax strategies to ease the burden? Yes, there are! Let us find out how you can plan your taxes effectively!
What is Tax Planning?
Tax planning means financial planning for tax efficiency. It aims at reducing tax liabilities and optimally utilizing tax rebates, tax exemptions, and benefits as much as possible. Essentially, tax planning includes making business and financial decisions to minimize the incidence of tax. According to statistics, around 20% to 22% of small and medium businesses do not know their effective tax rate. So, they end up paying more than required due to the lack of knowledge.
It takes time to plan taxes, but the time and effort are worth the money you save in the process. Intelligent entrepreneurs pay utmost heed to this aspect and come up with different types of tax planning strategies to cut down the burden of cost associated with taxes.
Types of Tax Planning
Most business professionals perceive tax planning as a mere process that helps to reduce tax liabilities. However, it is more than that and involves investing in the right assets for your financial goals.
Following are some of the methods of tax planning:
- Short-range Tax Planning
Here, tax planning is considered and executed by the end of the fiscal year. Businesses resort to this planning to seek ways to legally limit their tax liability when the financial year nears its end. This method does not consider long-term commitments. Despite this fact, it can ensure substantial tax savings.
- Long-term Tax Planning
This type of plan is chalked out at the start of the fiscal year, and the taxpayer sticks to this plan throughout the financial year. As opposed to short-range tax planning, you may not derive immediate tax benefits with this tax planning strategy, but it is highly useful in the long run.
- Permissive Tax Planning
Permissive tax planning deals with planning under different provisions of the taxation laws. Tax planning offers various provisions such as deductions, contributions, exemptions, and incentives. Small and medium businesses can tap into the perks of those deductions and exemptions to minimize the burden of tax and save their finances in the process.
- Purposive Tax Planning
It involves using tax-saving instruments with a particular goal in mind. This ensures that you derive optimal benefits from those investments. It includes selecting the appropriate investments accurately, creating an appropriate agenda to replace assets (if needed), and diversification of income and business assets based on your residential status.
Different Tax Strategies
Now that you know what is tax planning and its types, you should get familiar with different strategies aimed at reducing tax. Only 30 percent of small and medium businesses do effective tax planning strategies. You could be one of them. Here are the top options.
- Consider a Tax Status Change
Any small business has various options to structure its venture. You may operate as a partnership firm, sole proprietor, limited liability company, or private limited firm. The choice of the business structure impacts how you file your taxes.
- Take Advantage of Tax Deductions
The qualified business income deduction provides pass-through business owners with a tax deduction on their business income – though it does come with many limitations and rules. Similarly, you may capitalize on other deductions available for small businesses. Popular ones include home office deductions for those running their ventures from their homes.
- Leverage Tax Credits
This is a fantastic way to bring down the tax amount for any small and medium business. Unlike tax deductions that reduce a business’s taxable income, tax credits reduce the tax amount. Disabled access credit, work opportunity tax credit, and credit for small employer health coverage premiums are some of the options that you may use to directly reduce the tax amount.
- Defer or Accelerate Income
Many small businesses apply the cash method of accounting. Under this method, a venture recognizes income when it is received and expenses when paid. That opens room for some interesting tax strategies. For instance, if you expect the income to be in a lower tax bracket in the coming year, you might defer income to that year when you will pay taxes at a lower rate, thus saving enough cash in the process.
- Set up or Contribute to a Retirement Account
If you set up your retirement fund before the tax year ends, you can deduct any contributions you make to the plan while filing your tax return. The terms of the plan dictate how much a business (an employer) can contribute. In addition to saving taxes, this account also acts as a dependable source of income after your retirement.
Bottom LineTax strategies are financial weapons that can save a ton of cash for 3.35 lakh small and medium businesses and 630 lakh micro-enterprises. All it takes is diligence and attention to available tax-saving options. With proper planning and strategies in place, you can cut down your tax burden and channel your funds for income generation, too.