Small business owners often face uncertainty when it comes to their tax strategy. What is the best way to deal with taxation such that the taxes don’t eat into your income, and how should they plan their tax strategy.
Small business owners often face uncertainty when it comes to their tax strategy. What is the best way to deal with taxation such that the taxes don’t eat into your income, and how should they plan their tax strategy.
If you have wondered if there was a better way to deal with your taxes, this article is just for you. Here are three ways to avoid tax. These methods are legal, and the only thing you will have to spend is some time planning. Planning is an essential requirement for building a solid tax strategy.
- Retain money in the corporation
- Take a corporate-owned life insurance policy.
- Personal pension plan
Incorporating a business offers benefits that help soften the tax blow, including tax deferral and income splitting. Tax deferral refers to retaining funds inside the corporation and later paying tax at the personal level. At the same time, income splitting means paying dividends to family members in lower personal tax brackets.
Financial planners often urge clients to think twice before withdrawing funds from their incorporated companies if it means pushing up their personal income above the $220,000 mark.
For example, if you have a mortgage or a line of credit held at a personal level, it could carry a low rate of interest given today’s low-rate environment. Still, it might be more beneficial to avoid accelerating debt payment through corporate withdrawals and instead carry the debt.
This way, the funds are retained in the corporation and can be invested and withdrawn later when the taxpayer is most likely in a lower tax bracket. The main message is that if the taxpayers are earning income in their corporations that they don’t need to withdraw to live on, then it is best to retain it in the business.
Financial planners feel that reinvesting the business’s money as capital or investing in a portfolio of securities inside the business is a better alternative. Another way to retain the money is in a corporate-owned life insurance policy.
This approach to taxation could be especially beneficial to small businesses that continue to benefit from a low tax rate in their corporations. This small business deduction is still available even after recent taxation policies.
While the advice to retain money in your corporation may be very sensible, you must have wondered how to bring it out once you need it.
One way is to purchase a corporate-owned universal life insurance policy. In this approach, when the business owner dies, money is paid out through the capital dividend account, usually tax-free to beneficiaries. However, quick action is required to use the benefits of this approach as the new rules affecting tax-free insurance beneficiaries are going to be formulated soon. If the policies are purchased this year, they will be governed by the old rules.
Another way for taxpayers to retrieve the money they have in their corporations is to set up a personal pension plan. When contributions are made to a pension plan, they are tax-deductible.
This is a great way to plan for the future if the business owners are taking a salary. Then they can contribute more to a pension than a Registered Retirement Savings Plan. They also receive the benefit of tax deductions to save on tax.
It is important to remember that having a comprehensive financial plan could help a lot more than any other strategy. The small business owner should be able to project his tax bracket at retirement.
The financial plan should also determine the dependency on corporate assets, and small business owners with surplus funds in the corporations they intend to give to other beneficiaries like adult children should increase dividend payouts rather than make withdrawals.
