Financing Growth — Tax strategies to generate cash or enhance cash flow
Cash flow has always been the lifeblood of a business and critical to its growth. Limited cash flow can constrain the financial mobility of small-sized companies; however, experts believe that a comprehensive assessment of business tax strategies can assist in protecting the cash required to fund both short-term working capital needs and long-term strategic initiatives.
Taking caution and being proactive to review your company’s existing tax strategy can be the most cost-effective ways to increase your company’s cash flow. Likewise, experts contend that no single strategy works for every business, so it is essential to align your company’s tax and business strategies to make certain that both are working together to maximize shareholder value of the firm.
In actuality, strategic tax management is valuable for more than long-term operational and investment planning. It also can help you manage your company’s day-to-day revenue and expense streams. Provided herein are some suggestions that can help you better understand more about the relationship between tax strategies and cash flow.
Additionally, you will want to be very cautious in using any of these approaches, as you don’t want to violate any tax laws. Consult your accountant or attorney before moving forward with any of these ideas.
First and foremost, the golden rule for maximizing cash flow from a tax perspective is to have as much revenue come into your business as soon as possible, while deferring tax payments on that revenue for as long as possible.
Under the law now, Section 179 depreciation provides immediate tax relief, increasing cash flow and reducing the after-tax costs of investing in new business property. The Section 179 deduction allows a small business to write off up to $25,000 with a $200,000 investment ceiling. This amount must be spread out over the life of the asset.
“Strategic tax management is valuable for more than long-term operational and investment planning. It also can help you manage your company’s day-to-day revenue and expense streams.”
However, the write-off amount can be accelerated within the period of depreciation. In other words, more depreciation can be used earlier or later, depending upon when cash is expected to be received.
Another way to increase cash flow for a “new” startup business is to write off some of the expense incurred in preparing to launch the business—for instance, costs incurred while investigating the creation or acquisition of an active trade or business. Some of the eligible expenses include costs incurred for surveying markets, product analysis, labor supply, visiting potential business locations, and similar expenditures.
Equally, the cost of getting a business ready to operate before you open your doors or start generating income can be written off and reduce taxable income. For example, some of the common expenses include employee training and wages, consultant fees, advertising, and travel costs associated with finding suppliers, distributors, and customers.
In all these illustrations, these expenses can only be claimed if your research and preparation ends with the formation of a successful business.
Sometimes a business does not perform well in a given year and incurs an operating loss. The good news is that the loss can be used in other tax periods to offset a tax. You may apply a net operating loss (NOL) to past tax years by filing an application for refund or amended return for those years. This is called carrying a loss back.
As a general rule, it’s advisable to carry a loss back, so you can get a quick refund from the IRS on your prior years’ taxes. However, it may not be a good idea if you paid no income tax in prior years, or if you expect your income to rise substantially in future years and you want to use your NOL in the future when you’ll be subject to a higher tax rate.
Ordinarily, you may carry back an NOL for the two years before the year you incurred the loss. The carry-back period is increased to three years, though, if the NOL is due to a casualty or theft or if you have a qualified small business and the loss is in a presidentially declared disaster area.
Any part of your NOL left after using it for the carry-back years is carried forward for use for future years. You have the option of applying your NOL only to future tax years. This is called carrying a loss forward.
You can carry the NOL forward for up to 20 years and use it to reduce your taxable income in the future. When you do this, you must attach a statement that includes a computation showing how you figured the NOL deduction. If you deduct more than one NOL in the same year, your statement must cover each of them.
Furthermore, a business can improve cash and simultaneously prepare for retirement by using a retirement plan. Saving for retirement is a key consideration for many small-business owners. Some of those options include: IRA-based plans such as Savings Incentive Match for Employees (SIMPLE) and Simplified Employee Pension (SEP) plans, in addition to profit-sharing plans and a variety of 401(k) plans.
The key for the small business in using these plans is that a tax benefit exists for both the employer and employee. With traditional plans, employers get a tax deduction for contributions, and employees may be allowed to make pre-tax contributions and defer taxes on income until a distribution is requested.
Additionally, you must set up and fund a qualified retirement plan by the required deadline. There are different contribution levels depending on the retirement program that is used, but this is an area that should be maximized by the small-business owner.
Another method to improve cash flow for the small business is to consider charitable contributions to an eligible organization. Not only can this serve a wonderful community purpose, but the deduction can also offset income and reduce tax liability, thereby increasing cash flow.
However, be careful to make certain that you identify an eligible charitable organization, meet the IRS requirements, and understand the limitations associated with the category of giving. Clearly, cash and assets are the best resources to donate to a charitable organization for cash-flow purposes.
Inventory accounting methods can have a profound impact on a company’s cash flow. For example, if you find your cost of goods is rising due to inflation, modifying to the last-in, first-out (LIFO) method of inventory accounting can allow you to accelerate the deduction of inventory costs when prices are rising.
This approach may provide a permanent tax deferral because lowering ending inventory values increases the cost of goods sold, thus decreasing the company’s overall taxable income.
If your company plans to build or buy a new building, you can take several tax initiatives to improve cash flow, including conducting a cost-segregation study to depreciate certain building items more quickly and identifying research and experimentation expenditures that qualify for a current tax deduction.
State and local tax incentives also should be considered during this process. Tax credits, financing incentives, or other opportunities may be available to help fund this growth.
If you plan to launch a new product that will require research and development, it’s a good idea to first conduct an R&D credit study to see if you qualify for a permanent R&D tax savings associated with the development of new or improved products, processes, formulas, software, or other technical business components.
Most of these suggestions require planning and working with an expert in the field so that mistakes are not made. It is highly recommended to develop a comprehensive strategy to use some of these options to reduce your tax liability.
The bottom line is that you should have a tax strategy in place for your business. And it should coincide with your business strategy and goals.