Agencies are always looking to have the cleanest financials with the most profitability, at least ones that enjoy staying in business. The new tax law will have a major impact on corporate profitability, giving companies a lot more flexibility. At the same time, there are many existing tax breaks and loop holes to take advantage of in the tax code. Companies should be sure to take advantage of as many of these as they can. There are a few tips to consider in particular. [Editor’s Note: Matt isn’t an accountant, nor does he even play one on TV]
R&D Tax Credits
Federal and state governments are keen to reduce overall tax rates. They R&D tax credits are the most important tax factor for agencies to consider compared to other companies. Virtually any type of web development, coding, fundamental research, app development or other research can be written down on taxes. So employee compensation, computers, routers, software and other tools used to develop technology products including software can all be written down from taxable income. For agencies, that could mean the difference between a large tax payment and virtually none.
There are also tax credits for small businesses that engage in R&D. In fact, they can write off their costs against their payroll taxes for employees. According to a 2015 federal law, companies with less than $5 million in revenue can use their credit to even offset any payroll taxes (unless the employee earns more than $250,000). That can make a big impact on tax payments.
Agencies need to be very focused on this tax credit because it can allow them to offer more competitive prices and grow much quicker. For example, a small agency with $4 million in revenue, 15 employees making a total of $2 million in compensation has a $500,000 net profit, which they pay about $150,000 in taxes on. However, if they are provided a $1.5 million credit for the costs for employees engaged in application development, the firm suddenly has no tax liability at all. The firm now makes an additional $150,000 which they may re-invest in hiring more people or lowering prices slightly to gain more long-term clients.
Cell Phone and other Personal Expenses
Agencies should put more expenses from the owners under business expenses. That benefits the company in two ways. Firstly, they can slightly reduce the cash compensation to the owners or senior managers. Secondly, they can write off all of these expenses are business expenses that reduce taxable income.
Cell phones are the most common expense for senior managers that can be written off. These are instrumental in getting business done so the case to the IRS is easy. Travel to and from the office can also be written down. Public transportation on work days can all be written off. A car may also be used for personal travel so only a portion of those costs may be written down. However, the gas going to and from the office can also be written off. Of course, airline travel for business is a taxable expense. Even any meals purchased at the airport are considered business expenses.
Agencies have high costs for hardware. Many of them have their own servers and virtually all of them invest in computers, routers, tablets, copiers, fax machines, phones and other devices. These devices can be written off over time through depreciation rather than as a standard business expense. This can be extremely valuable, especially to help manage cash flow when there are profits in some years and losses in others.
Of course, agencies make other investments that are not strictly technology focused. Those include furniture, office equipment and other goods that are also depreciated to save taxes.
Pass Through Corporate Tax Rate
The biggest single change in the 2018 law was the effect on limited liability company (LLC) tax rates. These firms are also called “pass throughs” because the taxes flow from the business directly to the personal taxes of the owners. They must be held by a small group of individuals and are not typically ideal for agencies because they have outside investors that require a corporate structure. However, many investors and owners might be willing to alter the corporate structure in the name of much lower tax rates.
Tax rates for these entities are extremely variable based on their size and the current taxable income of the owners. However, in the most extreme example, tax rates can decrease from 39% all the way down to 21%. For those type of savings, investors will be willing to re-organize. Predictably, many agencies are now seeking to restructure their books in order to meet the new tax regulations to radically reduce their tax burden.
Health Care Expense Deductible
Technology workers are generally highly sought after. They are seeking companies that offer special benefits like a generous health care package that includes low deductibles, no caps, vision, dental and even coverage for cosmetic procedures. These insurance plans are expensive but are valuable in attracting top talent.
Fortunately, these plans are also completely tax deductible which is not true of traditional compensation where matching payments are required for payroll taxes. For that reason, companies can offer a far more generous total package to employees while reducing their overall taxes. They simply reduce their overall cash compensation to employees and raise the health care component of compensation. That lowers taxes for both parties.
The government tries to encourage healthy retirement savings through the tax code. There are several tax protected vehicles that are used to save money over time. These generally grow tax free until they can be liquidated at the prevailing rate when the individual is 72 and a half. Company contributions to these retirement accounts are generally tax free although there are hard caps on the total amount provided to each employee annually.
Small agencies with majority owners can fund retirements through SEP IRA or Keogh plans. Employees can then get a 401(k) or Roth IRA depending on their preference. Again, the company that contributes to employee retirements as part of its compensation package will have a lower effective tax rate for the same amount of cost.
Overall, small businesses have a number of ways that they can take advantage of the tax code. Agencies are particularly fortunate in that they have more investment in technology which is treated favorably by the government for tax purposes. Use the above tips to save.