For many business owners, there is no clear line between “business taxes” and “personal taxes.”
The business may file its own tax return, but the decisions made inside the business often have a direct impact on the owner’s personal tax situation.
Business income can affect estimated tax payments. Owner compensation can affect payroll taxes and retirement contributions. Equipment purchases, distributions, health insurance, retirement plans, and changes in ownership can all have consequences that extend beyond the business itself.
That’s why effective tax planning for a closely held business should consider both the business and the people who own it.
Business Income Often Flows to the Owner
Many small businesses operate as pass-through entities, including S corporations and partnerships.
Generally, the taxable income from these businesses passes through to their owners and is reported on the owners’ individual income tax returns.
That creates an important distinction:
The amount of cash an owner receives from the business is not necessarily the same as the amount of income on which the owner is taxed.
A business may retain cash for operations while still generating taxable income for its owners. Conversely, an owner may receive distributions that don’t correspond directly with the current year’s taxable profit.
Understanding both sides is important when planning for taxes and cash flow.
Estimated Taxes Depend on More Than the Business Return
For many business owners, quarterly estimated tax payments are a significant part of their overall tax strategy.
But determining an appropriate estimated payment generally requires looking beyond the company’s income.
The owner’s overall tax picture may include:
- Business income
- W-2 wages
- Spousal income
- Investment income
- Rental properties
- Capital gains or losses
- Retirement contributions
- Itemized deductions
- Tax credits
- Prior-year overpayments or carryforwards
That’s why simply looking at the business’s profit—or automatically paying the same estimated tax amount every quarter—may not always produce the right result.
As circumstances change during the year, estimates may need to change too.
Owner Compensation Affects Both Sides
For S corporation owners, reasonable compensation is another area where business and personal planning intersect.
The salary paid by the company affects its payroll expense and taxable income. At the same time, those wages appear on the owner’s personal return and can affect payroll taxes, withholding, retirement contributions, and other planning decisions.
Distributions introduce another consideration.
The question isn’t simply how much salary to pay or how much cash to distribute. Those decisions should be considered alongside the company’s profitability, cash needs, the owner’s tax situation, and the applicable tax rules.
Retirement Planning Can Start With the Business
Retirement contributions are another good example of why business and personal planning shouldn’t happen separately.
Depending on the retirement plan, owner compensation, employee population, and other factors can affect how much the business and its owners may contribute.
For a business owner, retirement planning can therefore be both a personal financial decision and a business tax-planning decision.
Waiting until the individual tax return is being prepared may limit the strategies that are still available.
Major Business Decisions Can Have Personal Tax Consequences
The connection becomes even more important when something significant changes.
For example, a business owner might:
- Purchase major equipment
- Hire employees
- Open another location
- Acquire another business
- Add or buy out an owner
- Change entity structure
- Purchase or sell real estate
- Sell the business
Each decision may have business, tax, cash-flow, and personal consequences.
The earlier these issues are considered, the more opportunity there generally is to evaluate alternatives before a transaction is completed.
Tax Preparation and Tax Planning Are Different
Tax preparation tells us what happened.
Tax planning asks what we can do before it happens.
By the time a tax return is prepared, many important decisions affecting that year’s taxes have already been made. A year-round planning process creates opportunities to review changes while there is still time to respond.
That doesn’t mean every business owner needs complicated projections every month.
For many owners, the process can be relatively straightforward: maintain accurate financial information, periodically review how the business is performing, consider the owner’s broader tax situation, and revisit the plan when something materially changes.
Looking at the Whole Picture
Business owners shouldn’t have to manage their company’s accounting and taxes in one place while trying to independently figure out how those decisions affect their personal taxes somewhere else.
The two are too closely connected.
A coordinated approach can help answer questions such as:
- Are estimated tax payments still appropriate?
- Is owner compensation reasonable?
- How much cash should remain in the business?
- Should distributions change?
- Are there retirement planning opportunities?
- Are there tax decisions that should be made before year-end?
- How could a major business decision affect the owner personally?
The objective isn’t simply to prepare accurate tax returns.
It’s to use accurate accounting and proactive planning to help business owners make better decisions throughout the year.
At Durkin Advisory Group, that’s how we approach the relationship: understanding the business, understanding the owner, and planning for both.
Durkin Advisory Group provides accounting, tax, and advisory services to businesses and their owners. We help clients coordinate business accounting, tax planning, and owner-level decisions throughout the year.
This article is intended for general informational purposes only and does not constitute tax, legal, investment, or financial advice. Tax rules depend on individual facts and circumstances.