Taxation in the Budget Process
Each November, Cathedral recommends that companies using a calendar year should develop a
budget. On www.cathedralconsulting.com there are a number of whitepapers outlining the budget
process and the various actions needed to develop a budget. The key is to build a budget that
correlates with the first year of the strategic plan. We recommend the strategy be updated each
September.
Proper tax planning in the budget process allows your company to hedge against unnecessary
expense associated with poor planning. It also allows you to benefit from tax minimization and
better cash flow. In this Topic of the Month, Cathedral explores some of the current issues and
best practices related to budgeting for taxation in the New Year.
Tax Implications of (Small) Business Structures
A company pays taxes based on the company’s structure. Sole Proprietorships, Partnerships,
Limited Liability Companies (LLC), and S Corporations do not pay taxes on income. The owners
include the company’s taxable income in their personal tax returns in order to pay the taxes on the
profits of the company. The company will, however, distribute cash to the company owner in the
amount needed to pay these taxes. Thus, although it is often said that these companies do not
pay taxes, as a practical matter they do. Therefore, the company’s budgets should include
estimated taxes based on the budgeted income. For more on taxes and business structure, please
read Tax Planning: Which Organization Structure is Best.1
A C corp is treated as a separate taxpaying entity from its shareholder. As an entity, a C corp is
responsible for taxes on its earnings. The shareholders of a C corp are also responsible for taxes
on their individual earnings, creating double taxation. The shareholders pay their tax on the
operating earnings when they are distributed in the form of dividends. Many times, C corps will use
pay-out bonuses at the end of the year to minimize taxes to the company by reducing earnings.
While such bonuses are more tax efficient than having the company report the income, pay taxes,
and then pay the balance to the shareholder in dividends who then pay dividend taxes, an S corp
is far more efficient. For budgeting purposes the C corp needs to decide if it will report income or
pay bonuses. If it reports income then the budget should show estimated taxes on the company’s
earnings.
Tax Calendar for Estimated Taxes
The Tax Calendar for Small Businesses and Self-Employed -- Publication 1518 -- is available
here.2 Small businesses pay quarterly estimated tax payments, not annual. Tax on the first three
months (January-March) results are to be paid by the 15th day of the following month, April 15. The
next two months (April-May) are to be paid the 15th day of the following month, June 15. The next
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2
http://cathedralconsulting.com/content/tax-planning-business-structure
http://www.tax.gov/calendar/
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three months (June-August) are to be paid the 15th day of following month, September 15. The final
four months (September-December) are to be paid the 15th day of the following month, January 15.
States will generally follow this same pattern, but there are some exceptions.
In budgeting estimated taxes, there are several safe harbors, such as paying in the prior year’s
taxes. These should be reviewed as part of the budget process to see which might apply.
Publication 1518 has a 12-month calendar filled with information on other business taxes, IRS and
Social Security Administration customer assistance, electronic filing and paying options, retirement
plans, business publications and forms, and common tax filing dates.
Budgeting for Taxes Related to Capital Expenditures
A capital expense is an expenditure that has multiple year benefit and is sufficiently large that it is
capitalized and depreciated over several years. Depreciation is a key area of tax planning,
because the US government encourages capital expenditures through acceleration of depreciation,
thereby allowing for reduced taxes.
The absolute amount of capital expenditures should be budgeted in a normal fashion based on the
needs of the business and the available cash flows. It is the timing of capital expenses that involve
most tax planning. For example in the end of 2012, the political landscape suggests that tax rates
will increase in 2013. Therefore, depreciation taken in 2013 will save more taxes than depreciation
taken in 2012. As a result, an equipment purchase in December could be more tax advantaged by
being deferred to January 2013. In 2012, small businesses were allowed to deduct as much as
$125,000.
In addition, there can be bonus depreciation and regular accelerated depreciation on larger
equipment purchases. These rules have varied widely over the past and probably will in the future.
Because of the tax law changes and the potential benefits, tax planning for capital expenditures
can be quite useful.
Conclusion and Actions
Budgeting and financial control are the backbone of small business financing. Taxes and tax
planning need to be part of the budgeting process. Recommended actions:
1. Complete the business budget.
2. Develop the capital expenditure plan for the next year.
3. Consider tax planning for the next year related to a) capital expenditure and b)
bonus/compensation.
4. Based on the net income for the months, budget the estimated tax payments.
Additional Reading
1. Tax Foundation: 2013 State Business Tax Climate Index, gives information on the tax
environment for 2013.
http://taxfoundation.org/sites/taxfoundation.org/files/docs/2013_Index.pdf
2. US Small Business Administration: Guide to Budgeting For the Small Business, gives
further basics on budgeting.
http://archive.sba.gov/idc/groups/public/documents/sba_homepage/pub_fm8.pdf
3. Estimated taxes guidance.
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http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes
4. Cathedral Consulting Group, LLC. Tax Planning: Which Organization Structure is Best?
http://www.cathedralconsulting.com/files/TOPIC_Tax_Planning_February_2012.pdf
Philip Clements is the CEO and a Managing Director in the New York Office. Ryan Collopy is a
former Associate in the Midwest Office.
For more information, please visit Cathedral Consulting Group LLC online at
www.cathedralconsulting.com or contact us at info@cathedralconsulting.com.
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