Aligning business tax shelters with a tax strategy

Two weeks ago, we gave an overview of aligning business investments with a tax strategy.

That’s always a good idea, but it’s also wise to do the same with tax shelters. So, this week’s post will provide an overview of how to do that. 

Let’s go! 

Business investment vs. tax shelter: What’s the difference? 

Before we get into aligning tax shelters with tax strategy, it’s best to clarify the difference between a tax shelter and a business investment. 

The two can be the same, but they can also be very different. 

So, it’s best to clarify, or the rest of our discussion will feel a little like that first day in algebra class. 

The big difference between the two is in their objectives. A pure business investment seeks to achieve long-term growth or profitability first. Tax optimization is secondary. 

For a shelter, it’s just the opposite. 

The primary goal of a tax shelter is to minimize tax liabilities. Growth is secondary if considered at all. 

A pure example of a business investment might be investing in equities. Of course, the idea is to grow capital. 

A tax shelter example is making charitable contributions. Yes, the contribution might be publicized and lead to goodwill and even sales, but the primary monetary goal is to lower taxable income. 

Of course, there are hybrids. Programs like the Research and Development Tax Credit are a good example. Yes, R&D can help grow a business, but it can also help optimize its tax burden. No matter the original intent, the program serves both objectives. 

Now that the distinction has been made, let’s move on to the main event. 

Aligning Tax Shelters with a Tax Strategy

Since the goal of a tax shelter is to reduce tax liabilities, aligning them with a tax strategy doesn’t include worrying about return on investment. 

That difference in focus from a business investment results in a different approach. 

So, some basic tenets of alignment must be established. 

One of the primary concerns is identifying tax shelters that fit the business structure and cash flow. Otherwise, you may run into compliance issues and trigger an IRS audit. 

While the idea of a tax shelter is to reduce taxes, not generate profit, it must still serve a legitimate purpose. 

Let’s use the example of charitable contributions. Giving old equipment to a legitimate 501(c)(3) organization serves the purpose of helping out a non-profit. 

The tax reduction is a side benefit. So, if a company deducts the equipment at fair market value, they’ve flipped the script, making tax deduction the primary goal. 

Another key component of alignment is timing. 

Contributions to retirement plans and Health Savings Accounts should be made toward the end of the year to maximize deductions. 

Lastly, there’s charity. 

Just because you give from the heart doesn’t mean there’s no room for strategy. 

 For example, suppose you have an appreciated asset, like a stock. In that case, it can be donated to a qualified 501(c)(3) instead of being sold and realizing a capital gain. 

Not only can capital gains be avoided, but the fair market value of that stock can also often be deducted. 

The IRS views both of these moves as legitimate, so the chance of negative repercussions is low. 

The Bottom Line

By aligning investments and tax shelters, businesses can potentially realize more profit and take full advantage of legal ways to optimize taxes. 

But be careful. 

It’s not difficult to make a mistake, so consult with a tax professional to gain the full benefit without getting an unwanted letter from the IRS.