My first real encounter with taxes came when I was 17 and spent the first of four summers working at the Raytheon plant in Andover, which was producing guided missile parts and sub-assemblies for the Department of Defense.Starting out in Production Control, I learned how to develop work orders, purchase orders, and job tickets for the then-princely beginning wage of $1.37/hr., about $8.25today (this was a while ago!).

I worked 40 hours a week, except during the month- end physical inventory, when we all picked up 16 hours of overtime for counting resistors, transistors, and capacitors. So my regular gross pay was $54.80 a week, increasing to$87.76with time-and-a-half for inventory.

My net pay, thanks to withholding taxes, was something less than that, but I had been told I’d get it back the following April- hence my initial understanding of “tax return.” So the next 25 springs came and went, and even though I fully understood the folly of giving Uncle Sam an interest-free loan every year, I did look forward to my annual April “bonus” check. Clearly, I was one of Leona’s”little people,” working for a weekly paycheck long after I graduated from Raytheon.

Then I went into business for myself. I learned to “arrange[my] affairs” in such a way as to “minimize my taxes.” Given a primer by legal and accounting counsel, supplemented by a subscription to the “Tax Avoidance Digest” (now defunct),I decided that part of being successful in small business results from hanging on to what you have earned by legitimately reducing your tax bill.

Five basic things that I have learned as a business owner about minimizing my taxes:

1. Take advantage of the S Corporation or the LLC corporate structure if your business is closely held. Unlike a C Corporation, in most cases there’s no corporate income tax- your income flows through to your personal return, which can be a significant benefit, especially when you sell the company.

2. Understand the difference between tax reporting and financial reporting – you can keep two sets of books. For example, as a service company, you may have accounts receivable at year-end, representing uncollected cash.At the same time, you likely will not only have incurred, but paid, your labor costs that produced these A.R. For financial reporting, you’ll want to show the results on an accrual basis- revenues earned vs. expenses incurred for the period.For tax purposes, however, it may be best to report on a cash basis, deferring taxes on those uncollected receivables even while getting a tax deduction for all of the expenses actually paid by the end of the period.

3. Don’t keep increasing your salary in an S Corporation just because your company’s profits are increasing. Your W-2 compensation is subject to taxation of 15.3%(employee’s+ employer’s share) on the first $90,000 of 2005income for Social Security and Medicare, a total of $13,770.Above$90,000, you’ll pay 2.9% for Medicare (only) on each dollar of earnings – that’s $2,900 on every $100,000.The profits of an S Corporation, however, are not subject to FICA and Medicare taxes, only to income taxes at your personal rate. So set your salary at a market rate commensurate with your responsibilities (lest the IRS ding you for being too aggressive in tax avoidance), take the rest as a distribution, and save that $2,900 on your total income package.

4. Before you put your kids and your spouse on the payroll, crunch some numbers, especially if they’re not actually going to be working. On payroll, you as the employer and they as the employed will each pay 6.2% in FICA(not Medicare) tax, a total of 12.4%. Alternatively, you might increase your own pay to cover what you distribute to them personally, off-payroll. Assuming that your salary alone puts you above the $90,000 FICA maximum, you’ll save the 12.4%total FICA tax for them. [Caveat 1 -See “Draining the Swamp” sidebar. Caveat 2 – You will want to consider the difference in your respective incremental income tax rates before deciding on the appropriate course of action.Caveat 3- Not all reasons for having a spouse or children on the payroll are objective.]

5. Don’t trust yourself to make your own withholding tax deposits – get a payroll service. When cash is tight there’s nothing like having some external discipline and thereby avoiding the stiff penalties for “failure to file and remit” in timely fashion. Knowing that you have to cover the looming tax deposit is a great incentive to get on the phone to collect those overdue receivables.

I was on the far side of 40 before I began to recognize the benefits, including tax advantages, of being in business for myself. Fortunately, I wasn’t on the far side of 60.But if I were to reprise the whole thing, I’d have learned these lessons( not at Raytheon) while still on the good side of 20.Then, in arranging my affairs to minimize taxes, I might have rearranged my life…

For an update on Ben Franklin’s comment, I am indebted to QuotesExchange.com:

“There will always be death and taxes; however, death doesn’t get worse every year.”

Alligator Bites

The update on Leona Helmsley, “The Queen of Mean:”

“…convicted in 1989 of tax evasion…[she]served time for 18 months in F.C.I. Danbury. Now [2004]an 84-year-old widow and the 247th richest person in the world[Forbes], Helmsley still lives in her deluxe apartment overlooking Central Park.

“Since returning to her big apartment from the big house in1994, Helmsley has had a recurring role in the legal system… [paying] more than $100,000 to her former landscaper for breach of contract. And she has slapped a $150 million lawsuit on the Woodlawn Cemetery in the Bronx, where her late husband and son rest in a palatial mausoleum.The cemetery is constructing an affordable mausoleum, large enough to hold the remains of more than 2,000 people, near the Helmsley site. Helmsley claims it disrupts the serenity she was promised for her family’s eternal resting place, and she plans to move their remains elsewhere.

“While Helmsley now may be paying taxes as the little people do, she evidently has no intention of being laid to rest next to them.”

– Megan Barnett USNews.com, 8/16/04

On an affordable retainer basis, FM serves as the part-time controller and senior financial manager for multiple clients, leading them to profitability and positivecash flow.

The goal is for the organization to outgrow Financial Manager’s services, at which time FM will take the lead in identifying and hiring the right full-time financial person for the firm, and effect a smooth transition to his or her management.

Draining the Swamp

Having paid into the Social Security Trust Fund for something over 40 years now, and hearing the President extol the benefits of Personal Savings Accounts, I decided to see what my maximum payments for all of those years will do for my wife, Anne, and me when the time comes.

I discovered that in most cases, spousal Social Security benefits are based on the higher earner’s contributions over a35-year period and are set at 50% of the higher earner’s benefits, unless the lower earner qualifies for more than 50%on his/her own. On the death of either spouse, the payout is adjusted to the established benefit of the higher- earner.

Then I tracked down several useful web pages starting with the government’s Social Security Online web site to learn that, for example, for people born between 1943-54 who retire at 62 instead of normal retirement age of 66, the reduction in benefits is25%.Similarly, for those who wait until the maximum age of 70, the increase in benefits is 24%.

In the example given on the site, the annual payout is $17,424(age 62) vs. $22,488 (66) vs. $27,024 (70). Based on a life expectancy of 20 years after age 65, the total return would be$400,752 (62; 23 years of payout) vs. $427,272 (66;19 years)vs. $405,360 (70; 15 years). Even a 10% annual return on the earnings stream from age 62 to age 66 doesn’t make up the difference in total expected value.

But perhaps only the actuaries among us make such a decision this way…