|
Learn how to make the most of a taxing element on your
Internet business and transform painful possible losses into gainful planned
profits.
Developing an overall tax strategy will impact not only your Internet businesses' annual tax bill, but
also that of its principals, investors and shareholders. A strategic tax plan
will also have a noticeable effect on non-tax areas including financial
opportunities from insurance plans, licensing agreements, compensation programs,
among operational issues.
Under federal tax rules, the predominant classifications of business
enterprises are:
- Regular or C Corporation
- S Corporation
- Partnership
- Limited Liability Company
- Sole Proprietorship
The most common choice of ISP owners is C or S Coporation, so I'll focus my
attention on the subtle differences between the two classifications.
Since most ISP owners want or need outside investment or financing, external
factors once again impact your decision as to which business classification will
provide the best tax strategy for your Internet operation.
Good fit
Of all the classifications of business
organizations, C Corporations are subject to the toughest tax laws that could
take the biggest bite out of your business because C Corp earnings are also
taxed twice.
First, C Corps pay a corporate income tax as levied against the ISP's
earnings. After the earnings are distributed to shareholders as dividends, each
shareholder must pay taxes separately on his or her share of the premium. Since
a C Corp cannot claim a tax deduction for distributing dividends, there is no
opportunity to decrease the tax drain on earnings.
Of course, if earnings distributions are not an issue for your Internet
service-based business, then C Corp status is fine and commonly the tax
classification of choice for much of the industry.
Necessary evil
Why not avoid the corporate
classifications of doing business altogether?
Truth be known, many banks will not lend to individuals or partners. Also,
venture capitalists and investors usually demand that ISP owners grant them
partial ownership or a share of the business. The need for financing creates the
obligation to incorporate your Internet business.
A S Corporation is a regular corporation that has chosen to be treated as a
partnership for Federal income tax purposes. S Corp classification could pass
along the business operation's profits without being levied a "double-tax."
So, why not opt for S Corp status for your ISP? Unfortunately, both the
number of shareholders and the types of stock an S Corp may issue limit the
ability of this tax classification to protect your businesses profits. A good
accountant will provide you with the proper guidance to determine if S Corp
status is right for your ISP.
Counting matters
Even the choice of the method
of accounting employed by your ISP will have a significant effect on your tax
bill. There are two common methods of accounting for overall income ? the cash
basis and the accrual basis. Most individuals use the cash basis of accounting
based on cash receipts and disbursements. Income is generally reported for the
year in which it is was actually or constructively received. Deductions or
credits are generally taken for the year in which the related expenditures were
actually paid.
Under the accrual method of accounting, income is reported when the right to
receive it comes into being -- i.e., when all the events that determine the
right have accrued. It is not the actual receipt, but the right to receive that
governs this method of accounting. Expenses are deductible on the accrual basis
in the year incurred ? i.e. when all the events have occurred that fix
the amount of the item and determine the liability of the taxpayer to pay it.
Accounting methods should be part of your ISP's tax strategy because it is
relatively simple to switch from the user-friendly cash accounting method to the
more complex accrual basis ? or vice versa. Plus, if it's time to sell your ISP
operation, those using the cash method can report the capitol gain from the sale
on an installment basis, which has some interesting benefits.
Bottom line building
In the past, selling a
business in exchange for agreed-upon installment payments usually produced a
higher selling price. Installment payments also allowed buyers to acquire
ongoing operations with less out-of-pocket expenditures.
Currently, selling any business could result in having a large portion of
profits whittled away by taxes. As a result, sellers are often quite receptive
to receiving a lower price for the business because installment payments take a
sip out of the profits from the sale, rather than a big gulp.
In December of 1999, federal lawmakers forbid all users of the accrual method
of accounting to utilize installment sales. The tax-breaks associated with
installment sales were an important factor in the sales price ? and the sale
itself ? of many Internet services.
In an effort to alleviate some of the sting inflicted by the new law, the
Internal Revenue Service issued a Revenue Procedure that allowed any business
with an average gross income of less than $1 million a year to use the cash
method of accounting ? and employ installment sales ? regardless of whether
inventories accruement schedules were used, without question.
The bottom line? If your ISP business generates income less than $1 million a
year, you're selling your Internet business, and using the accrual method of
accounting, switch to the cash method now to produce the best possible tax
benefits on a transaction utilizing installment payments. If you're a buyer, the
opposite scheme may be best.
Cash in pocket
The best tax strategy for your
ISP business is one that produces a lower tax bill ? unfortunately no tax
strategy involves taxes only.
For example, leasing necessary capital equipment rather than purchasing
hardware may involve other considerations that could provide substantial tax
benefits for your ISP business.
On the other hand, your Internet operation might not have funds available for
a down payment on capitol equipment purchases and you may have no choice but to
lease hardware though a vendor program.
Just make sure your accounting method and business classification fulfill the
goal of your ISP's business plan. Do you want cash in pocket, and
investor-friendly firm, or a buyer?
Obviously, tax strategies should not govern the day-to-day operations of any
ISP-related business. A good game plan for taxes may not help your ISP operation
add new subscribers or grow profits. But a well-planned tax scheme could insure
that more profit remains in your pocket - rather than going to the "Tax Man."
Securing a Small Business Loan by Mark E. Battersby
5 Stupid Things ISPs Do to Screw Up Their AUPs by Rachel Luxemburg
Management 101: Creating Structures by Jason Zigmont
Protect Your ISP With A Strong AUP by Christopher Knight
Self-Rental, a Tax Strategy by Mark E. Battersby
Tax-Saving Tax Strategies by Mark E. Battersby
Extremely Affordable Worker Magnets by Mark E. Battersby
Reward Yourself With Fringe Benefits by Mark E. Battersby
Turn Your ISPs Business Losses into Tax Benefits by Mark E. Battersby
|
