Business Tax

In this article, we discuss excise taxes, what they are, how they work, and who pays them. Read on to learn the fundamentals of excise taxes.

What Is an Excise Tax?

According to the IRS, excise taxes are “imposed on various goods, services, and activities.” That definition is vague, so let’s understand exactly what an excise tax is.

Excise taxes are imposed on specific goods or activities to discourage their use. Some everyday items that excise taxes are levied on are:

• Cigarettes
• Alcoholic beverages
• Soda
• Gasoline
• Insurance premiums
• Amusement activities
• Betting

From the list of items that incur an excise tax, you may guess that their purpose is to reduce the consumption of items or activities considered to have the potential to cause a negative social impact. For example, cigarettes and sugary sodas can pose a health risk. Excess gasoline consumption leads to more motorists on roadways, which leads to the need for repairs, traffic modulation, etc. In that case, motorists are “paying dues” to use public roads and highways.

These taxes are typically levied at the state and local levels and, in some cases, the federal level.

Two Types of Excise Tax

Excise taxes can fall into one of two categories:

1. Ad Valorem Taxes

Ad valorem is Latin for “according to value.” Fitting with that meaning, ad valorem taxes are assessed based on the determined value of the item being taxed. These taxes are fixed percentage rates levied on particular goods or services such as real estate or personal property. Ad valorem taxes can also include import duty taxes on foreign goods.

2. Specific Taxes

Unlike ad valorem taxes, specific taxes are imposed as a fixed amount applied to certain purchases. These taxes are generally applied to items with a high social cost, such as cigarettes are alcohol. For example, the federal government assesses a $1.01 per pack specific tax on cigarettes. Because of the type of items taxed in this way, specific taxes are sometimes called “sin taxes.”

Now that you understand what excise taxes are and the two types let’s learn more about how they work.

How Excise Taxes Work

Excise taxes are generally levied against businesses. For example, a merchant will pay the wholesaler, then pass that added expense on to the consumer through inflated retail pricing of a product or service. In many cases, consumers never realize they are absorbing the excise tax paid by the merchant.

Excise Tax vs. Sales Tax

Excise taxes are not the same as sales tax. Again, excise taxes are levied against particular goods and services. The responsibility to pay them usually falls on the merchant. Alternatively, sales tax is charged on nearly every item or service and is openly and directly collected by the merchant from the consumer and then passed along to the government. Sales tax is also not a fixed amount but a percentage of the sale price of an item.

Businesses that charge or receive excise taxes must file Form 720 Federal Excise Tax Return quarterly along with quarterly payments. If you have questions about excise taxes, the best way to address this is to have a qualified accountant or CPA explain how excise taxes impact your business.

Some small businesses develop gradually, transforming from a part-time hobby to a full-time operation. Others go from zero to a hundred in just a few weeks, as entrepreneurs turn ideas into profitable enterprises, seemingly overnight. In either case, it’s easy to overlook certain details, such as how the business is structured. After all, there are more pressing concerns in bringing a product or service to market.

Certainly, it is possible to run a business without making a deliberate decision on which business entity is best. The company defaults to a sole proprietorship or partnership. However, from a tax perspective – and a liability perspective – leaving your business structure to chance can be costly. Other options may offer better protection for your personal assets, as well as significant savings on your tax bill.

Weighing the pros and cons of each option can get complicated. Fortunately, your Certified Tax Coach can help. These experts think outside the tax box to guide you on selecting and implementing the business entity that benefits you most.

Simplicity vs. Tax Savings

Sole proprietorships and partnerships are the default business structure because they are so simple. A quick registration and minimal fees are all that you need to get started. The downside is that you might find yourself paying taxes twice on the same income. You owe taxes on any profits earned by your company, then you pay tax again when you file your personal returns. An additional concern that comes along with sole proprietorships and partnerships is liability.

For legal and financial purposes, you and your company are a single entity. Business creditors may be able to settle debts by going after your personal assets, and any legal claims against your company can be held against you personally. While the level of simplicity does make sole proprietorships and partnerships tempting, you might discover that the tradeoff of a higher tax bill is more than you are willing to pay.

Conquering Corporate Complexity

It’s true that C-Corporations are primarily reserved for massive companies with millions, or billions, in revenue. The cost of creating and maintaining such a business structure is rarely practical for smaller organizations. However, that doesn’t take the corporate structure off the table altogether. S-Corporations are much simpler than their larger C-Corporation peers, and they offer many of the same advantages.

One of the biggest benefits of a corporate business structure is how taxes are handled. Shareholders may pay capital gains taxes or taxes on dividends, but the issue with double-taxation on the same income is eliminated. Another important benefit to this type of business entity is the complete separation of personal and business assets. Financial and legal issues that come up for the business aren’t transferred to corporate shareholders.

The Best of Both Worlds

When a sole proprietorship or partnership isn’t quite right, but incorporating doesn’t make sense for your business, you do have another option. A Limited Liability Company, also known as an LLC, offers important features that keep taxes and liability low, without excessive fees and paperwork for setup and maintenance. This business entity is built to be flexible, so it adapts as your company grows and expands.

How you structure your business can be as important to your bottom-line profits as the amount of product you sell. The business entity you choose dramatically impacts your total tax expense, which can mean the difference between a good year and a great one. Partnering with your Certified Tax Coach to evaluate your options ensures your business is structured in a manner that makes sense with your total financial plan.

Learn more about choosing the best business entity for your company, minimizing your taxes, and building your wealth by working with a Certified Tax Coach.

When it comes to minimizing taxes, most people focus their efforts on maximizing deductions. They look for opportunities to reduce their taxable income by taking advantage of tax laws that allow a wide variety of expenses to be claimed as costs of doing business. This technique is a critical component of your comprehensive tax strategy, but it isn’t the only opportunity to bring your tax bill down. Think bigger, by looking for ways to shift current income or generate new income that enjoys favorable tax treatment.

Your Certified Tax Coach is an expert at thinking outside the tax box to reduce your tax liability. You can partner with these professionals to identify methods of creating tax-deferred or tax-free income to grow your wealth more quickly.

The Trouble with Traditional Investment Income

Average taxpayers rely on traditional financial products for saving and investing. Examples include standard savings and money market accounts, certificates of deposit (CDs), mutual funds, and brokerage accounts. The problem is that income earned from interest, dividends, and increased share value is subject to fairly high tax rates. Certainly, these options play an important role in your financial plan, but there is no need to rely on them exclusively. Instead, maximize use of tax-deferred and tax-free programs to reduce your total tax liability.

Options for Tax-Deferred Income

It’s no secret that it is getting harder to achieve the retirement lifestyle you want. Setting money aside to ensure you can enjoy the years after you leave the workforce is a top priority. The good news is that there are retirement savings programs specifically designed to make this goal more achievable. They offer an opportunity to earn tax-deferred or tax-free income, which lowers the total amount you hand over to the IRS.

Traditional IRAs, certain employer-sponsored retirement programs, and specific types of annuities enjoy tax-deferred status. Essentially, you contribute a portion of your current income on a pre-tax basis. You don’t pay income taxes on that amount today. Instead, taxes are assessed when you eventually take distributions.

This benefits you in two ways. First, your money stays with you longer, so you can generate interest on funds that would otherwise be lost to tax. Second, most people find themselves in lower tax brackets after retirement. That means you pay less later than you would if you paid today.

The Tax-Free Alternative

If your goal is to generate income that is completely free from taxes, you have options. Certain types of life insurance, specific annuities, and retirement savings plans like the Roth IRA make it possible to eliminate taxes on a portion of your income. Unlike tax-deferred plans, your contributions to these types of programs are made from after-tax dollars. In other words, you pay income tax on the funds you set aside in these accounts in the same year that income is earned. However, once you have paid that initial income tax, you don’t owe another penny. Any increase in value from interest, dividends, and similar is completely tax-free.

The bottom line is that minimizing taxes is more than finding deductible expenses. You can drive your tax bill down by incorporating a variety of techniques into your overall strategy. Shifting income or creating new income that enjoys favorable tax treatment is another tool you can use to reduce taxes and grow your wealth.

Learn more about transitioning to tax-advantaged income by working with a Certified Tax Coach.

Savvy investors can build wealth by deferring capital gains taxes via a 1031 exchange. Learn how it works and how it can help you as a real estate investor. For the in-depth information required to execute a 1031 exchange, a qualified intermediary is necessary.

What is a 1031 Exchange?

A 1031 exchange allows real estate investors to avoid paying capital gains taxes when selling an investment property and reinvesting in a replacement property. The name 1031 exchange comes from Section 1031 of the U.S. Internal Revenue Code.

A 1031 is also called a like-kind exchange. It is essentially a swap of one investment property for another. The “like-kind” refers to the fact that the properties in the exchange must be similar (i.e., of like kind) and the exchange property must be of equal or greater value as the property sold.

How Does a 1031 Exchange Work?

Under IRS code section 1031, which applies to real estate, investors can reinvest proceeds from the sale of one property into another property within a specified time frame to avoid paying capital gains taxes (the taxes on the growth of an investment when it is sold). Because it is rare for an even property swap to occur between parties, the most common type of exchange is the delayed “forward” exchange. In this case, the sold property funds are sent to a qualified intermediary and later used to acquire a replacement property from a seller.

What is a Qualified Intermediary?

A qualified intermediary facilitates a 1031 exchange. They hold the transaction funds from the sale of the first property until those funds are transferred to the seller of a replacement property. The qualified intermediary also prepares the legal documents required for the exchange. The qualified intermediary can have no formal relationship with the exchange parties outside of the exchange.

1031 Exchange Important Deadlines

• The seller of the first property (the relinquished property) must identify a replacement property (their new investment property) within 45 days of the transfer of the relinquished property.
• The replacement property must be received by the exchanger within either (1) 180 days of the date the exchanger transferred the first Relinquished Property or (2) the due date of the exchanger’s tax return for the year that the transfer of the first relinquished property occurs.
• These are strict timelines and are not extended even if the 45th or 180th days fall on a weekend or holiday.

What You Need to Know about a 1031 Exchange

1031 exchange transactions should be handled by a professional qualified intermediary that is a third party (i.e., not a family member, friend, acquaintance, or business associate of either party involved in the exchange).

Exceptions

The IRS does not allow capital gains tax avoidance if the exchange:

• is U.S. real estate for real estate in another country
• involves property for personal use
• is between related parties and either disposes of the property within two years

Why Do Investors Use a 1031 Exchange?

• They can use what they would have paid in capital gains taxes to put more down on a replacement property to improve their buying power.
• The savings on federal capital gains taxes could be 15 to 20 percent.
• There could be savings at the state level (this varies by state, so your qualified intermediary should be consulted for this information).
• The amount of income taxes paid could be reduced due to depreciation of the investment property.

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A 1031 exchange is a tool that savvy real estate investors use to build wealth over time. To further understand how a 1031 exchange can benefit you, ask your CPA or accountant to help put you in touch with a qualified intermediary. Their guidance is critical in executing a 1031 whether you’re swapping two properties or working with a full portfolio of investment real estate properties.