Taxes and Business Strategy

This paper will take an in-depth look at how businesses develop their strategies relative to taxation. Specifically, the essay will look at several key areas of business activity, how companies' liability is impacted as a result of such activity, and how they may plan their respective tax returns in a way that serves the best interests of the business by incurring the least impact on profit. Discussion of internal operations tax strategies and more complex tax situations is presented.

Keywords: Apportionment; Electronic Federal Tax Payment System (EFTPS); Multinational Corporation; Payroll Tax Fund; Tax Liability; Writeoff

Overview

There are few elements of life in modern industrial society more popularly unpopular than taxation. Governments impose taxes on income, property, retail sales, restaurant patronage and commerce. In the United States, one of the targets of most citizens' vitriol is the agency responsible for collecting taxes — the Internal Revenue Service (IRS). Taxes are typically levied on the basis of commercial transactions — an individual receives compensation for working at a factory, while the owner is taxed because his or her factory generates profits. Out of this application of taxes to nearly every aspect of life, an unknown author once quipped, "A fine is a tax for doing something wrong … a tax is a fine for doing something right" (www.QuoteGarden.com).

Still, although they do so begrudgingly, most taxpayers acknowledge the fact that taxes are used to fund government programs and projects at the federal, state and local levels. From police, schools and roadway repair to national security, international trade and support of the elderly, taxes play an integral role in society. As such, taxes are largely viewed as a necessary evil.

This reluctant acceptance of taxes does not mean, however, that individuals and businesses alike will not seek to minimize their tax liability. The effort to find ways to avoid paying excessive taxes is at the core of tax planning. Individual taxpayers, for example, will ideally look at ways to modify their adjusted gross income, one of the main areas targeted by taxation agencies, so that as much of their financial assets as possible are fragmented into non-taxable funds (such as retirement accounts and 401(k) programs) or offset by tax credits.

Businesses must also seek to reduce their tax liability "footprints," taking into account their employee expenses, new tax laws and regulations and any existing tax credits and exemptions for which they may be eligible. This paper will take an in-depth look at how businesses develop their own strategies relative to taxation. Specifically, the essay will look at several key areas of business activity, how companies' liability is impacted as a result of such activity, and how they plan their respective tax returns in a way that serves the best interests of the business.

Doing Business in the 21st Century Economy

The fundamentals of conducting business in the 21st century are in many ways not dissimilar from those of commercial enterprises of the latter 20th century and earlier eras. Business exists to meet the demands of the customer. In order to sell its product or service to the consumer, the company will market it, helping spread the word about the value of the product, tapping into and taking advantage of various networking opportunities in order to present the product to as many consumers as possible. As demand for the company's goods increases, the company hires additional personnel to conduct internal operations (such as human resources and accounting), public relations, sales and marketing.

Of course, the landscapes involved with commerce have changed considerably. In the late 1980s, for example, the American financial system was in relative disrepair while the rest of the economy was experiencing sluggish growth. Meanwhile, Japan's technological industries gave that country's economy an extraordinary boost. By the late 1990s, the United States economy, revived by the explosion of information technology and financial services, re-captured the lead from Japan in terms of prominence in the international economy ("The 21st Century," 1998). In fact, the development of a new international economy in only the last few decades represents a major evolution in the way business is now conducted, attributed in no small part to the development of new information technologies and Internet commerce.

The economy of the 21st century is global. Many transactions are conducted via the Internet, which means that companies that seek to be competitive in this marketplace must expand and diversify their operations to account for increased business opportunities. Large and small businesses alike may act similarly in this regard — they may expand their staffs, develop web-based commercial platforms and link with other companies to fortify their positioning in the market.

Because of this evolution, businesses must also adjust their tax planning endeavors in order to account for recently imposed and/or heretofore irrelevant tax laws and regulations. There are many examples of taxation issues facing businesses in this new environment.

Applications

Internal Operations

When developing a tax strategy, a business, like any other taxpayer, will seek to minimize its taxable income. This pursuit does not literally mean cutting staff and other assets — rather, it means that by taking a full account of all expenses and taking advantage of all tax exemptions and credits, a company may see a reduction in its tax liability.

Reducing Tax Liability

There are a number of steps businesses may take toward this end. In one area, internal operations, the company seeks to reduce its liability by increasing expenses. Businesses all require office supplies and office machines (such as copy paper and computers). These items qualify as business expenses, which may be used to offset tax liability. In other words, businesses often seek to purchase equipment as well as basic office supplies in large quantities. The rationale is simple — if a company purchases all of the items it needs in a given tax year, then that company will also see a reduction in the amount of taxes it owes. Similarly, tax advisers recommend that businesses that are nearing the end of the year should make sure that all of their bills for that year are paid before December 31 — any bills paid in the next year are applied to the following year's tax bill.

Writeoffs

In addition, it is important for businesses to take account of any expenses or investments that for whatever reason fail to bring a return. Companies may purchase shares of another company, or purchase computer systems or otherwise acquire systems and products that are designed to benefit the business's operations. If the investment fails to generate that return, its purchase may be considered a "writeoff" — listed on a tax return as a deduction from the company's overall tax liability. While companies seek to avoid such types of purchases and investments, they may offset the losses via tax reporting. Careful monitoring of writeoffs may help a company recoup losses caused by that expense and at the same reduce the company's overall tax bill.

Employee Income Tax

One of the most important elements of a business tax strategy is addressing payroll. Employee income is, after all, subject to taxation, and businesses are required to withhold a percentage of full-time employee salary for state and federal taxes. In order to help organize these funds, companies often create a separate fund for the purposes of paying state and federal income taxes. For some of these companies, however, the presence of a payroll tax fund is a tempting resource from which to draw when business is slow, and if that fund is drained when it is time to submit income taxes, the company must scramble to find those owed monies or risk stiff fines.

In this arena, tax experts recommend that businesses organize well in advance of impending deadlines, budgeting for at least 10% of each employee's salary to be paid to the state and governments. In order to avoid the temptation of dipping into a company's payroll tax fund, businesses are encouraged to use computerized payment systems, such as the federal government's Electronic Federal Tax Payment System (EFTPS), so that payments are made automatically and not withdrawn from the payroll tax fund. Others simply never handle payroll, deferring instead to an external payroll and/or accounting service to manage this aspect of a company's operations (Rozbruch, 2009).

Internal Audits

Payroll is also one of the most audited aspects of a company's tax report. In 2004, the IRS saw over $43 billion in enforcement revenue (money collected as a result of audits and collections activity). The main source of such audit revenues was payroll. With payroll activities firmly in the crosshairs of revenue collection agencies, most businesses, whether small, medium or large in size, are strongly encouraged by tax experts to conduct internal audits well in advance of tax time. By doing so, these companies may account for any discrepancies in income reporting. Internal audits are not easy — they may take months to conduct — but may help a business avoid a far more painful government audit ("Follow these strategies," 2005).

Internal operations such as the ones described above comprise an arena in which many companies (and in particular, small businesses) minimize their tax liability. By organization and careful strategizing, businesses may avoid painful audits and fines. Still, in the 21st century global economy, there are many businesses for which taxation is a much more complex issue.

Complex Tax Situations

The fundamentals of business today are not dissimilar from the basic tenets of business that have been practiced for millennia. Businesses provide goods and services based on customer demand. However, the environment in which business is conducted has changed considerably, especially in the last few decades. An ever-growing segment of the business population uses the Internet as an invaluable marketing tool to draw customers from broader regions, including other states and even other countries. Inter-state and international commerce is common in the 21st century — not just for large multinational corporations but for small businesses as well.

While the global economy brings enormous potential for business development and ultimately, profit generation, it also presents a challenge for businesses in terms of taxes. Indeed, while the global economy has taken shape in spite of state and international borders, governments remain invariably bound by them. Regional trade and commerce organizations have become increasingly prevalent in the United States and in other countries, led by one of the most comprehensive multinational integrations, the European Union. However, tax codes generally remain compartmentalized and specific to the regions they serve.

Taxes Between States

In the United States, taxes vary from state to state, both in terms of rate and application. For example, a person could purchase a cup of coffee in Massachusetts and pay a few cents more than he or she would in New Hampshire or Connecticut, but for different reasons: Massachusetts applies a 6.25% sales tax, while Connecticut imposes a 5.5% tax and New Hampshire does not have a sales tax at all (Sales Tax Institute, 2009).

One of the most complex areas of assessing the application of taxes in other states and countries is payroll. Companies that operate regional or satellite offices and branches in other states and countries must take into account the income tax regulations and rates applied in the area in which they operate. Many large and/or multinational corporations are able to effectively address this issue by creating or establishing payroll groups (organizations dedicated to managing local employee payrolls), which are fully versed in the tax laws applied to the business. Payroll groups are able to simply shift employees from group to group with all the proper tax protocols in order. Other companies, however, do not have the resources to create or hire such groups — they must operate on a site-to-site basis.

Taxes Between Countries

This issue is particularly complicated when dealing in multinational situations. Businesses seeking to conduct operations in another country must glean a full understanding of that country's income tax withholding rules. For example, U.S. and British citizens working abroad are subject to laws that require employers to withhold employee taxes in their home countries. However, companies with workers whose homes are in countries without such exemption laws to other locations where those laws are also nonexistent may be forced to withhold payroll taxes for both countries (Moore, 2005). In light of this fact, employers must be extremely vigilant of in-country rules governing employee income tax liability.

As the payroll example demonstrates, taxes on business operations in multiple states or countries present sizable challenges for companies in terms of strategy. Companies that conduct business in other states or countries must keep careful records and a watchful eye on the tax rates and laws of those regions as well as the expenses and revenues generated from those areas. A company's business strategy must follow two general objectives. The first is to extensively assess the company's activity in a given state. By conducting this analysis, a business may effectively establish its taxable income subject to apportionment (the distribution of taxes among various jurisdictions in which the company operates). Doing so will both help paint an accurate illustration of a company's tax liability while assisting planners in structuring the company's overall operational strategy. The second objective is to minimize the tax costs. Such an endeavor involves a total analysis, however, instead of a segment-by-segment assessment. Companies with multi-state or multi-national activities must weigh the various tax codes and rates in each system in order to determine whether taxes saved in one state or country are not offset by higher tax rates in other systems (Healy & Schadewald, 2009).

As businesses vary in size, industry and operations, so too do the systems by which they pay and withhold taxes. In some cases, the company's tax reporting system is simple — the business may be small in terms of staff and client base as well as service area. In cases that involve multi-state or international business, however, taxation policies to which companies must adhere become more complex and, as a result, business strategies related thereto must be detailed and observant of that complexity.

Conclusions

Albert Einstein once complained that "the hardest thing in the world to understand is the income tax", a comment that was quickly seized upon by prominent Congressman and Senator Warren Magnuson (D-Washington): "If Einstein and the agents of the Internal Revenue Service cannot understand the Tax Code, then the ordinary taxpayers of the US are entitled to a little help" (cited in Goodman, 2007).

For the uninitiated citizen with simple tax reporting responsibilities, understanding the complexities of tax policy and administration is often a daunting task. For small businesses, the task is sometimes even more challenging, and for large businesses, that complexity is compounded. Regardless of the unfavorable nature of this undertaking, countless people, business owners and managers alike must take stock of their tax liability and develop strategies to minimize that liability. Businesses must take care when developing their strategies toward minimizing liability. All businesses must carefully monitor their internal operations, accounting for expenses and writeoffs, as well as assessing payroll. By doing so, the company may also help glean a better understanding of ways it might adjust its operations to contain costs and create better efficiencies in addition to minimizing tax liability.

In the global economy of the 21st century, the broader scope of potential clients and customers in neighboring states and across national borders has added a considerable degree of complexity to the development of a business's tax strategy. Multijurisdictional taxation requires that companies pay extra attention to the income and sales tax requirements of the areas in which they conduct business. In many cases, these businesses must either dedicated a larger sum of their budgets to local taxation analysis or acquire the services of external vendors to do so.

Whether the company is large or small and the client base is local or international, the fundamental necessity of business tax strategy remains careful vigilance. Without a comprehensive and up-to-date understanding of a company's tax requirements in the market in which it operates, a lack of attention to detail may significantly impact the health and sustainability of that company.

Terms & Concepts

Apportionment: The distribution of taxes among various jurisdictions in which the company operates.

Electronic Federal Tax Payment System (EFTPS): An automatic federal payroll tax withholding system.

Multinational Corporation: A corporation based in one country but with operations in other countries.

Payroll Tax Fund: Organization dedicated to managing local employee payrolls.

Tax Liability: The amount of taxes owed.

Writeoff: An investment that fails to generate a return that is cited on a tax return as a deduction.

Bibliography

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Suggested Reading

Barrett, J. (2009). 2009 mid-year tax planning. Business West, 26, 30-34. Retrieved September 25, 2009 from EBSCO Online Database Regional Business News. http://search.ebscohost.com/login.aspx?direct=true&db=bwh&AN=43443978&site=ehost-live

Leverich, J. (2005). Developing a better business tax strategy. Enterprise/Salt Lake City, 34, 9. Retrieved September 24, 2009 from EBSCO Online Database Regional Business News. http://search.ebscohost.com/login.aspx?direct=true&db=bwh&AN=16284033&site=ehost-live.

Mayover, S. (1989). The Coopers and Lybrand guide to business tax strategies and planning. Library Journal, 114. Retrieved September 24, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=13408984&site=ehost-live.

Mitrusi, A. & Poterba, J. (2000). The distribution of payroll and income tax burdens, 1979-2009. National Tax Journal, 53, 765-795. Retrieved September 25 2009 from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=17089145&site=ehost-live.

Young, R. (1980). Taxation … multistate corporations. American Bar Association Journal, 66, 780. Retrieved September 24, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=4798922&site=ehost-live.