Tax planning is about much more than filing your tax return each year. In this episode of the Wise Money Show, we break down the four levels of tax planning and explain how proactive tax planning strategies can help individuals, business owners, and entrepreneurs reduce lifetime taxes and build more wealth. Learn the difference between tax preparation and tax planning, discover legal tax-saving opportunities, and avoid common mistakes that can lead to costly tax surprises. We’re joined in the studio by special guest and tax planning expert Patrick Lonergan.
Season 11, Episode 48
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This information is for general financial education and is not intended to provide specific investment advice or recommendations. All investing and investment strategies involve risk, including the potential loss of principal. Asset allocation & diversification do not ensure a profit or prevent a loss in a declining market. Past performance is not a guarantee of future results. This video may discuss estate planning concepts but does not constitute legal advice. Please consult an attorney for advice specific to your situation.
How Entity Structure Fits Into the Four Levels of Tax Planning
For business owners, choosing an entity structure can feel like a decision you make once and then forget about. You establish an LLC, partnership, S corporation, or another structure, file the necessary paperwork, and get back to running your business.
But your business can change significantly over time. Revenue grows, profits increase, you hire employees, and your personal financial situation evolves. The entity structure that made sense when your business started may not be the most tax-efficient choice today.
That’s why reviewing your entity structure can be an important part of proactive tax planning.
Legal Structure and Tax Structure Aren’t Always the Same
One important distinction for business owners is the difference between a business’s legal structure and how it is taxed.
For example, forming a limited liability company (LLC) establishes a legal structure, but an LLC can potentially be taxed in different ways depending on its circumstances and the elections it makes. In some situations, a business owner may elect to have an LLC taxed as an S corporation.
Why does that matter? Because the way your business is taxed can affect how business income flows to you and the taxes you ultimately pay.
This is where tax planning differs from simply preparing a tax return. Tax preparation generally looks backward at transactions that have already occurred. Tax planning looks forward and asks whether there are changes you can make to improve your financial situation.
Could an S Corporation Election Reduce Taxes?
An S corporation election is one example of how entity structure can affect a business owner’s taxes.
When an eligible business elects S corporation tax treatment, an owner who works in the business generally receives reasonable compensation as wages. Additional business profits may then pass through to the owner differently for employment tax purposes.
Depending on the business’s profitability and other circumstances, that distinction could potentially produce meaningful tax savings.
However, electing S corporation taxation isn’t automatically the right move for every business. There are additional administrative responsibilities, payroll requirements, tax filings, and rules surrounding reasonable compensation.
That makes this a planning decision—not simply a tax-saving trick.
Entity Structure and the Four Levels of Tax Planning
During a recent episode of the Wise Money Show, we discussed the four levels of tax planning, a framework for thinking about increasingly complex tax strategies.
Entity structure can be a good example of why proactive tax planning matters. Rather than simply accepting the way a business has always been taxed, a business owner and their financial and tax professionals can periodically evaluate whether the current structure still makes sense.
The goal isn’t to find a loophole or aggressively avoid taxes. It’s to understand the options available within the tax rules and determine which strategies fit your specific financial situation.
That distinction becomes increasingly important as a business grows. A structure that was perfectly appropriate when a business generated modest profits may deserve another look after the business becomes significantly more profitable.
Your Entity Structure Affects More Than Taxes
Taxes shouldn’t be the only consideration when choosing a business structure.
Entity decisions can potentially affect several areas of your financial life, including liability protection, payroll, retirement planning, business succession, estate planning, and how you eventually exit or transfer the business.
That’s why these decisions shouldn’t be made in isolation.
Imagine making an entity change solely because it could reduce your current tax bill, only to discover that the change creates complications elsewhere in your financial plan. A better approach is to evaluate the potential tax benefits alongside the downstream effects.
Financial planning works best when your tax professional, financial advisor, attorney, insurance professionals, and other advisors understand the broader strategy and work together.
When Should You Review Your Entity Structure?
Your business structure shouldn’t necessarily remain unchanged simply because that’s how you’ve always done things.
Consider reviewing your entity and tax structure when your business experiences a meaningful change. That could include a substantial increase in profitability, adding or removing owners, hiring employees, expanding into new states, changing how much you work in the business, or beginning to plan for a future sale or succession.
Even without a major event, periodically reviewing your structure can help ensure it continues to align with your business and personal financial goals.
Make Entity Structure Part of Your Tax Planning
Good tax planning isn’t about waiting until tax season and hoping your return produces a favorable result. It’s about looking ahead for opportunities to make intentional decisions before the tax consequences are locked in.
Entity structure is just one piece of that process, but for some business owners, it can be a significant one.
As you consider the four levels of tax planning, start by asking whether you’re taking advantage of the straightforward planning opportunities already available to you. Reviewing how your business is structured and taxed may reveal opportunities you’ve overlooked—and help ensure your business, tax strategy, and overall financial plan are working together.
