expenses. Careful purchasing will go far in expense reduction, but taxes have
one of the most profound effects on business profitability. Most business planning
is tax driven, and prudent businesspeople are careful to determine the tax
consequence of virtually every transaction.
You should have periodic meetings with your business lawyer and tax accountant
to determine the most expeditious and cost-effective method of conducting
your business. Restaurant businesses should have at least one year-end planning
session for the purpose of evaluating business activities and tax planning.
The U.S. Tax Code allows for basic needs through personal exemptions, a narrow
list of personal deductions, and a reduced tax rate for those at the low end
of the income scale. As of 2005, there are five graduated tax rates for individuals—
10% on the lowest taxable income range, 15% and 28% on income in the
middle taxable income ranges, and 33% and 35% on income in the highest taxable
Capital gains taxes for many long-term investments were cut by the Jobs and
Growth Tax Relief Reconciliation Act. This applies to sales of capital assets made
after May 6, 2003, and is a great tax advantage over the higher capital gains rates
in place over the preceding decade.
Note that the tax rates for gains on such items as depreciation recapture and
gain on the sale of collectibles remain at the regular ordinary graduated tax rates.
There are two important means of reducing tax liability. The first is spreading
taxable income by the use of several provisions in the Tax Code. The second is
the use of tax deductions.
Installments and Deferred Payments
One way a business can spread income is to receive payment in installments.
Care must be taken with the mechanics of this arrangement. If a business
makes a sale for a negotiable note due in full at some future date, or for some
other deferred payment obligation that is essentially equivalent to cash or that
has an ascertainable fair market value, the business may have to report the
total proceeds of the sale as income realized when the note is received, not
when the note is paid. (A negotiable note is a written and signed promise to
pay a specified sum of money either on demand or at a specified time, payable
either to an identified party or to the bearer.) The Internal Revenue Code (IRC)
does, however, enable a taxpayer who sells property with payments received in
successive tax years to report the income on an installment basis in some situations,
if the sale is properly structured. Under this method, tax is assessed
only as payments are received.
EXAMPLE: Suppose you remodel your restaurant kitchen and sell your
used equipment for $15,000. Ordinarily, the entire
$15,000 would be taxable income in the year you received
it (not allowing for recaptured depreciation, which is
beyond the scope of this discussion). If, however, you use
the installment method, with three annual payments of
$5,000, income from the sale will be taxed as the installments
are received. In either case, the amount of income is
$15,000, but under the installment method, the amount
is spread out over three years, and you may be able to take
advantage of being in a lower tax bracket than had you
taken the full $15,000 in the year you sold the equipment.
Be aware that there are special rules for installment sales,
which are extremely complex and should be discussed with
your tax advisor.