Understanding the taxes your business is liable for is critical when evaluating how to avoid taxes altogether. A particular tax to watch out for is the Federal Excise Tax (FET). If your business pays a lot in FET, then it’s natural to start wondering if there’s a legitimate way to avoid them and keep more of your hard-earned money.
Well, the answer is yes. Of course, it is possible to navigate and possibly avoid the federal excise tax strategically.
Even though it is essential to comply with all state and national taxes, there are legal and ethical methods to optimize your financial position strategically. In this article, let’s explore ways to minimize the impact of the federal excise tax and ensure that you retain more control over your financial resources.
The ways to avoid federal excise tax
The United States has many income treaties with countries from all around the world that contain specific provisions for the exemption of certain types of income from U.S. taxation. One of such income types is the insurance premiums paid to a foreign insurer who is a resident of a treaty country.
But to claim this exception, the foreign insurer or reinsurer must enter into a closing agreement with the Internal Revenue Service (IRS) to establish its eligibility for the benefit of the treaty. A closing agreement is a written agreement between the IRS and a taxpayer that conclusively settles a tax matter.
The closing agreement should include the following information:
The closing agreement is signed by the foreign insurer or reinsurer and the IRS. Once the closing agreement is in effect, the foreign insurer or reinsurer can provide a copy to the person paying the insurance premiums to prove that the premiums are exempt from the federal excise tax.
An excess IRA(Individual Retirement Arrangements) contribution happens when you either contribute more than the annual limit to the traditional or Roth IRA or if you make an improper rollover contribution. There’s an annual list of these contributions. This limit is $6,500 ($7,500 if you are 50 or older) in 2023.
If you do make an excess contribution, then you must pay a 6% penalty tax on the excess amount each year until you fix the mistake. You must withdraw the excess and any earnings by the extended due date for that year’s income tax return. This due date is usually on the 15th of October of the following year if you file an extension.
For instance, if you contributed $7,000 to your IRA in 2023 and your limit was $6,500, then you have an excess contribution of $500. If this $500 earned $50 in interest by the end of the year, you would have to withdraw the $550 by the 15th of October, 2024, to avoid the 6% penalty tax.
But if you withdraw the excess contribution and earnings, you must include the earnings in your taxable income for the year you contributed. If you withdraw the $550 in 2024, you have to report the $50 as income on your 2023 tax return.
Moreover, if you are under the age of 59 1/2, you may have to pay a 10% early withdrawal penalty on the earnings as well. This means that if you withdraw the $550 in 2024, you may have to pay a $5 penalty on the $50 earnings.
Therefore, withdrawing the excess contribution and earnings is one way to avoid the 6% excise tax, but it may incur additional taxes and penalties. Consulting a tax professional before making any decisions regarding your IRA contributions and withdrawals is highly recommended.
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There is something called RMD, which is the required minimum distribution, where the minimum amount that one can withdraw from the retirement account after a certain age each year. The rules of the RMD apply to SEP IRA's traditional IRAs, 401(k) plans, 457(b) plans, 403(b) plans, SIMPLE IRAs, and other contribution plans.
The required beginning date (RBD) can be calculated by dividing the cumulative account balance in the previous year’s month-end by a factor of life expectancy as published in the IRS. Depending on your type of beneficiary and age. Using the tables and worksheets provided by the IRS, you can easily determine the RMD account.
RBD is the required beginning date; it is the age at which you begin to take the RMD. April 1 of the calendar year, when you have reached the age of 72, is the RBD for most of the retirement accounts.
But in case you are working and involved in a retirement plan in the workplace, the delay of the RBD can be done until the 1st of April of the following year, when you retire, unless you must own 5% or more of the plan sponsored by your business.
While this concept is clear if you fail to take the RMD at the time of RBD or take less than the required amount, a 50% excise tax must be paid on that amount that was not distributed. For instance, if the RMD is $10,000 for 2023 and you have withdrawn only $6000, you need to pay a penalty of $2000 on the distributed amount of $4000.
One can avoid this 50% excise tax by taking the RMD on time and entirely every year. You can even withdraw more than the RMD amount, but in the future, you can't opt for an excess amount. In your taxable income, withdrawals will be included, excluding those already taxed.
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Based on the service type or the product, tax is calculated based on the amount per unit, the price, or both.
As per the IRS regulations, the taxpayer can deduct the amount of excise taxes as business expenses for those that are necessary for carrying on a business and those that are ordinary.
Necessary expenses are used to help your business, whereas ordinary taxes are the ones that are accepted to do business and are common for your industry.
For instance, paying excise taxes on fuel utilized for trucks applies to a trucking company. You can deduct the expense as a business expense, as they are necessary expenses for a business. But gasoline utilized for the car can't be deducted as a business expense as it comes under personal use.
It is essential to keep records of the transactions to deduct them as business expenses, and you must report these on the business tax return. For a restaurant business, the cost of the beer case, for instance, can be included as the cost of purchasing the goods instead of considering it as a separate item. Wherein you can deduct its cost and the excise tax applicable to it as an expense to the business.
We have discovered some of the ethical ways in which federal excise taxes can be lowered. It is about leveraging treaties, ensuring accurate contribution reporting, considering the business expense essentials, and meeting the required minimum distributions to reduce the tax burden.
These are only some of the avenues. As you continue to explore ways to lower your tax bill, keep these straightforward approaches in mind so that you may get a higher percentage of your business's revenue.
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