My first real encounter with taxes came when I was 17 and spent the first of four summers working at the Raytheon plant in Andover, which was producing guided missile parts and sub-assemblies for the Department of Defense. Starting out in Production Control, I learned how to develop work orders, purchase orders, and job tickets for the then-princely beginning wage of $1.37/hr., about $8.25 today (this was a while ago!).

I worked 40 hours a week, except during the month- end physical inventory, when we all picked up 16 hours of overtime for counting resistors, transistors, and capacitors. So my regular gross pay was $54.80 a week, increasing to $87.76 with time-and-a-half for inventory.

My net pay, thanks to withholding taxes, was something less than that, but I had been told I'd get it back the following April — hence my initial understanding of "tax return." So the next 25 springs came and went, and even though I fully understood the folly of giving Uncle Sam an interest-free loan every year, I did look forward to my annual April "bonus" check. Clearly, I was one of Leona's "little people," working for a weekly paycheck long after I graduated from Raytheon.

Then I went into business for myself. I learned to "arrange [my] affairs" in such a way as to "minimize my taxes." Given a primer by legal and accounting counsel, supplemented by a subscription to the "Tax Avoidance Digest" (now defunct), I decided that part of being successful in small business results from hanging on to what you have earned by legitimately reducing your tax bill.

Five basic things that I have learned as a business owner about minimizing my taxes:

1. Take advantage of the S Corporation or the LLC corporate structure if your business is closely held. Unlike a C Corporation, in most cases there's no corporate income tax — your income flows through to your personal return, which can be a significant benefit, especially when you sell the company.
2. Understand the difference between tax reporting and financial reporting — you can keep two sets of books. For example, as a service company, you may have accounts receivable at year-end, representing uncollected cash. At the same time, you likely will not only have incurred, but paid, your labor costs that produced these A.R. For financial reporting, you'll want to show the results on an accrual basis — revenues earned vs. expenses incurred for the period. For tax purposes, however, it may be best to report on a cash basis, deferring taxes on those uncollected receivables even while getting a tax deduction for all of the expenses actually paid by the end of the period.
3. Don't keep increasing your salary in an S Corporation just because your company's profits are increasing. Your W-2 compensation is subject to taxation of 15.3% (employee's + employer's share) on the first $90,000 of 2005 income for Social Security and Medicare, a total of $13,770. Above $90,000, you'll pay 2.9% for Medicare (only) on each dollar of earnings — that's $2,900 on every $100,000. The profits of an S Corporation, however, are not subject to FICA and Medicare taxes, only to income taxes at your personal rate. So set your salary at a market rate commensurate with your responsibilities (lest the IRS ding you for being too aggressive in tax avoidance), take the rest as a distribution, and save that $2,900 on your total income package.
4. Before you put your kids and your spouse on the payroll, crunch some numbers, especially if they're not actually going to be working. On payroll, you as the employer and they as the employed will each pay 6.2% in FICA (not Medicare) tax, a total of 12.4%. Alternatively, you might increase your own pay to cover what you distribute to them personally, off-payroll. Assuming that your salary alone puts you above the $90,000 FICA maximum, you'll save the 12.4% total FICA tax for them. [Caveat 1 — See "Draining the Swamp" sidebar. Caveat 2 — You will want to consider the difference in your respective incremental income tax rates before deciding on the appropriate course of action. Caveat 3 — Not all reasons for having a spouse or children on the payroll are objective.]
5. Don't trust yourself to make your own withholding tax deposits — get a payroll service. When cash is tight there's nothing like having some external discipline and thereby avoiding the stiff penalties for "failure to file and remit" in timely fashion. Knowing that you have to cover the looming tax deposit is a great incentive to get on the phone to collect those overdue receivables.

I was on the far side of 40 before I began to recognize the benefits, including tax advantages, of being in business for myself. Fortunately, I wasn't on the far side of 60. But if I were to reprise the whole thing, I'd have learned these lessons (not at Raytheon) while still on the good side of 20. Then, in arranging my affairs to minimize taxes, I might have rearranged my life…