Looking for proven tax saving strategies for small business owners?
Running a small business means managing many tasks, from customer complaints to human resources. Amid these responsibilities, taxes can become overwhelming. Fortunately, effective tax planning can ease this burden and save you money.
Here are 5 key tax saving strategies for small business owners:
- Reduce Your Adjusted Gross Income (AGI): Contribute to tax-deferred retirement or health savings plans.
- Be Strategic with Tax Elections: Consider depreciation and deductions like home office expenses and insurance.
- Rethink Exit and Wealth Transfer Strategies: Adjust income recognition strategies based on your accounting method.
- Set Up or Contribute to Retirement Plans: Leverage tax benefits from traditional IRAs and 401(k)s.
- Hire a Tax Advisor: Stay updated and compliant with expert guidance.
Introduction
As a small business owner, mastering tax planning is critical. I’ve guided countless small business owners through effective tax planning to maximize their financial strategy.
By keeping these strategies in mind throughout the year, you’ll be better prepared for tax season and more likely to uncover valuable deductions.
Choose the Right Business Structure
Choosing the right business structure is a critical decision that can significantly impact your taxes. Each structure has its own pros and cons, and understanding these can help you save money and avoid headaches.
Sole Proprietorship
A sole proprietorship is the simplest structure. Your business income is reported on your personal tax return, which means you file a Schedule C (Form 1040) to report profits and losses. You also need to file a Schedule SE to report Social Security and Medicare taxes.
Pros:
- Easy to set up
- Simple tax filing
Cons:
- Full responsibility for taxes, debts, and legal issues
Partnerships
Partnerships are pass-through entities, meaning the business itself doesn’t pay income tax. Instead, profits and losses are passed on to the individual partners. Each partner reports their share on their personal tax returns.
Pros:
- Shared financial responsibility
- Pass-through taxation
Cons:
- Joint liability for business debts and obligations
Limited Liability Company (LLC)
An LLC offers flexibility. The IRS allows qualifying LLCs to file as a sole proprietorship, partnership, S corporation, or C corporation, depending on what makes the most sense for your business.
Pros:
- Limited liability protection
- Flexible tax options
Cons:
- More complex than sole proprietorships and partnerships
- Potentially higher administrative costs
S Corporation
An S corporation can be a smart choice if you want to avoid double taxation. Profits and losses are passed through to shareholders, who report them on their personal tax returns. This can help you save on Social Security and Medicare taxes.
Pros:
- Avoids double taxation
- Potential savings on payroll taxes
Cons:
- More stringent IRS requirements
- Limited to 100 shareholders
C Corporation
A C corporation is a separate tax entity that pays its own taxes. This structure can be beneficial if you plan to reinvest profits back into the business, as it allows for lower corporate tax rates on retained earnings.
Pros:
- Lower corporate tax rates on retained earnings
- No limit on the number of shareholders
Cons:
- Double taxation (corporate and shareholder levels)
- More complex and costly to set up and maintain
Expert Insight
Ines Zemelman, EA, Founder and President of TFX, notes:
“If you have a stable income stream and earn enough to pay yourself as an ’employer’ and ’employee,’ converting a partnership or sole proprietorship into an S corporation could lower your taxes.”
Choosing the right structure is not a one-time decision. As your business grows, you might need to reconsider your structure to align with your financial goals. Always consult a tax professional to ensure you’re making the best choice for your unique situation.
Next, let’s explore how to maximize your tax deductions to save even more.
Maximize Your Tax Deductions
As a small business owner, maximizing your tax deductions can significantly reduce your overall tax burden. Here are some key areas to focus on:
Home Office Deductions
If you use part of your home exclusively and regularly for business, you may qualify for the home office deduction. This can be a game-changer for small business owners who work from home.
Two Calculation Methods:
- Simplified Method: Deduct $5 per square foot of your home used for business, up to 300 square feet.
- Actual Expenses Method: Calculate the percentage of your home used for business and apply that to your actual expenses like mortgage interest, rent, utilities, and repairs.
For example, if your home office is 10% of your home’s total square footage, you can deduct 10% of your qualified home expenses.
Internet and Phone Expenses
Your internet and phone bills can also be partially deductible if used for business purposes. Be reasonable with your estimates to avoid red flags during an audit.
Pro Tip: Keep a log of business-related calls and internet usage to substantiate your claims.
Travel and Entertainment Expenses
Travel and entertainment costs can add up, but they are deductible if they are directly related to your business.
Travel Costs:
- Accommodations: 100% deductible if the trip is for business.
- Meals: Generally, 50% deductible, but temporary provisions allow for 100% deduction for meals provided by restaurants in 2021 and 2022.
Entertainment:
- Client Meals: Deductible if you can demonstrate a clear business purpose.
Example: Chris Gadek from AdQuick mentions that keeping detailed records of your travel expenses can help back up your claims if the IRS decides to challenge them.
Education Expenses
Continuing education can be essential for staying ahead in your industry. Fortunately, education expenses that maintain or improve your skills are deductible.
Examples:
- Online courses
- Seminars
- Professional certifications
Professional Fees
Fees paid to accountants, lawyers, and other professionals are also deductible. This includes costs related to tax preparation and business consultations.
Pro Tip: Hiring a reputable CPA can uncover deductions you might not be aware of. Stephanie Venn-Watson from fatty15 emphasizes that CPAs don’t cost you money; they save you money.
By strategically planning and keeping detailed records, you can maximize your deductions and save significantly on taxes. Next, let’s look at how to use tax credits to further reduce your tax burden.
Use Tax Credits
Tax credits are a powerful tool for small business owners. Unlike deductions, which reduce your taxable income, tax credits directly reduce the amount of tax you owe. Here are three key tax credits you should know about:
Work Opportunity Tax Credit (WOTC)
The Work Opportunity Tax Credit (WOTC) is designed to help employers hire and retain individuals from specific targeted groups who have faced significant barriers to employment. This credit can be worth up to $2,400 per eligible new hire.
Targeted Groups Include:
- Veterans
- Ex-felons
- Members of families receiving benefits under the Temporary Assistance for Needy Families (TANF) program
- Other groups facing employment barriers
How to Qualify:
- Hire individuals from these targeted groups.
- Complete Form 8850.
- Submit the form to your local state agency within 28 days of the new employee’s start date.
Once the state agency confirms eligibility, you can claim the credit on your next tax return.
Small Employer Health Insurance Credit
The Small Employer Health Insurance Credit can help small businesses offset the costs of providing health insurance to their employees. This credit is worth up to 50% of the premiums you paid during the year.
To Qualify:
- Have fewer than 25 full-time equivalent employees.
- Pay average wages of less than $62,000 per year per full-time equivalent in 2023.
- Purchase group health insurance through the Small Business Health Options Program Marketplace.
- Pay at least 50% of the cost of employee-only coverage for each employee.
This credit can be claimed for two consecutive tax years.
Clean Energy Credits
The Clean Energy Credits were part of the federal Inflation Reduction Act, offering nearly $400 billion in available credits. These credits aim to offset the costs of adopting green energy solutions, such as purchasing electric or hybrid vehicles for your business.
Examples of Qualifying Expenses:
- Electric or hybrid clean vehicles
- Solar panels
- Energy-efficient building improvements
These credits not only help reduce your tax burden but also contribute to a more sustainable business model.
By leveraging these tax credits, you can significantly reduce your tax liability and reinvest those savings back into your business.
Next, let’s explore how retirement savings plans can further benefit your small business.
Retirement Savings Plans
Setting up a retirement savings plan can be a smart move for both you and your employees. These plans not only help secure financial futures but also offer significant tax benefits. Here’s a closer look at some popular options:
SIMPLE IRA, SEP IRA, 401(k), and Profit-Sharing Plans
SIMPLE IRA (Savings Incentive Match Plan for Employees)
- Eligibility: Small businesses with 100 or fewer employees.
- Contribution Limits (2023): Employees can contribute up to $15,500, with an additional $3,500 catch-up contribution for those 50 and older. Employers must either match up to 3% of employee contributions or contribute 2% of compensation for all eligible employees.
- Benefits: Easy to set up and administer. Contributions are tax-deductible.
SEP IRA (Simplified Employee Pension)
- Eligibility: Any business, large or small.
- Contribution Limits (2023): The lesser of 25% of compensation or $66,000. Contributions are made solely by the employer.
- Benefits: High contribution limits and flexibility in funding. Ideal for self-employed individuals and small businesses.
401(k) Plans
- Eligibility: Any business.
- Contribution Limits (2023): Employees can defer up to $22,500, with an additional $7,500 for those 50 and older. Employers can also make contributions, with total contributions (employee and employer) not exceeding $66,000.
- Types: Traditional 401(k) and Roth 401(k). Contributions to a Traditional 401(k) are tax-deferred, while Roth 401(k) contributions are made with after-tax dollars but grow tax-free.
- Benefits: High contribution limits and potential employer matching.
Profit-Sharing Plans
- Eligibility: Any business.
- Contribution Limits (2023): Contributions are discretionary and can be up to 25% of compensation or $66,000.
- Benefits: Flexibility in contributions, which can vary based on the company’s profitability each year.
Contribution Limits and Deadlines
Understanding contribution limits and deadlines is crucial for maximizing tax benefits:
- Annual Contribution Limits: Each plan has specific limits. For instance, the 401(k) limit is $22,500 for 2023, with a catch-up contribution of $7,500 for those aged 50 and older.
- Deadlines: Contributions to SEP IRAs and profit-sharing plans can be made up until the tax filing deadline, including extensions. SIMPLE IRA and 401(k) contributions generally need to be made by the end of the calendar year.
Tax Credits for Retirement Plans
Small businesses may qualify for tax credits when setting up new retirement plans:
- Retirement Plans Startup Costs Tax Credit: Businesses with 100 or fewer employees can claim a credit of up to 50% of the costs to set up and administer a new retirement plan, up to a maximum of $5,000 per year, for the first three years.
- Employer Contributions: Contributions made by the employer to employee retirement accounts are tax-deductible, reducing the overall taxable income of the business.
By investing in retirement plans, you not only help your employees save for the future but also take advantage of valuable tax deductions and credits.
Next, we’ll look into how equipment and real estate deductions can further optimize your tax savings.
Equipment and Real Estate Deductions
Investing in your business equipment and property can lead to significant tax savings. Here’s how you can maximize those savings through Section 179 deduction, bonus depreciation, and green energy tax credits.
Section 179 Deduction
The Section 179 deduction allows small businesses to deduct the full cost of qualifying equipment and software purchased or financed during the tax year. This is a powerful tool to reduce your taxable income, especially if you need to make substantial investments in your business.
Key Points:
- Deduction Limit (2023): Up to $1,160,000.
- Phase-Out Threshold: Begins at $2.89 million and completely phases out at $4.05 million.
- Qualifying Equipment: Includes machinery, vehicles, computers, office furniture, and more. The equipment must be used for business purposes more than 50% of the time.
Example: If you buy a piece of equipment for $100,000, you can deduct the full $100,000 under Section 179, reducing your taxable income by the same amount.
Bonus Depreciation
Bonus depreciation is another way to write off the cost of qualifying assets. Unlike Section 179, it can be used for both new and used equipment. This deduction is particularly useful if you exceed the Section 179 spending cap.
Key Points:
- Depreciation Rate (2023): 80% of the cost of qualifying property.
- Future Rates: The rate will drop to 60% in 2024, so consider making purchases sooner rather than later.
- Qualifying Property: Includes machinery, equipment, certain vehicles, and improvements to non-residential property.
Example: If you purchase qualifying equipment for $50,000, you can immediately deduct $40,000 (80% of $50,000) in the first year.
Green Energy Tax Credits
The federal Inflation Reduction Act offers various clean energy tax credits to encourage businesses to adopt sustainable practices. These credits can significantly lower your tax bill while promoting eco-friendly improvements.
Key Points:
- Electric Vehicles: Tax credits for buying new or used electric or hybrid vehicles.
- Energy-Efficient Property: Tax credits for installing solar panels, wind turbines, or other renewable energy sources.
- Restrictions: Check with your tax advisor for specific eligibility requirements and limitations.
Example: Installing solar panels on your business property could qualify you for a tax credit that covers a portion of the installation costs, reducing your overall tax liability.
By leveraging these deductions and credits, you can reduce your tax burden while investing in the growth and sustainability of your business.
Next, we’ll explore how hiring family members can offer additional tax benefits.
Hire Family Members
Hiring family members can be a smart tax-saving strategy for small business owners. Here’s how it works:
Lower Marginal Tax Rate
When you hire a family member, such as a spouse or your children, their income may be taxed at a lower marginal rate compared to your own. This can result in overall tax savings for the family unit.
Example: If you pay your child $12,000 a year, that income might be taxed at a lower rate than if you kept that money as business profit. Plus, your child can use that income to contribute to a Roth IRA, setting them up for future financial success.
FUTA Exemption
The Federal Unemployment Tax Act (FUTA) requires businesses to pay unemployment taxes on wages paid to employees. However, wages paid to your spouse or children under 21 are exempt from FUTA. This can save you money directly on your tax bill.
Example: If you pay your spouse $30,000 a year, you won’t have to pay FUTA taxes on those wages, reducing your overall tax burden.
Business Purposes
It’s important to ensure that the family members you hire are actually performing legitimate work for your business. The IRS requires that the wages paid must be reasonable and the work performed must be necessary for the business.
Example: If you run a small retail store, hiring your teenager to manage social media or help with inventory can be a legitimate business expense. Just make sure to keep detailed records of their work and compensation.
By hiring family members, you can take advantage of lower marginal tax rates and FUTA exemptions, all while keeping the money within your family. Make sure to consult with a tax professional to ensure compliance with IRS regulations.
Next, we’ll discuss how tracking business losses can further reduce your taxable income.
Track Business Losses
Tracking business losses is a crucial tax saving strategy for small business owners. Properly documenting your losses can significantly reduce your taxable income, and here’s how:
Deductible Losses
When your business incurs a loss, you can often deduct it from your taxable income. This means if your business spends more money than it earns, the IRS allows you to use those losses to offset other income. This can lower your overall tax bill.
Example: If your business had a net operating loss (NOL) of $10,000 in 2023, you could potentially deduct that amount from your other income, reducing your taxable income for the year.
Taxable Income Reduction
By deducting your business losses, you effectively lower your adjusted gross income (AGI). A lower AGI can mean fewer taxes owed and can also help you qualify for other tax credits and deductions.
Example: Suppose your AGI is $100,000, and you have $20,000 in deductible business losses. Your new AGI would be $80,000, potentially putting you in a lower tax bracket and reducing your overall tax liability.
Types of Deductible Losses
Here are some common types of losses you can track and deduct:
- Capital Losses: If you sell a business asset at a loss, you can deduct the capital loss from your capital gains. If your losses exceed your gains, you can deduct up to $3,000 against other income.
- Bad Debts: If you’ve lent money to a client or supplier and can’t collect it, you may be able to deduct it as a business bad debt.
- Casualty and Theft Losses: If your business property is damaged or stolen, you can deduct the loss, provided you meet certain IRS requirements.
Carryover Deductions
Some losses can be carried over to future tax years if you can’t use them all in the current year. This ensures you don’t miss out on valuable deductions.
Example: If you have a net operating loss of $50,000 but can only use $30,000 this year, you can carry over the remaining $20,000 to deduct in future years.
Case Study: A small business owner named Alex experienced a significant loss due to a natural disaster. By carefully documenting and deducting these losses, Alex was able to reduce his taxable income for that year and carry over some of the losses to offset future income, saving thousands in taxes over the next few years.
Keep Detailed Records
To take full advantage of these deductions, maintain thorough records. Use software to track receipts and losses accurately. This not only helps at tax time but also ensures you’re ready if the IRS questions your deductions.
Tip: Investing in receipt tracking software can save you hours and help you catch every deductible expense. As Nick Drewe from Wethrift suggests, “Catching every single deductible expense is the key to saving money.”
By diligently tracking and deducting your business losses, you can significantly reduce your taxable income and save money on your taxes.
Next, we’ll discuss the importance of keeping organized records to maximize your tax savings.
Keep Organized Records
Keeping organized records is essential for tax saving strategies for small business owners. Proper documentation not only makes tax filing easier but also helps you maximize deductions and credits. Here’s how to do it effectively:
Dedicated File System
Whether you prefer digital or physical records, having a dedicated file system is crucial. Use a standardized organization method—alphabetize, assign client codes, or sort chronologically. The key is to keep it simple and consistent.
Example: If you’re using digital files, create folders for each client or project and subfolders for different types of documents like invoices, receipts, and contracts.
Pro Tip: Invest in accounting software that can automate this process. It can save you time and reduce the risk of errors.
Document Retention Policy
Federal, state, and local laws dictate how long you need to keep certain documents. For example, the IRS recommends keeping tax records for at least three years, but some records might need to be kept longer.
Action Step: Research the specific retention requirements for your region and industry. Create a policy that outlines how long each type of document should be kept and when it can be disposed of.
Case Study: Jane, a small business owner, avoided penalties by keeping her employee records for the required period. Her organized system made it easy to produce documents during a state audit.
Receipt Tracking Software
Keeping all receipts is crucial for claiming deductions. Categorize them by date and type for easy reference. Using receipt tracking software can make this process much simpler.
Benefits:
- Time-saving: Quickly scan and categorize receipts.
- Accuracy: Reduce the risk of missing deductions.
- Security: Keep digital copies safe from physical damage.
Example: John, who runs a small consulting firm, uses receipt tracking software to scan and categorize all his business expenses. At tax time, he simply exports the data to his accountant, saving hours of manual work.
Tip: Look for software that integrates with your accounting system to streamline the workflow.
Backup Digital Files
Files can be lost due to computer crashes or other unforeseen events. Always back up your digital files in at least two separate locations, like a hard drive and the Cloud.
Pro Tip: Use a system that automatically backs up your files. This ensures you won’t lose important documents and can access them anytime.
Expert Quote: As Nick Drewe from Wethrift suggests, “Catching every single deductible expense is the key to saving money.” Backing up files ensures you have all necessary documents to claim these deductions.
Secure Your Records
Some records, like employee medical files, need to be kept secure due to privacy laws. Even if your records aren’t under special protection, it’s good practice to keep sensitive files locked up and away from prying eyes.
Action Step: Invest in secure storage solutions for physical records and use encryption for digital files.
Example: A small business owner uses a locked filing cabinet for sensitive documents and encrypted cloud storage for digital files, ensuring compliance and security.
By keeping organized records, you can streamline your tax filing process, ensure compliance, and maximize your tax savings.
Next, we’ll dig into how to maximize your tax deductions to further boost your savings.
Frequently Asked Questions about Tax Saving Strategies for Small Business Owners
What are the best tax-saving strategies for small businesses?
Choosing the right business structure: Your business structure—whether it’s a sole proprietorship, LLC, S corporation, or C corporation—can significantly impact your taxes. For example, LLCs and S corporations offer pass-through taxation, which can be beneficial for some business owners. Consult with a tax professional to determine the best structure for your business.
Maximizing tax deductions: Take advantage of deductions like home office expenses, travel and entertainment costs, and professional fees. For instance, if you use part of your home for business, you can deduct a portion of your mortgage, utilities, and property taxes.
Utilizing tax credits: Look into credits like the Work Opportunity Tax Credit (WOTC) for hiring employees from targeted groups, or the Small Employer Health Insurance Credit if you provide health coverage to your employees.
Retirement savings plans: Contributing to retirement plans like a SIMPLE IRA or SEP IRA can provide significant tax benefits. These contributions are often tax-deductible, reducing your taxable income.
Hiring family members: Employing family members can offer tax advantages. For example, wages paid to children under 18 are not subject to Social Security and Medicare taxes if your business is a sole proprietorship.
How can an LLC reduce taxable income?
Qualified Business Income (QBI) deduction: LLCs can benefit from the QBI deduction, which allows eligible business owners to deduct up to 20% of their qualified business income. However, this deduction has specific rules and income limits, especially for specified service trades or businesses (SSTBs) like law firms and consulting firms.
Business expense deductions: LLCs can deduct various business expenses such as rent, utilities, and employee wages. These deductions lower the overall taxable income of the business.
Retirement contributions: LLC owners can set up retirement plans like a SEP IRA or 401(k). Contributions to these plans are tax-deductible, reducing the business’s taxable income.
Depreciation: LLCs can use Section 179 deduction and bonus depreciation to deduct the cost of qualifying equipment and property. This can be particularly beneficial for new businesses investing in significant assets.
How to pay the least amount of taxes as a small business owner?
Keep detailed records: Organized records are crucial for claiming all possible deductions and credits. Use accounting software and receipt tracking tools to ensure you don’t miss any deductible expenses.
Plan your income and expenses: Timing your income and expenses can help manage your tax liability. For example, if you expect to be in a higher tax bracket next year, you might defer income or accelerate expenses to the current year.
Take advantage of tax credits: Credits directly reduce your tax bill, so make sure you’re aware of all the credits you qualify for, such as the Work Opportunity Tax Credit or clean energy credits.
Hire a reputable CPA: A certified public accountant can help you steer the complexities of the tax code, identify deductions and credits you might have missed, and ensure you’re compliant with all tax laws.
Use retirement plans: Contributing to retirement plans can provide significant tax savings. Not only do these contributions reduce your taxable income, but they also help you save for the future.
By leveraging these tax saving strategies for small business owners, you can minimize your tax burden and keep more money in your pocket.
Next, we’ll dig into how to maximize your tax deductions to further boost your savings.
Conclusion
Navigating the complexities of tax planning can be overwhelming for small business owners. However, with the right strategies and support, you can significantly reduce your tax burden and maximize your savings.
At Versed Entrepreneur, we provide comprehensive resources and insights to help you develop effective business strategies, including tax planning. Our goal is to empower you with the knowledge and tools you need to make informed decisions that benefit your business in the long run.
Consult a Tax Advisor: One of the most crucial steps in your tax planning journey is consulting with a qualified tax advisor. They can help you understand the specific tax laws and regulations that apply to your business, identify potential deductions and credits, and ensure compliance with all tax requirements. A good tax advisor can also help you plan for the future, making sure you are prepared for any changes in tax laws.
Adopt a Long-Term Strategy: Tax planning is not just a one-time task; it’s an ongoing process that should be integrated into your overall business strategy. By regularly reviewing your financials, staying updated on tax law changes, and making strategic business decisions, you can continue to optimize your tax situation year after year.
The key to successful tax planning is to be proactive and informed. Whether you’re maximizing deductions, utilizing tax credits, or planning for retirement, every step you take can contribute to a healthier financial future for your business.
For more insights on business strategies and tax planning, visit our Running a Business page. We are here to support you in every aspect of your entrepreneurial journey.
By leveraging these tax saving strategies for small business owners, you can ensure your business thrives financially while remaining compliant with tax laws.
Stay proactive, stay informed, and let Versed Entrepreneur guide you to success.
