For many small business owners, tax consequences can mean the difference between having a profitable or unprofitable year. The last thing you want as a business owner is to pay more of your hard-earned income to Uncle Sam than is absolutely necessary. If you want to reduce your tax burden this year, the following tax saving strategies will help you do just that.
1. Don’t Put the Tax Cart Before the Business Horse
Effective tax reduction strategies can help business owners save a tremendous amount of money. However, fixation on tax issues can become detrimental when it leads to poor business decisions or less focus on a company’s core objectives. For example, incorporating a business in a state that offers attractive corporate tax rates only to discover that labor costs are twice the national average can do more damage than good. Decisions aimed at beneficial tax treatment must also be economically sound.
It is not uncommon for zealous business owners, in an attempt to generate qualified tax exempt distributions, to classify their equity contributions as loans to the business. While it is acceptable for business owners to make personal loans to the company, the transactions must be consistent and made in accordance with tax law. Any misguided tax deduction strategy could very easily result in an IRS audit and litigation. Tax saving plans and efficient tax deduction strategies should be structured and executed within the scope of a business’ core objectives with the help of an experienced tax professional.
2. Structure Your Business as an LLC
Small businesses often think of themselves as being too “small” to incorporate their business, but this could not be farther from the truth. Every business, large and small, must adopt a legal corporate structure that aligns with their business needs, objectives, and financial strategies. An LLC is designed to limit the owner’s personal liability for business debts, but a sole proprietorship offers less protection because no legal distinction is made between the owner and the business. Running a small business as an LLC can decrease self-employment tax and lead to a myriad of other tax benefits.
3. Invest in Retirement Plans
One of the most proactive tax savings strategies available to business owners today is investing in a retirement account. Unlike other investments, a retirement account allows taxpayers to claim a deduction without losing the money that is spent to qualify for the benefit. Typically, the money must be held in the account for a certain amount of time, but all of the earnings that build up in a retirement plan are tax-deferred until a distribution is taken.
4. Upgrade Equipment with IRC Section 179
Section 179 of the IRS tax code is an extremely valuable resource that allows businesses to deduct the full price of qualifying equipment or software purchased during the tax year up to $1,000,000. The value of personal property is usually depreciated over seven years, but IRC Section 179 makes it possible to deduct the full amount of business property in the same year it is purchased. It does not make sense to buy unnecessary equipment to qualify for this deduction, yet business owners with plans to make major purchases may want to speed up the process to take advantage of the
deduction this year.
5. Be Aware of Tax Law Changes
Signed into law in 2017 by President Donald Trump, the The Cut and Jobs Act (TCJA) reduces the corporate income tax rate from 35 to 21 percent. While this particular tax change is
favorable to the taxpayer, there are other tax changes that may be less favorable. With this in mind, it is imperative that business owners keep themselves informed of any new tax laws that may be enacted during the year. Understanding how these changes may affect a business is critical for professionals to make smart decisions and stay on top of their taxes.
6. Know What Qualifies for Bonus Depreciation
Bonus depreciation is a tax incentive that allows businesses to deduct a large percentage of the purchase price of eligible assets right away, instead of writing them off over the course of their useful life. Machinery and other qualified business property that is placed in service after September 27, 2017 and before January 1, 2023 now qualifies for a bonus depreciation percentage of 100 percent. In addition, new tax rules state that any vehicle which was put in service after December 31, 2017 is eligible for the maximum first-year auto depreciation allowance of $18,000, which is up from $10,000 in 2017.
7. Claim a Home Office Deduction
For home-based businesses, there is a home office deduction that can provide generous tax
savings regardless of whether the home is rented or owned. Depending on how much space the
office takes up, a percentage of general repairs and maintenance, utility bills, internet, and other expenses can be deducted. The IRS requires that any room claimed as an office space be used regularly and exclusively for occupational practices. For example, if children watch television in the same room that is used for an office, the space does not qualify for the home office deduction.
Furthermore, this deduction is only granted if the home is the principal location of the company. Keep in mind, however, business can be conducted outside of the home and still qualify for the deduction if the home office is the primary work space.
8. Take Advantage of IRC Section 170(e)(3)
For companies that sell any type of goods, Internal Revenue Code Section 170(e)(3)
is one of the best-kept secrets in corporate tax law, offering a considerable tax benefit to C corporations. This benefit can turn corporate liabilities, such as surplus inventory, into substantial assets in the form of a tax deduction. If every C corporation owner took advantage of it, Internal Revenue Code 170(e)(3) could transform the way corporate America disposes of unprofitable inventory. At the same time, the incentive could dramatically improve how nonprofit agencies assist those in need.
9. LLCs Can File as an S Corporation
A business structured as an LLC can file an S Corporation Tax Election (Form 2553) for major tax savings. This form instructs the IRS to tax an LLC as an S corporation, which can significantly lower the amount of income that is taxable. Even though many business owners are not aware of this option, the S Corporation Tax Election is one of the best strategies for tax savings.
If a business generated $120,000 in revenue this year – consisting of $90,000 in profits and $30,000 in expenses – a standard LLC tax arrangement requires that self-employment tax is paid on the total profit of $90,000. At a self-employment rate of approximately 15%, this amounts to $13,500 in taxes. On the other hand, business owners who file Form 2553 are only required to pay taxes on their salary. For example, if the owner’s salary is $50,000, he or she will pay $7,500 in taxes. The remaining $40,000 will be classified as a business distribution and will not be taxed.
10. Invest in Captive Insurance
Captive insurance is not only one of the most overlooked ways for business owners to save on taxes, but is also one of the best moves a company can make to protect its assets. To take advantage, companies create their own insurance, which is referred to as the “captive.” Premiums paid to the captive serve as a tax deduction for the company, but are not considered income. This allows for the indefinite deferral of earnings. The money will be taxed upon succession of the captive, but at lower dividend rates.
With this in mind, there are other products that may be more suitable for small businesses than captive insurance. Companies typically need to have earnings of at least $500,000 and revenue of at least $2,000,000 for a captive to make sense due to the compliance and tax work that is involved.
11. Look into IRC Section 199A
Section 199A is the most important change in the new tax law, yet most business owners are not even aware of it. The deduction is relevant to self-employed business owners, or to any other business that is structured as a pass-through entity. For those who qualify, a pension plan can be set up before the end of the year in an effort to reduce taxable income and take advantage of a 20-percent tax deduction. This strategy could lead to potential savings of over $100,000.
12. Stay Organized All Year
At the beginning of the year, many business owners are scrambling to get their books and receipts prepared for tax time. When professionals make it a priority to stay organized all year long, valuable time and energy can be saved. Clean books and detailed records make it easy for business owners to take advantage of all available tax incentives, reduce preparation costs, and avoid late filing penalties.
13. Hire Independent Contractors
Labor costs can be substantially reduced by hiring independent contractors instead of full-time employees. Independent contractors are available to work when they are needed, and can be let go when they are not. Compared to a full-time employee, a company’s legal and financial obligation to an independent contractor is very low. Self-employed workers can be excluded from: Social Security and Medicare taxes; medical, life, and disability insurance; company retirement plans; and vacation or holiday benefits. Business owners should look at the IRS website to become familiar with all of the legal requirements related to independent contractors.
14. Use an App to Track Business-Related Travel Expenses
Business-related driving expenses can be used for tax deductions, but it is important to note that the taxpayer is responsible for documenting these costs. One solution is to use an app
such as DriveDollar or Stride Tax, which can take a lot of the hassle out of calculating deductible travel expenses. These and other free apps track mileage and log receipts, keeping all relevant tax information organized in one place.
15. Know Which Deductions Apply to Your Business
Business owners should always be looking for strategies to minimize tax costs and for ways to take advantage of all the tax incentives that are made available by government agencies. Professionals who remain proactively aware of their company’s deductible operating expenses will be prepared to capitalize on these deductions when tax time rolls around. In addition, staying informed of which expenses are deductible will help business owners make smarter decisions throughout the year.
16. Reduce Taxable Income Through Retirement Plans
Taxable income can be reduced by contributions to a retirement plan, and these investments may allow companies to take advantage of tax benefits that they would not qualify for otherwise. For example, business owners who are close to or above the income bracket can pull back below the threshold by investing money in retirement plans. As a result, the company may qualify for the full 20-percent deduction on its qualified pass-through business income.
17. Take Advantage of IRC Section 1202
Business owners who are planning to sell a company after five to ten years of new stock ownership may want to consider taking advantage of the Section 1202 gain exclusion by converting the company to a C corporation. This incentive, also called the Small Business Stock Gains Exclusion, was developed to protect investors who risk their funds in new ventures and small businesses. Under this tax code, any gain from the sale of stock is exempt from federal income tax as long as the stock was held for more than five years and the business is a C corporation.
IRC Section 1202 was not designed exclusively for new companies. Partnership or S corporations can form a subsidiary that is a C corporation and contribute business assets to the corporation in exchange for stock. The new corporation stock will qualify for the gain exclusion if the business is maintained for an additional five years.
18. Real Estate Investors Should Own Rental Property
For those involved in house-flipping, it can be very beneficial to purchase small apartments for the business. The revenue will help to offset the taxes on profits with rental property tax deductions, and will also provide a steady cash flow that can keep the business stable during project delays or falling markets. Considering that these types of assets run parallel, any company in the real estate industry can invest in rental property without losing focus on core objectives.
19. File Taxes on Time
A simple solution for cutting down on taxes is to avoid penalties that are imposed on taxpayers for late payments, which begin to accrue the day after the tax filing due date. One recommendation is to file on time, regardless of whether the full payment can be made. IRS penalties vary among different types of business entities, and state taxing authorities use a similar approach. For example, C corporations are subject to a late filing penalty and a late payment penalty on any overdue taxes, while partnerships are subject to a late filing penalty based on the number of partners. S corporations are subject to a late filing penalty based on the number of shareholders, as well as a late payment penalty on any overdue taxes.
20. Deduct Auto Expenses
The use of a personal vehicle often qualifies for a tax break. The IRS allows employees and self-employed individuals to deduct a standard mileage rate, which is currently 54.5 cents per mile. To take advantage of this deduction, taxpayers must keep track of the number of miles that were driven strictly for work. For example, deductible mileage may include a visit to a client’s home or a business trip, yet may not include miles racked up on the daily office commute. In addition, interest on an auto loan, registration, or parking fees may also contribute to considerable tax savings.
21. Donate Unneeded Inventory
Extra inventory that is not being used can be donated for charitable tax deductions. Property, money, and supplies are all deductible, and donating large items such as equipment can spare the expense of storage. However, business owners should be aware that the IRS has stricter rules on the donation of goods that are valued over $500. Furthermore, the organization that receives the donations must qualify as being a nonprofit entity that is tax-exempt.
22. Hire a Tax Professional
Properly documenting expenses and staying organized from January to December will help business owners maximize tax savings, whether they file independently or with professional help. Hiring a tax professional should be strongly considered to ensure that returns are prepared and filed accurately. The fees charged by a professional are usually more reasonable than expected, and can heavily outweigh the expenses associated with a tax audit or overlooked deductions. Tax professionals also have the experience to pinpoint valuable tax credits that may go unnoticed by business owners who file on their own.
23. Track Medical and Charitable Miles
Many people do not realize that mileage accumulated for charity and medical purposes is tax deductible. Transportation expenses that are racked up during volunteer work, such as parking and tolls, are considered charitable donations and have a tax deduction rate of 14 cents per mile. This rate is significantly lower than the tax deduction associated with business-related travel, but the miles can really add up over time. It is important to consistently track all mileage driven for both business and personal purposes.
24. Create A Cash Flow Model
A cash flow model can be created to help business owners prepare for tax payments and deductions. Mapping a company’s cash flow, which is the net amount of cash and cash-equivalents coming and going from the business, will be a tremendous help at tax time. The model can also be used to forecast future cash flows and to inform smart investments that will help a business grow and thrive year after year.
25. Overpay Tax Estimates
Many sole proprietors have a history of working W-2 jobs, which means they are not accustomed to paying quarterly taxes. These individuals may forget that a self-employed paycheck also includes their tax money. As a result, sole proprietors often have a difficult time staying on top of their taxes and tend to fall into a vicious cycle of late fees. To avoid tax interest and penalties, small business owners must be careful not to underestimate their taxes throughout the year. One smart budgeting solution is to overpay quarterly taxes.
26. Deduct All Startup Costs
A tax deduction that is often overlooked by small business owners involves startup costs, which are financial investments that are made before the business completes its first profitable transaction. These costs may include legal work, logo design, site improvements, and other expenses. Startup costs can only be claimed after the first sale, but they can be deducted over 15 years. In addition, the first $5,000 can be deducted in the first year of business. It is commonly assumed that small business owners can deduct all of their startup costs right away when opening a new business, but these expenses cannot be claimed until after the first sale.
27. File Tax Returns Electronically
Filing taxes electronically is a good way to guarantee that tax returns will be received on time. Many tax software programs like TurboTax will file federal tax returns for free as long as the business has a tax ID number. For an additional fee, TurboTax will also file state returns. Another benefit of filing electronically is that the IRS immediately issues a confirmation number when a return is received, while the use of snail mail could lead to weeks of waiting for confirmation. Electronic tax returns are usually processed faster, allowing for anticipated refunds to be distributed much more quickly.