Taxes for small businesses can be confusing. How much do I pay? Why do I have to pay this amount? How can I reduce taxable income? First, you don’t have to pay more than the tax law requires. But, as Albert Einstein said, “the hardest thing to understand in the world is the income tax.” Finding ways to lower your taxable income legitimately and avoiding pitfalls are important activities that can have great returns: lower taxes for your small business.
Unfortunately, nine out of ten small business owners overpay on their taxes. Considering the US tax code is roughly 70,000 pages long, it’s understandable why small business owners and even accountants have trouble navigating it. Here are 10 ways to save money on your small business taxes.
1. Keep an Eye on Adjusted Gross Income
Many tax breaks, limitations, and additional taxes tee off on adjusted gross income (AGI) or modified adjusted gross income, which for most filers is the same as AGI. For example, you’ll avoid the 0.9% additional Medicare tax on earned income from a salary or self-employment if AGI does not exceed $200,000 if you’re single or $250,000 if you file a joint return with a spouse.
2. Use Accountable Plans
If you reimburse employees for travel, entertainment, tools, or other costs, consider doing so using a plan that meets IRS requirements, which is called an accountable plan. With this plan, the business deducts the expenses but does not report the reimbursements as income to employees, potentially saving the company employment taxes and overall lowering taxable income.
3. Make Smart Tax Elections
Even though the year has ended there are still ways to reduce your taxable income. It is possible to favorably impact taxes by making tax elections for optimum results. For example, you are allowed to deduct the cost of acquiring machinery and equipment in full up to a set dollar amount ($500,000 in 2017;). However, if you’re just starting up or are not profitable, you can ask your accountant about depreciation for these items. This can help produce deductions for future years when these assets may be more valuable to you. For example, if you are in the 15% tax bracket now but expect to be in the 35% bracket in the future due to increased profitability, a $10,000 deduction would have you currently saving only $1,500 in taxes; depreciation over five or seven years (depending on the type of item) would produce total savings in the 35% bracket of $3,500, or $2,000 more. Other options to ask your accountant about:
- Deducting vehicle expenses based on actual costs or the IRS mileage allowance (53.5 cents per mile in 2017)
- Deducting home office expenses based on actual costs or the IRS simplified rate ($5 per square foot up to 300 square feet of space)
- Claiming disaster losses on prior-year returns rather than on the return for the year in which the disaster occurs
In addition to claiming disaster losses, you can also consider deducting the business insurance expenses that you pay every year. IRS form 1040 can help you determine your business insurance deduction. The following is a list of different business insurance coverages that you can deduct:
- Liability insurance
- Workers’ compensation insurance
- Commercial auto insurance
- Business interruption service insurance
Because small businesses are sometimes formed as a means to cheat on taxes, the IRS has begun to more heavily scrutinize small business filings. Small businesses that are registered as the following should consider seeking professional assistance in learning what premiums can be deducted and are legitimate.
- Single person LLCs
- Sole proprietorships
- Separate entities
4. Don’t Overlook Carryovers
Certain deductions and credits have limitations that can prevent you from using them fully in the current year, but could permit a carryover to future years. Keep track of carryovers so you won’t to help keep you from forgetting to use them in future years (this is done automatically by most tax preparation programs and should be done by tax professionals you may use). Examples:
- Capital losses
- Charitable contribution deductions
- General business credits
- Home office deduction
- Net operating losses
5. Use Tax-Free Ways to Extract Income From Your Business
While salary, bonuses, and distributions of your share of business profits are taxable, there are ways in which you can possibly benefit from your business’ success without triggering tax. Consider talking to your accountant about:
- Tax-free fringe benefits, including medical coverage and retirement plans.
- Loans by the business to you on a no- or low-interest basis. If the interest is below IRS-set rates, the business may have to report interest from this arrangement, but with interest rates low, this isn’t too costly these days.
6. Benefits of Abandon Property Rather Than Selling It
If property has no value to the business, talk to your accountant about the benefits of abandoning it rather than selling it for a nominal amount. This could allow the business to take an ordinary loss on the property, which is fully deductible, rather than treating the loss as a capital loss, which is subject to limitations. Depending on the property, it may be classified as Section 1231 property, a loss on which may be ordinary or capital, depending on other Section 1231 transactions for the year and prior Section 1231 losses.
7. Use Fringe Benefit Plans for Employees
Additional wages trigger employment tax costs for the business, but if the business pays for certain fringe benefits for employees, these taxes can be avoided, which is another way to reduce your taxable income. Tax-exempt benefits you can consider offering your employees include:
- Health benefits
- Long-term care insurance
- Group term life insurance
- Disability insurance
- Educational assistance
- Dependent care assistance
- Transportation benefits
- Meals provided for employee convenience
8. Shelter Profits in Retirement Plans
It’s actually quite easy to set up a simple retirement plan for your employees. You don’t pay taxes currently on contributions to retirement plans. The funds grow on a tax-deferred basis; distributions are taxable when taken in the future (when you may be in a lower tax bracket).
There are several retirement plan choices. The one to use depends on your situation. Remember that if you have employees, the business must cover them on a nondiscriminatory basis (owners and management cannot be favored). But a plan such as a 401(k) shifts most or all of the cost of savings to employees.
9. Do Year-End Planning
While tax planning is a year-round activity, you can achieve dramatic savings by actions at the end of the year. For example, if your business is on the cash basis for accounting purposes, you can delay billing for work done late in the year so that payment will be received in the following year. This effectively lowers your business as profits defer tax on the cash you would be collecting for one year. Of course, tax planning should be sensitive to business realities; don’t defer income in this manner if you have concerns about the ability of a customer to pay. Be sure to speak with your accountant about this.
There are several other strategies that can help you lower your taxable income just before the end of the year. One strategy is to purchase fixed assets and claim a portion of depreciation immediately. It is also important to revalue your assets that are listed on your books. This can help lower your net profit as you increase depreciation claimed on the asset. If an asset has no use or is of no more value, ask your accountant if you should delete it.
If you have an account receivable with a customer who is unlikely to pay, then you can also write this off. It will be considered a loss and will allow you to lower your profits and taxes.
Lastly, when it comes the end of year planning, it’s best to have your taxes filed and submitted on time. According to IRS.gov: The penalty for filing late is normally 5% of the unpaid taxes for each month or part of the month that a tax return is late. The penalty starts accruing the day after the tax filing due date and will not exceed 25% of your unpaid taxes.
10. Change Your Business Structure
Whether you’re a sole proprietorship, limited liability company (LLC), or use some other business structure, it may be time to pick a new business structure. For example, an LLC can elect to be taxed as an S corporation. In this way, only salary paid to the LLC owner is subject to FICA taxes. If no such election is made, the LLC owner pays self-employment tax (the equivalent of the employer’s and employee’s share of FICA) on all the business’ net earnings. For example, say the LLC has profits of $250,000 and it would be reasonable to pay the owner a salary of $100,000 if an election to be taxed as an S corporation is made. Without an election, the owner pays self-employment tax on $250,000; with the election, the business and the owner each pay FICA only on $100,000.
You can reduce the amount of taxes you pay if you take advantage of breaks and opportunities that are out there. It’s up to you (and your tax advisor) to discover new ways to lower taxes for your small business!