[This article has been updated to reflect the new tax law that went into effect on January 1, 2018]
One of the responsibilities of running a business is attending to taxes. Most small business owners don’t love paying taxes, but it’s part of life. And one nice thing about being a small business owner is that there are a few tax advantages that can help you keep more of your profits if you make the right moves during the year (or at tax time).
Admittedly, managing taxes isn’t always easy. Here are the five top tax concerns of small business owners and what you can do about them:
1. Having the Money to Pay Taxes Due
The price of success is higher taxes. And, in recent years, there have been a number of new taxes, limitations, and higher rates that apply to so-called “high income taxpayers.” The challenge for small business owners who’ve been profitable is having the cash available to pay the tax bill. The vast majority of small businesses are S corporations, partnerships, limited liability companies, or sole proprietorships; owners report their share of business profits on their personal returns and pay their own taxes.
What to do: S corporation shareholders can avoid paying estimated taxes by adjusting the income tax withholding on their salary to cover their projected tax bill for the year.
But for everyone else, who are obligated to make estimated payments, make sure to pay sufficient estimated taxes throughout the year to avoid penalties. Your accountant can help you figure out how to calculate your estimated payments and pay them on time at the end of each quarter. The quarterly estimated tax payment due dates are April 15, June 15, September 15, and January 15 of the following year.
For simplicity, you can peg this year’s estimated taxes to last year’s tax bill. So long as you pay this year 100% of your tax bill for last year (or 110% if your adjusted gross income last year was $150,000 or more, or $75,000 if married filing separately), you won’t owe any penalty, even if you’re more profitable this year than last year and you still owe money when you file your return.
The real challenge, of course, is having enough available cash on hand to pay estimated taxes. This requires you to set aside funds needed for tax payments; it may help to set up a separate bank account for this purpose. Talk to your accountant about what fixed percentage of your revenue should be saved for estimated tax payments — it’s always better to save “too much” for taxes and have money left over at the end of the year than it is to be scrambling at the last minute to find extra cash to pay the tax bill.
2. Keeping Required Records
You must have good records to know what items are deductible, and you will need these records to back you up in case the IRS questions your return. In some instances, such as with travel and entertainment expenses, the tax law specifically denies any deduction without proper records.
What to do: Create a recordkeeping system to track business expenses. Retain paper receipts, invoices, credit card statements, etc. to help you prove that you’re entitled to any deductions you claim.
You can simplify some recordkeeping with apps for your smartphone or other mobile device. For example, there are apps that can be used to record the necessary information about travel and entertainment costs, as well as allowing you to take photos of receipts.
3. Missing out on Tax Saving Opportunities
The tax law changes annually — due to new legislation, court decisions, and IRS pronouncements. The Tax Cuts and Jobs Act of 2017 represents some of the most significant tax changes in more than 30 years — there are big changes that affect small business owners that can help you keep more of your profits. In order to optimize your tax savings, you have to know what’s new and which breaks apply to you.
What to do: Read up on the changes in the tax law, which took effect on Jan. 1, 2018, so you can plan throughout the year to make business decisions that are strategically smart for tax purposes. Some of the biggest tax changes for small business owners include:
- 20% tax deduction for business income of pass-through entities. If you’re doing business as an LLC, partnership, S corporation or sole proprietorship (which most small businesses are), that means your business is considered a “pass-through entity” for tax purposes: The business itself does not pay taxes, and the business income “passes through” and is reported on the business owner’s personal income tax return. For example, if you operate as a sole proprietor, you can deduct 20% of your business income on your Schedule C. (Note that there is an exception: This deduction is not available for “specified service trades or businesses” with taxable income of more than $157,500 a year for single filers/$315,000 married filing jointly.)
- Lower corporate tax rates. If your business is a C corporation, your corporate tax rate just got reduced significantly — the corporate tax rate is reduced from 35% to 21%. Although most small businesses are not C corporations, this is a potential advantage to fast-growing startups that want to go public someday.
- Better bonus depreciation. The tax law revisions expand Section 168(k) of the tax code through 2022, which lets companies deduct 100% of the cost of qualified property purchased as a business expense.
There are lots of other details for small business owners in the fine print of the new tax law, but it pays to start now to figure out how your tax situation is likely to change. If you wait until you meet with your tax professional at tax time, it may be too late to take action that could benefit you tax-wise.
For example, if you’re profitable and want to set up a qualified retirement plan, the paperwork must be signed by the end of the year in most cases.
If it would help your tax situation to incorporate your business as a C corporation, you may want to start exploring that possibility now. Stay in touch with your tax professional throughout the year — it might be worth scheduling a midyear appointment to talk about new strategies to use under the tax laws as revised.
4. Dealing With Uncertainty
Business owners like to plan ahead, but many tax credits are set up by Congress to be “temporary,” and require new authorization every few years depending on the law. For example, the tax credit that encourages businesses to invest in research and development was created in 1981, and, even though it’s a popular tax credit, it has expired eight times (most recently on December 31, 2013) and been extended 14 times — and then, in 2015, this tax credit was finally made permanent. How can owners budget with tax breaks in mind?
What to do: Depending on the tax break involved, it may pay to delay action until the tax law is settled. For example, the Sec. 179 deduction for the purchase of equipment and machinery declined from a write-off of up to $500,000 in 2013 to $25,000 in 2014, which created uncertainty from year-to-year; but, as part of the Tax Cuts and Jobs Act of 2017, the situation with the Sec. 179 deduction is settled — and the final result is much more favorable for small businesses.
In other instances, you have to make plans that are tax-neutral. If you need equipment, make a business decision to buy it regardless of the tax breaks that may apply. Sometimes, of course, you need to invest in new equipment or new technology, regardless of the tax implications. But if you know the latest changes in the tax code that are relevant to your business, you can make smarter investments that boost your business profitability while also saving money on taxes.
5. Fearing an Audit
While the odds of being targeted by the IRS for review are very low, if you’re the unfortunate one selected, it can cost you significant time and money — even if you ultimately prevail by convincing the government that the tax positions on your return were correct. It takes time to gather the necessary records, such as paper receipts and online reports. It takes time to meet with a tax professional who will represent you. And it takes money to pay the professional for audit services.
What to do: While there’s no way to absolutely audit-proof your return, there are steps you can take to minimize an IRS audit:
- Report all business income unless the tax law lets you exclude it. Cash-intensive businesses attract greater IRS scrutiny and the government is hip to hidden income (see the IRS’s Audit Techniques Guide on cash intensive businesses).
- Work with a reputable tax professional; avoid anyone who makes unreasonable promises about refunds, who suggests hiding income, or who otherwise advises you to attempt questionable activities to evade your responsibilities. The IRS is hot on the trail of these unscrupulous tax advisors, and, if they get caught, their clients likely will be audited. Remember: You are ultimately responsible for what’s on your tax return, regardless of what professional advice you receive along the way.
While taxes are daunting because of their complexity and cost, the time you devote to dealing with them can pay off. You’ll likely end up with greater after-tax income and can be more confident that you’ve done your best to meet your tax responsibilities and minimize audit exposure. With the changes from the Tax Cuts and Jobs Act that took effect on Jan. 1, 2018, there are a number of new tax strategies that can help small business owners keep more of their profits. Hopefully, tax season can be a happier time of year for you and your business.