Small business taxes can be confusing and, as a small business owner, you likely have several questions: How much do I pay? Why do I have to pay this amount?
If you’re looking for the best ways to reduce taxable income, keep reading.
How to Lower Business Taxes
Unfortunately, many small business owners overpay on their taxes by missing out on certain deductions or managing their businesses and retirement savings in a way that is not efficient for tax purposes. Considering that the U.S. tax code is roughly 70,000 pages long, it’s understandable why small business owners and even accountants have trouble navigating it.
There are many complexities to deal with when trying to minimize your tax bill. But, with the right strategies, you can save money on taxes while making your life easier during tax season.
So, what are some ways to lower taxable income? Here are some of the best tax strategies for small businesses.
1. Keep an Eye on Adjusted Gross Income
Many tax breaks, limitations and additional taxes tee off of adjusted gross income (AGI) or modified adjusted gross income (MAGI). For example, you’ll avoid the 0.9% additional Medicare tax on earned income if your AGI does not exceed $200,000 (single) or $250,000 (married filing jointly). Despite other tax cuts that were part of the Tax Cuts and Jobs Act of 2017, this tax, which was intended to help pay for Obamacare, is still in effect.
2. Reimburse Using an Accountable Plan
You may need to reimburse employees for:
However, before you do so, you’ll want to make sure you use a reimbursement plan that meets the IRS requirements. This 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 lowering taxable income overall.
Also, if your company does not already offer an accountable plan for employee reimbursement, your employees will likely soon be asking you for one. Under the new tax law, employees cannot deduct miscellaneous unreimbursed employee expenses. Giving your employees an accountable plan for reimbursements can help your employees save money on taxes, as well as helping the business. It’s a win-win.
3. Make Smart Tax Elections
There are several ways to reduce taxable income by being strategic about your business expenditures. For example, you are allowed to deduct the cost of acquiring machinery and equipment in full, upfront, up to a set dollar amount. In 2018 that expensing cap increased to $1 million per the new tax law.
However, if your business is just starting up or is not yet profitable, you can ask your accountant about depreciation for these items. It might be better for your overall tax situation if you can spread out the value of the purchases across your future tax years instead of deducting the full purchase price all at once. 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 (currently 58 cents per mile)
- Deducting vehicle expenses based on actual costs or the IRS mileage allowance. Beginning in January 2019, it became 58 cents per mile.
- Deducting home office expenses based on actual costs or the IRS simplified rate. The current standard deduction is $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.
Another method for how to save tax is that 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:
- General Liability Insurance
- Workers’ Compensation Insurance
- Commercial Auto Insurance
- Business Interruption Insurance
Because unscrupulous people sometimes form small businesses as a fraudulent means to cheat on taxes, the IRS has begun to more heavily scrutinize small business filings to make sure the companies are legitimate businesses, and not just tax shelters. Small businesses that are registered as the following should consider seeking professional assistance in learning what insurance premiums can be deducted as legitimate business expenses:
- 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 and carryovers are a way to reduce taxable income. Keep track of carryovers so that you won’t forget 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 (limited to 80% of taxable income)
5. Use Tax-Free Ways to Extract Income
Salary, bonuses, and distributions of your share of business profits are taxable. However, there are ways in which you can possibly benefit from your business’s success without triggering the tax. Consider talking to your accountant about:
- Tax-free fringe benefits, including medical coverage, health savings accounts, and retirement plans.
- Loans by the business to you on a no- or low-interest basis. If the loan interest is below IRS-set rates (also known as Applicable Federal Rates), the business may have to report interest from this arrangement. But with interest rates low, this isn’t too costly these days.
Learn more about tax avoidance strategies for small businesses and the types of income that are tax-free.
6. Consider Abandoning vs Selling Property
If the 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.
7. Use Fringe Employee Benefits Plans
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. Tax-exempt benefits you can consider offering your employees include:
- Employer-sponsored health insurance
- Long-term care insurance
- Group term life insurance
- Disability insurance
- Educational assistance
- Dependent care assistance
- Transportation benefits
- Meals provided for employee convenience
More details on the tax benefits of fringe benefits plans are available in IRS Publication 15-B (2019), Employer’s Tax Guide to Fringe Benefits.
8. Shelter Profits in Retirement Plans
It’s actually quite easy to set up a simple small business retirement plan for your employees. An employer-sponsored 401(k) or a similar tax-deferred retirement plan will allow employees to make tax-deductible contributions to save for their future. With a tax-deferred retirement plan like a 401(k) or traditional IRA, the employee doesn’t pay taxes currently on contributions to retirement plans. Instead, the retirement savings funds grow on a tax-deferred basis. This means distributions are taxable when taken in the future (when the employee 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 while giving them choice and flexibility in planning for retirement. Many small businesses prefer this over a defined benefit pension plan where more of the burdens are on the employer.
Also, setting up a retirement plan is not just good for employees — it’s good for your company. That’s because employer contributions to an employee retirement plan are tax-deductible and you might qualify for a tax credit for setting up your employee retirement plan.
9. Do Year-End Planning
While tax planning is a year-round activity, you can achieve dramatic savings by taking action at the end of the year. There are several strategies that can help you lower your taxable income just before the end of the year.
- Delay billing for unpaid work until payment is received. If your business uses cash basis accounting, you can delay billing for work done at the end of the year until payment is received in the following year. This lowers your tax liability in the current year. Just don’t defer income if you are having a cash shortfall or have concerns about the customer’s ability to pay.
- Purchase fixed assets and claim immediate depreciation. You can lower taxable income in the current year by claiming a portion of depreciation on recently purchased fixed assets. It is also important to revalue your assets that are listed in your books. This can help lower your net profit as you increase claimed depreciation. If an asset has no use or value, ask your accountant if you could delete it.
- Write off bad debt. If you have an account receivable with a customer who is unlikely to pay, then you might be able to write this off as an uncollectible debt. This is known as a Bad Debt Deduction. It will be considered a loss and will allow you to lower your profits and taxes. However, to qualify for this deduction, you must have previously included the bad debt in your business income. You must also have intended the transaction to be a loan, such as a loan to clients and suppliers, credit sales to customers, or business-loan guarantees.
- File and submit your taxes on time. When it comes to end-of-year planning, it’s best to have your taxes filed and submitted on time. There are separate penalties that apply for late filing and for late payment, so you should file on time even if you’ll need more time to pay.
Even if “last year” is over, you can still make some tax moves within the first quarter of the new year to help save money on “last year’s” taxes.
10. Restructure Your Business
Wondering how to decrease taxable income as a sole proprietorship or partnership? It may be time to pick a new business structure. Many small business owners choose to do business as an LLC (Limited Liability Company). Why? Because it’s considered a “pass-through entity” that offers significant flexibility for the tax treatment of your business income.
For example, an LLC can elect to be taxed as an S corporation. The business owner pays themselves a reasonable salary (which is subject to FICA taxes just like any employee’s salary). Then the rest of the LLC’s income passes through as a “distribution” of business income that is not subject to FICA taxes. Operating as an LLC and filing taxes as an S corporation can help you save significant money at tax time. It would help you avoid owing self-employment tax on a large portion of your income.
If no such election is made and the LLC does not pay taxes as an S corporation then the LLC owner has to pay self-employment tax on all the business’s net earnings. This is the equivalent of the employer’s and employee’s share of FICA. For example, say the LLC has profits of $250,000 and it would be reasonable to pay the owner a salary of $100,000. 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. This can add up to thousands of dollars in tax savings.
As of the 2018 tax year, one other advantage to structuring your business as a pass-through entity began. Owners of LLCs and other pass-through entities are now able to deduct 20% of their business income on their individual tax returns.
There will be some limitations and exceptions to this pass-through deduction. For example, the deduction is phased out for owners of service businesses with a taxable income of $315,000 or more for married filing jointly/$157,500 for single filers.
There are some additional complexities to the pass-through deduction depending on what type of business you operate. For example, the maximum deduction depends on your company’s total wages and capital investment. So be sure to talk with your accountant about what the new tax law means for you.
Final Thoughts on How to Reduce Taxable Income for Small Businesses
When it comes to how companies save tax, 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 small business tax strategies. The moves you make now can potentially save you significant amounts of money this year and into the future.
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I can understand how a business could really benefit from getting the right tax advice in order to be better with their financials. Getting some help from a professional could help them plan for the future better. It was interesting to learn about how carryovers can reduce taxable income but deductions and limitations can’t be used in the current year.
Thanks for the comment, Adam! Glad you enjoyed the article.
I can understand how a business could really benefit from understanding their taxes, and help them be more effective with their finances. Getting some help from a professional to represent them when facing the IRS could be really useful. It was interesting to learn about how they are increasing profitability, so the 35% bracket will have businesses that are in the 15% bracket.
Thanks for sharing, Adam! Glad you enjoyed the article.
Can you help with forming a LLC by non-US resident and provide accounting services for it?
Response from Gene Marks: Best place to go is a legal site like legalzoom.com or nolo.com – there are others too that you can Google. You’ll have to pick a state and depending on that state visit the state’s local CPA society and ask for a referral.
It stood out to me when you explained how selective and strategic expenditures can help reduce the amount of taxable income for small businesses. According to my knowledge, it can also be beneficial to meet with a professional tax relief service to learn about strategies that could increase profitability. I enjoyed reading your article and learning more about the effects of taxable income, so thanks for sharing!
Thanks for sharing this amazing guide!
I am individual contractor… How do I reduce self-employment taxes?
The taxes seem very high. I am 71 years old. Do I still have to pay into ss and medicare?
The article says it is updated but still refers to this year as 2017 and 2018. A more thorough read through and update is needed. Thanks so much for this article!
When I saw the mileage reimbursement listed I went back to see when the article was written. It says it was revised 8/19, however, the person revising missed the mileage reimbursement. It is not 53.5 it is 58 cents per mile now.
I appreciate you publishing these articles, keep it up and make sure they are up to date.
Thank you, Kim! The mileage reimbursement has been updated for 2019 standards.
The article shows it was updated in 2019, so the Standard Mileage Rate should show as $.58 per mile. Also, consider a C-Corp as your business entity form. Corporate tax rates have decreased and if you sell the business you may qualify to excluded 100% of the capital gain if you meet the standards of Section 1202 for Qualified Small Business Stock (QSBS).
Thank you for bringing this to our attention. The correct Standard Mileage Rate for 2019 has been added.
Everything you need to know about forming an S-Corp can be found here:
I agree with your accountant. The IRS looks hard at what’s a reasonable salary and excessive distributions from an S-Corp may raise red flags.
Professionals like doctors, lawyers, engineer, chiropractors, and others that in the past were required to be a professional corporation if they incorporated as a regular C. That meant on the very first dollar of profit they were taxed at the highest corporate bracket. Of course that was very expensive and many of these professionals chose instead to get taxed as an S or an LLC flow through. But, the 2018 Corporation Professional Tax Savings Act (not the real name) put into effect January 1 2018 now allows those professionals and corporations to choose to be taxed at a significantly lower flat tax bracket for their entity at 21%.
Many of these same people could not qualify for the other tax break for Section 199A Deduction because that is fazed out completely with earnings over $207,500 as a single and $415,000 as a couple.
So many people who are making real money are confused about above.
Think about the ramifications of saving money to further business expansion, to buy machinery or have non deductible expenses such as life insurance disability insurance, etc. It is a lot less expensive to afford and save at 21% as opposed to 37+ for the highest income earner. Many a business owner as well as the accounting industry will then warn the object about double taxation when they sell or distribute money. Many times that business owner will not sell for many years but in the mean time save a much as 16% on taxes. That is a big number.
Often these same businesses have different streams of income so that it may not be a all or none proposition of having an entity taxed as a corporation. For example the attorney who does their own law but has a number of attorneys working for them. They could choose based on the income of maybe separating that income to 2 different companies and take advantage of the deductible expenses in the highest bracket and savings and non deductible expenses from the LLC or other entity.
So talk to your CPA and have what if scenarios of income and tax planning. You may be surprised.
Of course there are different circumstances for different owners so the decision may not be as simple as stated above. However if one does not inquire they can’t go back to the IRS 5 years later and ask to change their taxes.
Somethings to keep in mind if LLC is taxed as an S Corp:
1) Mass Annual Corp report is $500 per year for LLCs and
2) Mass has a minimum tax due from S Corps of $456
Even if no income both would be due annually.
A separate tax return is due for an S Corp vs just a Schedule C for sole member LLC.
Also, if changing from an LLC to an S vehicles owned by the LLC may be charged sales tax on the transfer to S Corp.
Just a few more items to consider with change of entity type.
Good work Keep it.Thanks
Thanks so much for this great post.
I have an S corp and I may make a donation to a 501c. The donation has an appraised value of 20k. I was told the law is changing and donations to 501c’s will not be deductable. Is this true and also if it is not true is there a limit on how much you can donate ?
I really appreciate this article. I will be looking forward to become an LLC with S election. I think I still need to do more research. Thank you.
This is an excellent, comprehensive guide that should be read by ALL small business people. Great! 🙂
According to my accountant, Distributions from an S corp. should not exceed the value of the paid salary, in other words a 50/50 split, or else the IRS may not deem the lower salary “reasonable”, and therefore risk IRS penalties.
All true and we’ll written!
Used some of these and they worked for my small business.
Thanks for the article, appreciated.
Thanks for your great tips. I’d like to have information for a S corp please.
Do you provide information for those of us who have a S Corp? I have an online eCommerce hair business and would appreciate some tips from you to put me in a better position.
Thanks so much.
Just one correction – the 2018 standard mileage allowance is .545 per mile, up one cent from the .535 allowance from 2017.
Terrific. Concise, well clarified,user friendly and easily applicable.
Thanks for the tax tips,especially about splitting my income threw LLC,and S-Corp,I Will be utilizing this tip going forward.
Being the president of a small S corporation for the last 45 years, I am continually looking for ways to minimize my taxes. The “10 Ways to Lower Taxes for Small Business Owners” has offered me many great methods for me to hold on to more of my money.
What I took from this: keep AGI under 200k, reimburse within an accountable plan, fringe benefits and loans to self by company, employee fringe benefits in place of raises, retirement plans to shelter profit, delay billing at end of year, buy fixed assets and claim depreciation, pay yourself something with an S-corp election.
Thank you for the good start.
thank you for the information. It was short but sweet. Accounting to me is sooooo boring and it is necessary for my small business. Thanks again.