[This article has been updated to reflect the new tax law that went into effect on January 1, 2018]
Are you overpaying your small business’s taxes? Many small business owners unwittingly overpay on tax bills every year. You’re probably wondering how to pay less taxes and you’re not the only one. One of the major reasons small business owners (including me) hate paying taxes is the mystery of it all.
The rules are complex.
The tax code is enormous.
The forms are onerous.
Even with the help of tax preparation software, most of us still aren’t entirely sure that we’re taking full advantage of the law.
“Isn’t there a loophole somewhere?” I frequently get asked.
“Isn’t there anything more to be done?” others plead.
“How to pay less taxes?” is the most common question I hear.
We hand our numbers over to our accountants, and they work their strange magic, and we trust that they know every conceivable way to save us money.
But the fact is that accountants don’t know it all. The code really is too complex and large. Most accountants have many clients and work by the billable hour. They are required by their state to get continuing professional education, but every hour not doing billable work is costly, so there’s less motivation to research, study, and learn all the nuances of the tax code.
Does that make you nervous that your accountant could be missing something big?
Don’t be. The fact is that, for most small businesses and individuals, even though the tax code is complicated, most tax returns are not. Unless you’re involved in some type of complex overseas deal (you’re probably not) or hiding money illegally (you’d better not be), the typical tax return of a small business is simple and repetitive.
Understanding Your Business Taxes
You have revenues and expenses; they net to profits. Maybe some personal expenses could be argued to be business-related. Maybe there are a few rules, like inventory valuation or depreciation, that apply to you or your industry.
But after the first year or two of tax return preparation, you’re going to see that it’s pretty much the same each year after—the same types of businesses tend to take the same types of deductions and claim the same types of expenses, and the only thing that changes are the specific numbers.
So, does this mean that you’re stuck? That you have no options? That you’re doing everything possible to pay the least amount of taxes? While there are ways for how to reduce taxable income, you might not have much flexibility here. But there is one thing you can do just to make sure: Get up to speed on the latest changes in the tax laws.
How to Lower Taxable Income by Keeping Up to Date
The Tax Cuts and Jobs Act of 2017, which took effect on Jan. 1, 2018, offers tax breaks, deductions, and favorable tax changes that could affect your income taxes and may be effective ways to lower taxable income. Here are a few of the biggest changes that small business owners need to know about.
Lower Personal Income Tax Rates
Tax rates have decreased across the board since the implementation of 2017’s tax reform. According to the IRS, for tax year 2019, the top rate is 37 percent for individual single taxpayers with incomes greater than $510,300 ($612,350 for married couples filing jointly). The other rates are:
- 35 percent, for incomes over $204,100 ($408,200 for married filing jointly);
- 32 percent, for incomes over $160,725 ($321,450 for married filing jointly);
- 24 percent, for incomes over $84,200 ($168,400 for married filing jointly);
- 22 percent, for incomes over $39,475 ($78,950 for married filing jointly);
- 12 percent, for incomes over $9,700 ($19,400 for married filing jointly).
- The lowest rate is 10 percent, for incomes of single individuals with incomes of $9,700 or less ($19,400 for married filing jointly).
20% Tax Deductions for Pass-Through Entities
Most small businesses operate as pass-through entities (LLCs, partnerships, S corporations, or sole proprietorships) where the company itself does not pay taxes, and the business income “passes through” to the business owner’s personal tax return.
One of the biggest benefits of the tax law for small business owners is that there is a 20% deduction for business income from pass-through entities, so long as your business is not a professional services firm with a taxable income of more than $157,500 for single filers/$315,000 married filing jointly. (Although the IRS has said that these amounts will be adjusted for inflation in future years, no such adjustments have been announced for the 2019 tax year as of the time of this writing.)
Talk to your accountant to make sure you qualify for this 20% deduction, as it may be one of the ways to reduce taxable income and it can make a big difference in your tax savings—and consider setting up your business as an LLC or other qualified pass-through entity if you haven’t already done so.
Expanded Section 179 Deductions
Buying property and business equipment is a major business expense for many small companies, and the tax law changes make your life easier by offering an expansion of the popular section 179 deduction: It increases the section 179 expensing cap from $500,000 to $1 million; the phase-out limit was increased to $2.5 million. (Although the IRS has said that these amounts will be adjusted for inflation in future years, no such adjustments have been announced for the 2019 tax year as of the time of this writing.)
The tax law also gives business owners more options for types of property claimed as business expenses, such as beds, refrigerators, new roofing, HVAC systems, security alarms for commercial buildings, and more. See if your business can claim some new business expenses—or get bigger tax savings out of an existing deduction.
When to Get a Fresh Opinion on Your Tax Planning
Even if you’re confident that you totally understand the changes to the tax law that first took effect on Jan. 1, 2018—and that you’re already making all the right moves to be ready for this year’s taxes—you still have another option: get another opinion about your tax planning.
A second opinion can be one of the most effective ways to reduce taxable income. If you’re preparing your tax return yourself or using tax prep software, take your prior year returns to a Certified Public Accountant (CPA) and ask to be audited.
If you already have a CPA, then take those same prior year returns and give them to another CPA and ask to be audited. You want a new set of eyes. You want someone to go through those returns being objective. You want a different perspective. Make sure the reviewing CPA knows that you have no specific expectations. Oh, and pay him or her. Getting this additional CPA audit might cost you a few hundred or even a thousand bucks. But it’ll feel worth it.
If the CPA does find something substantial that is a method for how to pay less taxes, then you’re going to want to understand why your current CPA (or tax prep software) isn’t identifying the same savings. You might decide to switch CPAs or start using the new person—that’s up to you. If the CPA does an audit and comes up with nothing new, then your money is still well spent. You’ve gone through the necessary due diligence to make sure you’re maximizing your tax situation. You’re performing a good, fiduciary duty to your shareholders, even if you’re the only shareholder.
Is this being disloyal to your current service provider? No. It’s being a good and responsible manager. Regardless of the outcome, bringing in an outsider—a competitor—to audit your tax returns, your insurance policies, or your computer network is something I see smart business owners doing all the time. You’d get another opinion from a doctor, right? So, what’s the difference?
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