As a business owner, it’s your job to take care of a host of obligations. One moment, you may be managing a human resources issue, and the next, coping with a customer complaint. Wearing so many different hats can make it difficult to stay on top of the big picture, especially when it comes to taxes.
At Cook Martin Poulson, we’re familiar with the tax challenges that businesses face. In fact, one of the most frequently asked questions we hear from our business clients is this:
What’s the best tax strategy to use for my business?
Having a tax strategy is essential because it governs everything you do and provides a framework that allows you to fulfill your tax obligations without overpaying. In this post, we will review some business tax basics and reveal 17 of the best tax strategies for business owners.
How Much Does a Small Business Pay in Taxes?
Another question we frequently hear from new business owners is the question that gives this section its title. People want to know how much they will need to pay, so they can prepare and be sure to have the money they need to meet their tax obligations.
The short answer is that every small business is unique, but we can still give you some idea of what to expect. The Small Business Administration released figures that gave an average of 19.8% as the effective tax rate for small businesses. The percentages can vary depending on your business structure and other factors.
There are five basic types of taxes that business owners may need to pay. They are as follows:
- Income tax
- Self-employment tax
- Estimated tax
- Employer tax
- Excise tax
The Tax Cuts and Jobs Act of 2017 changed the tax code for corporations. As of January 1, 2018, C corporations have a flat corporate income tax rate of 21%. This rate does not apply to other business structures. You should keep in mind that if you have a sole proprietorship or partnership – and in some cases, an LLC – you may need to pay self-employment tax.
Importance of Tax Planning for Small Business
As a business owner, paying taxes is your obligation, but the amount you owe should never be a surprise. It’s essential to understand how business taxes work and estimate the amount you need to pay each quarter or year to ensure that you have the appropriate amount of money.
Tax planning is something that can help you make accurate tax estimates, make all tax filings and reports on time, and avoid the potential repercussions of not doing so. As business taxes can be complicated, we recommend working with an experienced tax professional to help you with tax planning. You should also know that tax planning is often the best way to find tax savings.
Tax Strategies for Your Small Business
Now that we’ve covered some of the basics, here are 17 tax strategies to help you minimize your tax burden and save money at tax time.
1. Look for Ways to Reduce Your Adjusted Gross Income
Many of the taxes you pay are tied to your adjusted gross income or AGI. For example, if your AGI doesn’t exceed $200,000, or $250,000 if married and filing a joint return, you won’t be required to pay the additional 0.9% in Medicare taxes. You can lower your AGI by reducing your salary or doing one of the following things:
- Contributing to a tax-deferred retirement plan
- Itemizing deductions if they exceed your standard deduction
- Contributing to a health savings plan
If you think you might want to itemize deductions, consider tracking them on a spreadsheet throughout the year. That way, you won’t need to scramble to calculate them at tax time.
2. Be Strategic with Your Tax Elections
Applying some strategies to your business expenses can help you reduce your taxable income. For example, if you acquire new business equipment or machinery, you can deduct the cost upfront up to $1 million under the 2018 tax law.
However, for new businesses or those that aren’t yet turning a profit, you may want to consider depreciation as an alternative. Depreciation allows you to deduct the value of your purchase in future tax years instead of all at once. That’s beneficial if you expect your profits to increase and push you into a higher tax bracket.
Other tips include:
- Deducting home office expenses based on actual costs or the IRS simplified rate, which is $5 per square foot up to 300 square feet of space.
- If your business has been impacted by a disaster, you can claim the losses on your prior year’s returns instead of the year when the disaster occurred.
- You can choose between deducting vehicle expenses based on the actual cost or the IRS mileage allowance of 58.5 cents per mile.
- Deduct business insurance expenses, including liability, workers’ compensation, commercial auto, and business interruption services insurance.
The IRS scrutinizes insurance deductions closely, so ask your accountant before taking deductions.
3. Acquire Assets at the End of the Year
In some tax years, it may be beneficial to estimate your business taxes and then acquire new and used assets to reduce your taxes.
The Tax Cuts and Jobs Act of 2018 allows a 100% bonus depreciation. It may be worthwhile to take advantage of it – particularly in years when your profits have been high. It is important to remember that assets must be placed in service prior to the end of the year.
4. Establish Fringe Benefit Plans for Employees
When you increase employees’ wages, you also trigger higher employment tax costs. One way to get around that is to offer fringe benefits as part of employees’ compensation.
Some of the tax-exempt benefits you may want to consider include:
- Medical and dental insurance
- Long-term care insurance
- Disability insurance
- Group term life insurance
- Childcare assistance
- Tuition reimbursement
- Employee meals
You can find more information about eligible fringe benefits here.
5. Take a Tax-Free Loan from Your Business
A lot of business owners don’t know that they can take out a low- or no-interest loan from their business. If the loan interest is below the Applicable Federal Rates set by the IRS, you may need to report the interest.
You can check out the current IRS set rates here. Of course, you should ask your accountant before implementing this strategy.
6. Don’t Ignore Carryover Deductions
You already know that some deductions have limitations. The same is true of tax credits, which means that you may not be able to use them fully in the current year. However, you may not be aware that some of these deductions allow a carryover to future years.
Examples of carryovers that may be useful include capital losses, general business credits, home office deductions, net operating losses (up to 80% of taxable income), and charitable contributions.
7. Use Accountable Plans
Do you reimburse your employees for things like entertainment, travel, and other costs? If you do, you may want to use an accountable plan. Using an accountable plan allows you to deduct the expenses without reporting the reimbursements as employee income. In other words, it can reduce both your employment taxes and your overall taxable income.
As a bonus, using an accountable plan can also save your employees money on taxes. That’s because, under the new tax law, employees can no longer deduct miscellaneous unreimbursed employee expenses.
8. Abandon Property Instead of Reporting it as a Capital Loss
If your business owns property that has no value, you might be tempted to sell it and report it as a capital loss on your taxes. However, there are some benefits to abandoning it instead.
Abandonment of property allows you to take an ordinary loss – which is fully deductible – instead of a capital loss, which is subject to limitations. Keep in mind that a Section 1231 property may be ordinary or capital depending on other Section 1231 losses for the year and prior losses.
9. Defer Taxable Income
Are you using cash-method accounting for your business? If you are, you can take advantage of that by carefully managing your business taxable income to minimize your taxes. If you anticipate that your business income will be taxed at the same (or lower) rate next year, here are a few tips to help you defer some of your income:
- Put recurring expenses on your credit card. You can deduct them in the current year even though you won’t pay the credit card bill until next year.
- Mail checks a few days before the end of the year. You can deduct the expenses in the year you mail the checks. If you’re mailing a big check, use registered mail so you can prove the mailing date.
- Prepay expenses at the end of the year, provided that the benefit does not exceed IRS limitations (the earlier of 12 months before the first date on which your business realizes the benefit or the end of the next tax year.) For example, you could prepay your office rent or prepay some of your insurance premiums.
- Delay sending invoices until the last few days of the year. That way, you’ll receive payment in the new year and can report the income in the new year as well.
You’ll need to be cautious with the last strategy. Don’t delay sending invoices to customers who pay slowly.
10. Hire Your Spouse or Children
If your spouse or children can contribute to your business, then put them on the payroll. Kids can work tax-free if their income is below the IRS threshold. The Tax Cuts and Jobs Act of 2018 nearly doubled the exemption amount for dependent minors.
As a bonus, you can take the money you pay your kids and put it into an education savings account or Roth IRA. You also won’t need to withhold payroll taxes.
11. Evaluate Your Business Entity Type
The business entity type you choose has a significant impact on your tax liability. As we mentioned earlier, people who are sole proprietors, have Limited Partnerships, or certain Limited Liability Companies are on the hook to pay self-employment taxes. Depending on how much you earn as a sole proprietor or as an employee of any pass-through entity, you may also have to pay the additional 0.9% Medicare tax.
Tax season is a stressful time and there are often many questions surrounding how certain things will affect your tax bill. This article: A Guide to Pass-Through Deduction & How It Can Help You Save Taxes, explains pass-through deductions which can help lower your taxable income.
If your estimated business taxes are high, then you may want to consider taking a step back and reorganizing your business as a different type of entity. For example, reorganizing an LLC as a C corporation has some tax benefits. Navigating the ins and outs of different business entity types can be confusing, so it may be beneficial to work with a tax professional to determine the appropriate structure for your business.
12. Write Off Bad Debts
As a business owner, you may sell products or services to customers on credit – for example, many companies invoice clients and give them 15 or 30 days to pay. When you have delivered goods and services, then your instinct may be to continually try to collect them but that’s not always the most advantageous approach for taxes.
As the end of the tax year approaches, you may want to review your accounts, including past due invoices as well as loans you may have made to employees or vendors, and consider whether they should be written off as bad debt. Writing these debts off can help you to offset what you owe on your taxes and reduce your overall tax obligation. It is important to note that this applies to accrual basis taxpayers only (see below).
13. Review Your Accounting Method
There are several accounting methods you may use as a business owner and in some cases, you may have a choice about which method to use. The two most common methods are the cash method and the accrual method.
With the cash method, you must report any money you receive and any business expense you incur in the year that you pay them. This method is available to many small businesses, but businesses that have average receipts of more than $25 million for the past three years are not eligible.
The other option is the accrual method, which allows you to report income in the year it is earned and expenses in the year they are incurred. There are some benefits to both methods and you may want to consult with your accountant to determine which method best suits your business needs.
14. Check If You’re Eligible for Penalty Relief
Sometimes, despite their best efforts, business owners incur a penalty from the IRS. The penalty could be because they missed a tax filing deadline or underpaid their taxes, and in some cases, the penalties can be significant.
If you incur a penalty, it is worthwhile to see if you are eligible for penalty relief. Some of the circumstances that may be eligible for penalty relief include:
- Failing to file a tax return
- Failing to pay on time
- Failing to deposit taxes as required
You can check with the IRS or your accountant to find out if you are eligible for penalty relief. Often the IRS will remove the first penalty assessed to you.
15. Pay Down Your Debt
Payments that you make for business expenses are not tax-deductible in most cases but there is one exception: loan interest. If you have an outstanding business loan and cash on hand, then you may want to make extra payments or even pay off the loan entirely, so that you can deduct the interest when you file your tax return.
Keep in mind that the IRS does not allow an interest deduction for personal expenses paid with a credit card. You can view IRS Publication 334 for information about non-farm business interest deductions and IRS Publication 225 for information about interest deductions for farms.
16. Keep Tabs on the Current Small Business Tax Law Changes
As of January 2022, the fate of President Biden’s Build Back Better bill is still hanging in the balance. Several potential changes could impact business owners. The first is the expansion of the Net Investment Income Tax (NIIT) to include anybody with an income of more than $400,000 for single filers and $500,000 for joint filers. The NIIT is a 3.8% surtax that applies to passive business income.
The second potential change is the proposed Corporate Profits Minimum Tax of 15%, which would apply to the adjusted financial statement income of companies that pay more than $1 billion in profits to shareholders.
There is also a proposed 1% excise tax to be imposed upon shares repurchased by companies after December 31, 2021, as well as proposed changes to how foreign income is taxed and increases to the Base Erosion and Anti-Abuse Tax (BEAT) on the table. We are always watching to see what happens with pending tax legislation and as a business owner, you should be too.
17. Consult a Tax Advisor
One of the best things you can do as a small business owner to minimize the amount of tax you are required to pay is to consult a tax advisor. Even if you are someone who keeps a close eye on business news and stays up to date on tax law changes, you still need professional advice to help you file your taxes.
Business tax filings can be complex and the penalties for mistakes or oversights can be high. Ultimately, paying for a tax advisor will be less expensive than trying to clean up the aftermath of a mistake with your taxes.
Final Thoughts on Small Business Tax Strategies
Calculating, filing, and paying your business taxes can be a time-consuming and expensive endeavor. The 17 tax strategies we have reviewed here can help you to understand your tax obligations and minimize your tax burden.
Do you need assistance planning your income tax strategy? Cook Martin Poulson can help create an excellent tax plan for you and your business.