Small business tax liability is a complex issue, and you might not be taking advantage of all the potential strategies you could to help your business out and improve overall after-tax profits. Our expert CPA firm in Chicago knows 12 ways to reduce taxes for small businesses like yours. Keep reading to find out how to reduce tax liability for small business.
What Is Tax Liability?
How to minimize taxes for small businesses is probably what you're interested in learning, and knowing how to reduce the tax burden that small businesses face can be crucial to their success. However, you first need to know what a tax liability even is in the first place.
Your small business tax liability is the total amount you are responsible for paying to the IRS. That tax liability is ascertained by your level of revenue and the tax rate that applies to your small business. Taking advantage of potential deductions and managing your gross revenue help keep your tax bill lower.
12 Ways to Reduce Taxes for Small Business
Reducing your small business taxes lets you keep more of the hard-earned money you make. Not sure where to start? The following are a dozen different techniques you can try.
1. Know Your Small Business Tax Deductions
You need to know your small business tax deductions before you can hope to take advantage of them. Per the IRS, deductible expenses have to be both necessary and ordinary.
Ordinary expenses are commonly accepted within an industry, and necessary ones are those that help the business. Business travel is a common example, as are the mileage and maintenance of personal vehicles used for business activities. Business equipment, wireless phone bills, meals and entertainment, and even home office uses might qualify so long as they are done within IRS guidelines of business practices.
2. Utilize the Qualified Business Income Tax Deduction
The Tax Cuts and Jobs Act is also known as the TCJA. It created something called the Qualified Business Income, also known as the QBI. It lets you deduct 20% of your qualifying business income, should your business be a pass-through entity.
That could be a partnership, S corp, or sole proprietorship that passes income and also deductions to partners, owners, and shareholders who would then report things on personal tax returns. Your tax preparer might help you explore QBI options if your taxable income is under $164,900 as a single filer or $329,800 filing as a married couple. You might still be able to file for amounts over those, but it can get tricky.
3. Write Off Bad Debts to Reduce Income
When the year ends, it's time to go over your customer accounts to see if you operate your business using the accrual accounting method. Identify customers who are unlikely to pay you. Write off their amounts owed as bad debts so you can deduct those from business income. That will save you on taxes. Bad debts might include loans you make to clients, employees, and vendors that don't pay you back.
4. Buy Equipment and Vehicles for Depreciation Deductions
Vehicles, machinery, equipment, and even sometimes real estate are all things businesses can get tax write-offs for most of the time. You might even get to use these write-offs the very first year that you own and use such things.
Bonus depreciation is one common write-off for this, and Section 179 deductions are the other. You can deduct certain assets immediately using Section 179 with annual increases in the maximum deduction. Bonus depreciation is another benefit on top of that. Your tax preparer can help you determine which major assets of yours qualify.
5. Make Relatives Employees
Having an expert accountant can help you write this off, and you can use outsourced accounting services to do this.
One very effective move is to hire one of your family members. The IRS has numerous options for this, and they can help you shelter income from taxes. You might even get to hire your kids. Doing this means small business owners can pay lower marginal rates. They might even get to eliminate tax on any income they pay their children.
For example, a sole proprietorship doesn't have to pay FUTA, Medicare, or Social Security taxes on the wages of children. You do have to justify those earnings as legitimate business purposes. You can also get some tax deductions for hiring a spouse and avoid FUTA taxes. Based on benefits a spouse might get via another job, you might even be able to sock away some retirement savings for them.
6. Fund Retirement
Saving for retirement is just common sense. However, it can also help you avoid taxes. If you're a small business owner, then you can save a total of $57,000 each year in retirement contributions. These can actually be completely free of taxes. Not only that, but you have several ways of accomplishing this.
A SIMPLE IRA is a short name for the savings incentive match plan/individual retirement account. If you're an employer, you can mandate employees contribute 2% of their paychecks to the fund. You can also match up to 3% as another way of doing things. Employees get to contribute up to $13,500 each year. Employees older than 50 can contribute another $3,000 annually.
The Roth IRA permits tax-free withdrawals in qualifying circumstances. This kind of savings account might be preferable for anyone making under $140,000 per year but might face higher taxes later in the future. This money gets taxed at the time it goes into the IRA. The withdrawals are then free of taxes. Having said that, the employer match is all pre-tax money.
403(b) retirement accounts apply to particular public school and non-profit employees. These retirement plans are ones where employers can match the employee contributions before taxes and maximize benefits for employees who stick around for 15 years of overall employment. Employers can provide tax-free contributions and also enjoy a tax credit for starting the plan up.
7. Emphasize Healthcare
A high-deductible healthcare plan might make you eligible for a health savings account. That means you can save tax-free money for spending on health and wellness. Withdrawals and contributions are both free of taxes, so this option is doubly appealing.
As much as you might enjoy giving employees raises, contributing more to employee healthcare might help everyone out more. If you give an employee a raise, they will get hit with more FUTA and FICA taxes than the normal wages already are. Also, the employee will be taxed more on their side of the income. You can actually cove more health insurance costs for them without taxes going up for anyone.
Given how healthcare costs were skyrocketing even before the recent years of inflation hit everything all at once, employees are likely to appreciate any and all help that they can get in this area. For some households, it's a part of their budget as big as housing or food and runs the risk of totally bankrupting them. In a job market where professionals have lots of options, anything that makes your small business a great place to work can help you retain talent.
8. Alter the Structure of Your Business
When you own a small business, you don't have your own employer shouldering the burden of some of the taxes. You'll be responsible for the entirety of Medicare and Social Security taxes. You still need to pay these even if you get taxed as an LLC. There are ways to eliminate the employer portion of those tax obligations, however. You'll have to take risks related to paying yourself what the IRS deems a reasonable salary, but you can minimize your tax responsibility in the process.
9. Employee Contracts
If you can do so, consider hiring independent contractors or freelance employees. You can usually get high-caliber work for fewer taxes. You won't be responsible for their healthcare costs or employment taxes, but you'll still get similar results from them, if not better. Using contractors can certainly save you money on taxes, but they can also save you money in many other ways while you're at it.
If you have tasks or projects that aren't high enough in volume to justify full-time positions, you can save yourself the costs of having someone sitting around and just use contract labor when there is work to be done. For that matter, any contracting that can be done off-site, such as virtually or remotely, also minimize your overhead.
10. Deduct Charitable Assets
Charitable contributions let your business pay things forward. They also create trust with your customers. Pick charities that are effective and meaningful, and then track your donations. Your business should be able to deduct as much as a quarter of taxable income via charitable donations.
You can reduce your tax liability and build a great reputation in the community at the same time. Reflect on your brand's values, and spread that charity's message throughout your community. It can resonate with authenticity in a digital age where so much seems disconnected.
11. Put Accountable Plans into Place
Do you have expenses you need to reimburse employees for, such as mileage or travel? Save on taxes by adopting what is known as accountable plans. That means reimbursements aren't counted as W-2 income. That also makes them exempt from FUTA and FICA taxes.
12. Hire a Reputable CPA
Hiring a tax professional can do a lot for your business and help you with your federal income taxes. The right certified public accountant can help you navigate the laws and intricacies of business taxes and tax credits. They'll have the right strategies, whether it's the ones listed here or others, that prepare your income taxes properly in any financial situation. They'll know write-offs are not on this list so you can enjoy tax benefits and improve tax savings.