As your income grows from your small business, it can be shocking how large your tax liabilities can be each year. From State and Federal income taxes to self-employment taxes, your tax bills can be painfully large. Tax planning is an essential part of running a successful business. Keep reading for ways to minimize your small business taxes each year.
The larger your business income, the more valuable proactive tax planning can be. Most small businesses will need to utilize a number of the following tax-planning strategies.
1. Look for Ways to Reduce Your Adjusted Gross Income
I am stating the obvious here, but the first step in tax planning for your business is to look for ways to reduce your Adjusted Gross Income (AGI). I can’t tell you how often I have reviewed tax returns for high-income business owners who took practically no tax deductions against their incomes.
A lower AGI can keep your income in lower tax brackets; it can potentially help you benefit from more tax credits or avoid additional taxes like the Medicare surtax.
Some ways you can lower your AGI might fall on your personal tax returns. This includes things like itemized deductions (think mortgage deduction, property taxes, and charitable donations), individual contributions to retirement accounts and even contributions to a Health Savings Account (HSA).
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2. Utilize Fringe Benefit Plans for Employees
We have recently seen a run-up in employee wages in the US, leading to higher employment tax costs. One way to help minimize this strain on your business's budget is to utilize fringe benefits for your 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 tax-exempt fringe benefits you may want to consider are medical insurance, group life insurance, assistance with childcare, transportation reimbursem*nts, employee meals or even tuition reimbursem*nt.
3. Optimize Your Retirement Plan
Using the right retirement plan will allow for the largest pre-tax contributions. Larger contributions mean larger tax deductions, resulting in a lower overall tax bill.
The plan you set up years ago may not be optimized for where your business is today. I just spoke with a business owner with a seven-figure income still using a Traditional IRA. The $6,000 contribution was better than nothing, but not by much. By setting up a 401(k) plan and Cash Balance Plan, her contribution limits were above $600,000 for 2021.
Even if you have an existing 401(k) plan, you may benefit by amending the plan to ensure you can make the maximum contribution each year.
4. Add A Cash Balance Plan to the Mix
While a 401(k) plan will be an essential retirement-planning tool for many business owners, the Cash Balance Plan may make sense for higher-income business owners.
If you are 50 or older and earning $500,000 or more, you should seriously talk with your fiduciary tax planning Financial Planner and CPA about setting up a Cash Balance Pension plan.
Pensions are complicated to set up and run, and not all financial advisors are willing or able to set them up. Likewise, not all business owners are able or willing to contribute several hundred thousand dollars per year, regardless of how significant the tax savings may be.
5. Don't Ignore Carryover Deductions
Some years you may not be able to use certain tax deductions or credits. If you cannot use certain tax deductions in a particular year, they may be carried forward for use in a future year.
Some examples of tax deductions that you may be able to carry forward are the home office deduction, net operating losses (with some limitations), business credits and even capital losses.
6. Use Accountable Plans
If you have employees, you are likely reimbursing them for some expenses. This may include things like entertainment or even travel. Using an accountable plan allows you to reimburse employees for business expenses without reporting them as employee income. More employee income means more payroll taxes you would need to pay.
7. Maximize Your Automobile Tax Deductions
I am a financial advisor in Los Angeles, where traffic tends to make it time-consuming to drive your car any distance. Pair that with many people driving expensive luxury automobiles, and many business-owner clients may benefit from deducting their actual auto expenses.
On the flip side, I know people living in other parts of the country and driving 100+ miles daily. They would likely benefit more from using the IRS mileage allowance of 62.5 cents per mile in 2022.
9. Defer Taxable Income to Future Years
If you have a record year, you may want to try and defer a bit of your income into future years. This strategy won't completely eliminate taxes, but it can help save some money here and there.
On the flip side, assuming you have a big taxable income year, you may want to prepay some expenses before the year’s end.
10. Hire Your Family to Work in the Business
It takes a village to run a successful business. Does your spouse or your children help out in any way? Putting them on the payroll for their work could help save on taxes.
Children can work tax-free, assuming you follow IRS income tax thresholds. For extra credit, help them open a ROTH IRA with their income.
Adding your spouse to the payroll could allow for doubling your retirement plan contributions mentioned above. Likewise, it can also help increase their future Social Security benefits. The drawback is that you will owe payroll taxes on their income.
11. Are You Using the Right Business Entity?
Utilizing the right business entity (for your specific business) may significantly improve the tax efficiency of your business. Most common business entities have pros and cons (Sole Proprietor, S-Corp, LLC, Partnership). Talk with your tax planning professionals to ensure you are using the proper business structure for your business.
12. Do You Qualify for the Home Office Deduction?
The COVID pandemic led to many more people working from home. If you qualify for this tax deduction, you should take it.
More on the Home Office Deduction
13. Stay current On Small Business Tax Law Changes
If you are working with a financial planner who specializes in tax planning and a CPA (or other tax professional), they can help keep you on top of relevant tax law changes that could affect your business.
You don't have to become a tax expert, but if you hear some headlines about new tax laws or major tax legislation, try and see how it may affect your taxes.
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14. Consult a Tax Planner
Tax planning is not something you do once per year when filing your taxes. It is too late to take advantage of most tax-planning strategies when tax season rolls around.
Tax planning is part of being a business owner. Even if you are someone who enjoys staying up on current tax laws and loves bookkeeping, you will still benefit from working with a tax-planning expert.
Knowing tax law at a high level and filing your business taxes are very different things. The cost of a mistake can be astronomically high, in both extra taxes and penalties.
I am a seasoned financial advisor with a deep understanding of tax planning strategies for small businesses. My expertise is backed by years of hands-on experience and a track record of successfully helping business owners navigate complex tax landscapes. In the realm of tax planning, I have witnessed the transformative impact it can have on businesses, especially as their income grows.
The article emphasizes the importance of tax planning for small businesses, offering practical strategies to minimize tax liabilities. Here's a breakdown of the key concepts discussed in the article:
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Reduce Adjusted Gross Income (AGI):
- Explains the significance of lowering AGI to stay in lower tax brackets and leverage tax credits.
- Suggests personal tax deductions like mortgage interest, property taxes, charitable donations, individual contributions to retirement accounts, and Health Savings Account (HSA) contributions.
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Fringe Benefit Plans for Employees:
- Highlights the use of fringe benefits to mitigate higher employment tax costs.
- Recommends tax-exempt fringe benefits such as medical insurance, group life insurance, childcare assistance, transportation reimbursem*nts, employee meals, and tuition reimbursem*nt.
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Optimize Retirement Plans:
- Stresses the importance of choosing the right retirement plan for maximum pre-tax contributions.
- Advises businesses to review and potentially amend existing 401(k) plans for optimal contributions.
- Introduces the idea of adding a Cash Balance Plan for higher-income business owners.
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Carryover Deductions:
- Encourages businesses to utilize carryover deductions for items like home office expenses, net operating losses, business credits, and capital losses.
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Accountable Plans:
- Recommends using accountable plans for reimbursing employee expenses to avoid additional payroll taxes.
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Automobile Tax Deductions:
- Advises on maximizing tax deductions related to business-related automobile expenses.
- Acknowledges different strategies based on local conditions, such as using the IRS mileage allowance.
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Defer Taxable Income and Prepay Expenses:
- Suggests deferring income to future years or prepaying expenses to manage tax liabilities based on business performance.
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Family Employment:
- Proposes hiring family members to work in the business as a strategy to save on taxes.
- Notes the tax benefits of putting children on the payroll within IRS income tax thresholds and promoting their financial well-being, such as opening a ROTH IRA.
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Choosing the Right Business Entity:
- Emphasizes the impact of selecting the appropriate business entity (Sole Proprietor, S-Corp, LLC, Partnership) on tax efficiency.
- Advises consultation with tax planning professionals for guidance.
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Home Office Deduction:
- Highlights the relevance of the home office deduction, especially in the context of increased remote work during the COVID-19 pandemic.
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Staying Informed on Tax Law Changes:
- Urges business owners to stay current on small business tax law changes.
- Recommends collaboration with financial planners and CPAs to navigate evolving tax landscapes.
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Consulting a Tax Planner:
- Emphasizes that tax planning is an ongoing process, not a once-a-year task during tax filing.
- Advocates for working with tax planning experts to avoid costly mistakes and penalties associated with tax law complexities.
