For small business owners, navigating the complex landscape of business taxes can be a daunting task. However, with the right tax strategy, you can reduce your tax burden, maximize tax savings, and ensure that your business thrives financially. In this guide, we’ll explore five winning small business tax strategies to simplify the tax planning process and help you save money.
How do Small Businesses Avoid Paying High Taxes?
1. Take Advantage of Tax Deductions
One of the most effective ways to reduce small business owner taxable income is by claiming legitimate tax deductions. Small business owners can deduct a wide range of business expenses, such as office rent, utilities, business supplies, and marketing costs. Keep meticulous records of your expenses and work with a tax professional to ensure you’re not missing any deductions.
2. Consider Your Business Structure
The type of business entity you choose can significantly impact your tax liability. Sole proprietorships, partnerships, and LLCs often pass through business income to the owner’s personal tax return, simplifying tax filing. On the other hand, corporations may face corporate income tax. Evaluate the pros and cons of different business structures to find the one that offers the most tax benefits for your business.
3. Leverage Tax Credits
Tax credits directly reduce your tax bill and can lead to substantial savings. Explore available tax credits for small businesses, such as the Work Opportunity Tax Credit (WOTC) or the Small Business Health Care Tax Credit. These credits can provide significant tax relief and enhance your overall tax efficiency.
1. Contemplate Altering your Tax Classification
Explore the Possibility of Altering Your Tax Status As a small business proprietor, you possess a variety of choices when it comes to structuring your business entity. Your business structure, whether it’s a sole proprietorship, partnership, limited liability company (LLC), S corporation, or C corporation, will play a pivotal role in determining how you approach your small business tax obligations.
Should you find that your current business structure is no longer aligned with your needs, consider the potential benefits of switching to a more suitable option. For instance, LLCs have the flexibility to elect a tax status resembling that of a C corporation by submitting Form 8832 to the IRS.
Historically, such elections were infrequent, particularly due to the formerly high corporate tax rate of 35%. However, the Tax Cuts and Jobs Act of 2017 (TCJA) ushered in a reduction in the top corporate income tax rate from 35% to 21%.
2. Distinction Between Corporations and Pass-Through Entities
Pass-through entities, which encompass sole proprietorships, partnerships, LLCs, and S corporations, do not incur corporate income tax at the business level. Instead, the net income generated by the company flows through to the owner’s personal tax return, where it is subject to individual tax rates, with the highest bracket reaching 37%. For individuals within the highest tax bracket, altering their tax status can yield substantial tax advantages.
It’s crucial to note that, despite the reintroduction of the corporate alternative minimum tax (AMT) via the Inflation Reduction Act of 2022, its impact remains limited to large C corporations with an average annual income exceeding $1 billion. This means that small businesses are not affected by the new 15% corporate AMT.
However, it’s essential to recognize that tax savings should not be the sole determining factor when selecting the most suitable structure for your small business. Prior to making any decisions regarding a tax status change, it is advisable to seek guidance from a qualified tax professional.
They can assist you in performing a comprehensive financial analysis, evaluating the associated costs and benefits, and ensuring that your chosen structure aligns with your specific business needs.
3. Utilize Available Tax Deductions
Take advantage of tax deductions like the QBI deduction, which allows pass-through business owners to deduct up to 20% of their earnings. However, this deduction has rules and limits, and for individuals in specified service trades or businesses (SSTBs), it becomes unavailable if their income exceeds specific thresholds, such as $170,050 for singles in 2022. SSTBs encompass law firms, medical practices, consulting agencies, and others that rely on professional expertise.
The QBI deduction phases out for SSTBs as income increases, and it can be complex to calculate. For businesses not classified as SSTBs but with high income, the deduction is limited based on wages or property. If you think you qualify for this valuable tax benefit, consult a qualified accountant for guidance.
4. Make Use of Tax Credits
Tax credits offer businesses an effective means of reducing their tax liabilities, distinct from tax deductions that merely lower taxable income. These credits directly diminish the amount of taxes owed. Several noteworthy tax credits are worth exploring.
One such credit is the Work Opportunity Tax Credit (WOTC), which aims to assist employers in hiring and retaining individuals from disadvantaged target groups. These groups encompass recipients of benefits under the Temporary Assistance for Needy Families (TANF) program, veterans, felons, and others facing employment barriers.
The credit can be as high as $2,400 per eligible new hire. Small businesses can qualify for the WOTC by hiring individuals from these target groups, completing Form 8850, and submitting it to a designated state agency within 28 days of the new employee’s start date. Once eligibility is confirmed, businesses can claim the credit on their next regularly filed return.
Another valuable credit is the Disabled Access Credit (DAC), which aids small business owners in defraying costs related to providing accessibility for individuals with disabilities. The DAC is equivalent to 50% of eligible expenses, up to $10,000, although the first $250 in qualifying expenses is not eligible for the credit.
To qualify for the DAC, businesses must have annual revenue of $1 million or less and employ no more than 30 full-time workers. Eligible expenses may include facility modifications for disabled access, provision of Braille, large print, or audio materials, hiring sign language interpreters, or acquiring adaptive equipment.
5. Delay or Hasten Income
Adjusting the timing of income recognition can be a valuable tax strategy for many small businesses that follow the cash method of accounting. With this method, income is recorded when received, and expenses are recognized when paid, aligning with actual cash transactions. This approach opens up intriguing possibilities for tax planning.
If you anticipate moving into a lower tax bracket in the coming year, you may opt to defer income to that year, allowing you to pay taxes at a reduced rate. For instance, suppose you provided services to a client in December 2022 but haven’t billed them yet. By postponing the invoice until January 2023, you can defer income to the subsequent year, potentially lowering your 2022 tax liability.
Conversely, if you anticipate imminent tax rate increases, accelerating income into the current year may be advantageous. In this scenario, promptly sending your invoice and collecting payment in 2022 ensures that more income is taxed at your current, potentially lower tax rate.
The same principle applies to expenses: if you find yourself in a higher tax bracket for the current year, accelerating expenses in 2022 can effectively reduce your taxable income.
How do Small Businesses Plan for Taxes?
Optimize Retirement Plan Contributions
Contributing to a retirement plan for yourself and your employees not only secures your financial future but also offers valuable tax benefits. Contributions to retirement plans, like a Simplified Employee Pension (SEP) or a 401(k), are often tax-deductible, reducing your current taxable income. This strategy allows you to save money for retirement while lowering your tax bill.
Implement Tax-Efficient Business Practices
Strategically managing your business income and expenses can lead to significant tax savings. Consider deferring taxable income to the next tax year or accelerating expenses to reduce your taxable income in the current year. Additionally, explore opportunities to invest in assets that qualify for accelerated depreciation, which can provide larger tax deductions.
How can a Small Business Maximize Tax Returns?
Home Office Deduction
If you operate your business from a home office, you may be eligible for the home office deduction. This deduction allows you to deduct a portion of your home-related expenses, such as mortgage interest, property taxes, and utilities, based on the square footage of your home office. Ensure you meet the IRS criteria for claiming this deduction.
Consider Business Tax Planning
Collaborate with a tax professional who specializes in small business tax planning. They can help you devise a tax strategy tailored to your specific business needs, identify potential tax savings opportunities, and ensure compliance with tax laws and regulations.
Stay Informed About Tax Law Changes
Tax laws and regulations can change over time. Staying informed about these changes can help you adapt your tax strategy accordingly and make informed business decisions. Be proactive in seeking updates and guidance on tax matters that affect your business.
Small business tax planning involves a combination of tax deductions, business structure optimization, tax credits, and strategic financial management. By implementing these five winning tax strategies, you can minimize your tax burden, maximize tax savings, and ultimately achieve greater financial success for your small business.
Although certain business proprietors choose independent tax filing, seeking professional guidance remains crucial, particularly for complex financial situations. Consulting firms like Vyde, a Trusted Accounting Department serving over 10,000 small businesses nationwide, provide essential services including bookkeeping, tax, and accounting advice.
FAQ for Small Business Tax Strategies:
1. How do Small Businesses Avoid Paying High Taxes?
Small businesses can employ various strategies to minimize their tax burden:
Tax Deductions: Claim legitimate business expenses such as rent, utilities, and marketing costs.
Consider Business Structure: Evaluate different entity types to find the most tax-efficient option.
Leverage Tax Credits: Explore credits like the Work Opportunity Tax Credit (WOTC) to directly reduce tax bills.
2. How can Altering Tax Classification Benefit a Small Business?
Changing your business structure might offer tax advantages:
Switching structures (e.g., LLC to a C corporation) could provide new tax-saving opportunities.
Pass-through entities might benefit from a C corporation status with lower tax rates.
3. What are Key Tax Deductions and Credits for Small Businesses?
Essential deductions and credits include:
Qualified Business Income (QBI) Deduction: Allows up to 20% deduction for pass-through business owners.
Work Opportunity Tax Credit (WOTC): Provides up to $2,400 per eligible new hire from targeted groups.
Disabled Access Credit (DAC): Assists in covering expenses for accessibility improvements, up to $10,000.
4. How can Small Businesses Strategically Manage Income for Tax Purposes?
Timing income and expenses can impact tax liability:
Deferring income to a lower tax year or accelerating expenses can affect taxable income.
Cash accounting allows flexibility in recognizing income and expenses for tax planning.
5. What Strategies Help Small Businesses Maximize Tax Returns?
Optimize Retirement Contributions: Utilize retirement plans with tax-deductible contributions, like a SEP or 401(k).
Implement Tax-Efficient Practices: Manage income, expenses, and investments strategically for larger tax deductions.