Small Business Tax Savings
You don’t have to pay more than the tax law requires. But, as Albert
Einstein said, “the hardest thing to understand in the world is the income tax.” Finding ways to minimize your small business taxes legitimately and avoiding pitfalls are important activities that can have great returns: lower taxes.
Unfortunately, nine out of ten small business owners overpay on their taxes. Considering the US tax code is roughly 70,000 pages long, it’s understandable why small business owners and even accountants have trouble navigating it. Here are some good ways to save money on your small business taxes.
1. Keep an eye on AGI.
Adjusted gross income—line 37 of your Form 1040—is the starting point for a lot of damage. As it goes up, some tax benefit or other goodie is taken away, or some penalty or cost added to your life. It pays to know where the inflection points lie.
Many tax breaks, limitations, and additional taxes tee off on adjusted gross income or modified adjusted gross income, which for most filers is the same as AGI. For example, you’ll avoid the 0.9% additional Medicare tax on earned income from a salary or self-employment if AGI does not exceed $200,000 if you’re single or $250,000 if you file a joint return with a spouse.
2. Consider Adding Your Children to Company Payroll
This strategy tends to be a forgotten one, but paying your kids for real services provided can generate substantial tax savings. When paying your children through a sole proprietorship or single-member LLC, and the child is less than 18 years of age, the business is not required to withhold FICA or payroll taxes. Second, the child can use his or her standard deduction of $6,350 against any income you pay taxed as earned income exempt from income taxes. However, if you have an S or C-corporation, the Internal Revenue Code requires that you withhold FICA from all employees on the payroll.
Be sure to follow the proper procedures like creating bank accounts for the kids and paying them for actual services useful to the business. Jobs such as clerical work, filing papers, cleaning the office and other entry level tasks are all great ways to get your children involved in the family business. Who knows, they may be able to help you in new ways like social media marketing on Facebook, Twitter, Instagram or Snapchat.
3. Put your spouse on the payroll.
As a business owner, you should consider this strategy only if your spouse wants to contribute money to your company 401(k) for tax-planning purposes. Otherwise, generating earned income for your spouse and subjecting it to payroll taxes would be careless. Moreover, that move really doesn’t make sense, to get a deduction for a salary that will end up on your joint return anyway.
4. Take the home office deduction.
If you use part of your home for your business, you may be able to deduct a portion of expenses, like your mortgage interest, insurance, and utilities. This deduction is for homeowners and renters.
5. Take the auto expense deduction.
If you use your car in your business, you can deduct car expenses. You can choose one of the following methods for this deduction:
Standard mileage rate
For this method, you would multiply the total miles driven for business by the standard mileage rate for the year. For 2017, the standard mileage rate is 53.5 cents.
Actual car expenses
You can deduct actual car expenses like gas, repairs and insurance. However, if you use the car for personal and business then you will need to calculate the percentage that the vehicle was used for business purposes first and then apply that percentage to the total car expenses. For example, if you drove your car a total of 15,000 miles and based on your mileage tracker 6,000 of those miles were for business then you would divide 6000/15000 which equals 40%. Therefore, you can deduct 40% of your total car expenses as a business deduction.
6. Do lunch.
You can deduct 50% of meals that are considered business-related. This includes taking a client or even a potential client out to lunch. It could also include ordering pizza for the office as a special treat for your employees. Just make sure that these meals are not lavish or extravagant. A good rule of thumb is to treat your business finances as if they were your personal funds. Don’t dine at that new restaurant or play a round of golf at that country club just because you can write off half of the cost. However, if those are places that you wouldn’t hesitate to spend your own personal money then you should be ok to take the deduction.
7. Use a payroll tax software to avoid costly IRS penalties.
Did you know that approximately one-third of all companies get fined each year for incorrectly handling payroll taxes? This is due in large part to the fact that around 40% of businesses with employees try to handle payroll on their own, using paper or spreadsheets, without the assistance of a third party. Don’t get caught in this trap–I recommend Quickbooks for all your payroll handling needs. They will automatically calculate, deposit, and file your payroll taxes for you–and their US-based customer support means that help is easy to find when you need it.
8. Have an accountable plan.
If you reimburse employees for travel, entertainment, tools, or other costs, consider doing so using a plan that meets IRS requirements, which is called an “accountable plan”. With this plan, the business deducts the expenses but does not report the reimbursements as income to employees, potentially saving the company employment taxes.
So what is an” accountable plan”? It may seem obvious, but to qualify as a deduction to your business, but not be income to your employee you must meet some basic requirements. To satisfy the business connection component, the business expenses covered by the plan: (1) must satisfy the requirements for deduction as business expenses; and (2) must be paid or incurred by the employee in connection with the performance of services as an employee. Allowances under the plan may include per diem allowances, allowances for meals and incidental expenses, and mileage allowances.
Some examples – hotel costs for attending a business conference meets the guidelines. Buying tickets to a play while you are at the conference – do deal. Conference attendance is required, but going to a play while you are out of town is personal and not deductible. Uber or Lyft costs to go to the airport for a business trip is meets the guidelines. Uber or Lyft costs to get to work because your car is in the shop is not deductible as it is a personal expense. Employers to not pay for you to get to work.
9. Make smart tax elections.
Even though the year may have ended, it is possible to favorably impact taxes by making tax elections for optimum results. For example, you are allowed to deduct the cost of acquiring machinery and equipment in full up to a set dollar amount ($500,000 in 2017) even if you financed those purchases.
However, if you’re just starting up or are not profitable, you can ask your accountant about simply use depreciation for these items. This can help produce deductions for future years when these assets may be more valuable to you. For example, if you are in the 15% tax bracket now but expect to be in the 35% bracket in the future due to increased profitability, a $10,000 deduction would have you currently saving only $1,500 in taxes; depreciation over five or seven years (depending on the type of item) would produce total savings in the 35% bracket of $3,500, or $2,000 more.
10. Don’t overlook carryovers.
Certain deductions and credits have limitations that can prevent you from using them fully in the current year, but could permit a carryover to future years. Keep track of carryovers so you won’t to help keep you from forgetting to use them in future years (this is done automatically by most tax preparation programs and should be done by tax professionals you may use). Examples:
Charitable contribution deductions
General business credits
Home office deduction
Net operating losses
11. Use tax-free ways to extract income from your business.
While salary, bonuses, and distributions of your share of business profits are taxable, there are ways in which you can possibly benefit from your business’ success without triggering tax. Consider talking to your accountant about:
Tax-free fringe benefits, including medical coverage and retirement plans.
Loans by the business to you on a no- or low-interest basis. If the interest is below IRS-set rates, the business may have to report interest from this arrangement, but with interest rates low, this isn’t too costly these days.
12. Abandon property rather than selling it.
If property has no value to the business, talk to your accountant about the benefits of abandoning it rather than selling it for a nominal amount. This could allow the business to take an ordinary loss on the property, which is fully deductible, rather than treating the loss as a capital loss, which is subject to limitations.
13. Use fringe benefit plans for employees.
Additional wages trigger employment tax costs for the business, but if the business pays for certain fringe benefits for employees, these taxes can be avoided. Tax-exempt benefits you can consider offering your employees include:
Long-term care insurance
Group term life insurance
Dependent care assistance
Meals provided for employee convenience
Additional vacation or paid time off
14. Shelter profits in retirement plans.
It’s actually quite easy to set up a simple retirement plan for your
employees. You don’t pay taxes currently on contributions to retirement plans. The funds grow on a tax-deferred basis; distributions are taxable when taken in the future (when you may be in a lower tax bracket).
There are several retirement plan choices. The one to use depends on your situation. Remember that if you have employees, the business must cover them on a nondiscriminatory basis (owners and management cannot be favored). But a plan such as a 401(k) shifts most or all of the cost of savings to employees.
15. Do year-end planning.
While tax planning is a year-round activity, you can achieve dramatic savings by actions at the end of the year. For example, if your business is on the cash basis for accounting purposes, you can delay billing for work done late in the year so that payment will be received in the following year. This effectively lowers your business as profits defer tax on the cash you would be collecting for one year. Of course, tax planning should be sensitive to business realities; don’t defer income in this manner if you have concerns about the ability of a customer to pay. Be sure to speak with your accountant about this.
There are several other strategies that can help you lower your apparent profitability just before the end of the year. One strategy is to purchase fixed assets and claim a portion of depreciation immediately. It is also important to revalue your assets that are listed on your books. This can help lower your net profit as you increase depreciation claimed on the asset. If an asset has no use or is of no more value, ask your accountant if you should delete it.
If you have an account receivable with a customer who is unlikely to pay, then you can also write this off. It will be considered a loss and will allow you to lower your profits and taxes.
Lastly, when it comes the end of year planning, it’s best to have your taxes filed and submitted on time. According to IRS.gov: The penalty for filing late is normally 5% of the unpaid taxes for each month or part of the month that a tax return is late. The penalty starts accruing the day after the tax filing due date and will not exceed 25% of your unpaid taxes.
16. Change your business structure.
Whether you’re a sole proprietorship, limited liability company (LLC), or use some other business structure, it may be time to pick a new business structure. For example, an LLC can elect to be taxed as an S corporation.
In this way only salary paid to the LLC owner is subject to FICA taxes. If no such election is made, the LLC owner pays self-employment tax (the equivalent of the employer’s and employee’s share of FICA) on all of the business’ net earnings. For example, say the LLC has profits of $250,000 and it would be reasonable to pay the owner a salary of $100,000 if an election to be taxed as an S corporation is made. Without an election the owner pays self-employment tax on $250,000; with the election, the business and the owner each pay FICA only on $100,000.
You can significantly reduce the amount of taxes you pay if you take advantage of breaks and opportunities that are out there. It’s up to you (and your tax advisor) to discover them!
I would love to hear how you apply this in your life. Please send me an email about how you applied small business tax savings strategies and what the results were at firstname.lastname@example.org
Until next week
December 20, 2017
Join me every Wednesday on my podcast “Unlocking the Secret to Living Rich”.
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Who is Cindy B. Brown? Cindy is a CPA, MBA, CFO, and board member of public and private companies, business consultant, entrepreneur coach and a foremost expert in the field of financial mastery. Cindy’s purpose is to motivate, educate and inspire people to live their richest life. Host of “Unlocking the Secret to Living Rich”.