by Jason Vitucci, CFP® & Gene A. Schnabel
Finding ways to lower your taxable income legitimately and avoiding pitfalls are important activities that can have great return and lower taxes for your small business.
Unfortunately, many small business owners overpay on their taxes by missing out on certain deductions or managing their businesses and retirement savings in a way that is not efficient for tax purposes. There are many complexities to deal with when trying to minimize your tax bill, but, with the right strategies, you can save money on taxes while making your life easier throughout the year, as well as during tax season.
Here are some ways to save money on your small business taxes:
Make smart tax elections.
There are several ways to reduce your taxable income by being strategic about your business expenditures. For example, you are allowed to deduct the cost of acquiring machinery and equipment in full, up front, up to a set dollar amount - this increased to 1 million in 2018 as part of the new tax law.
However, if your business is just starting up or is not yet profitable, you can ask your accountant about depreciation for these items - it might be better for your overall tax situation if you can spread out the value of the purchases across your future tax years instead of deducting the full purchase price all at once. This can help produce deductions for future years when these assets may be more valuable to you.
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 that you won’t forget 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:
- Capital losses
- Charitable contribution deductions
- General business credits
- Home office deduction
- Net operating losses (limited to 80% of taxable income)
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’s 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 loan interest is below IRS-set rates (also known as Applicable Federal Rates), the business may have to report interest from this arrangement, but with interest rates low, this isn’t too costly these days.
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, which is another way to reduce your taxable income.
Tax-exempt benefits you can consider offering your employees include:
- Health benefits
- Long-term care insurance
- Group term life insurance
- Disability insurance
- Educational assistance
- Dependent care assistance
- Transportation benefits
- Meals provided for employee convenience
Shelter profits in retirement plans.It’s actually quite easy to set up a simple retirement plan for your employees, such as a 401(k) or a similar tax-deferred retirement plan where employees can make tax-deductible contributions to save for their future. With a tax-deferred retirement plan like a 401(k) or traditional IRA, the employee doesn’t pay taxes currently on contributions to retirement plans. Instead, the retirement savings funds grow on a tax-deferred basis; distributions are taxable when taken in the future (when the employee 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 while giving them choice and flexibility in planning for retirement, instead of a defined benefit pension plan where more of the burdens are on the employer.
Also, setting up a retirement plan is not just good for employees - it’s good for your company. That’s because employer contributions to an employee retirement plan are tax deductible and you might qualify for a tax credit for setting up your employee retirement plan.
Do year-end planning.While tax planning is a year-round activity, you can achieve dramatic savings by taking 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’s tax liability for the current year, since you can move those profits into the next tax year and 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 are having a cash flow shortfall or 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 taxable income 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.
Even if “last year” is over, you can still make some tax moves within the first quarter of the
new year to help save money on “last year’s” taxes.
Final ThoughtYou can 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 new ways to lower taxes for your small business.
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