As a small business’s income grows, so do its tax liabilities — that’s why small business owners must be proactive in their tax planning to avoid being surprised by unexpected, hefty bills. Employing effective tax strategies is crucial for a successful business, and various strategies are available for minimizing tax bills, especially for businesses with larger incomes.
From optimizing home office deductions to maximizing retirement contributions to reducing debt, below are some effective tax strategies your small businesses can start implementing today to save money.
Make the most of your home office deductions
Home office deductions are one of the most commonly missed expenses that can save you lots of money on your tax return. This is partially because there are some common misconceptions about what qualifies as a “home office.” The IRS allows both homeowners and renters to claim a home office deduction, so even if your space is leased, you may claim it on your tax return. The deduction is also available for all types of homes, from a houseboat to a studio apartment (but not a hotel or an Airbnb that you’re staying in on vacation). To claim a home office deduction, your space must meet these two requirements:
- Regular and exclusive use: The space you consider your office must be used exclusively for business purposes. For instance, if you use a guest bedroom as both your office and a place for your in-laws to stay, that room is ineligible for this deduction.
- Principal place of business: Your home office must be your primary place of business. That means you don’t have another office elsewhere. Your home office must be used “exclusively and regularly for administrative or management activities.” Management activities refer to things like billing customers, making sales calls, bookkeeping, and setting up appointments.
Check with your accountant to make sure you can take advantage of a home office deduction. It can save you a lot of money on your tax return!
[Read more: Running a Home-Based Business? Important Tax Information You Need to Know]
Defer income to reduce your taxable income
Remember, your income tax is charged based on the amount of income you made during the previous calendar year. In this case, a successful sales strategy is a double-edged sword: the higher your income, the higher your taxes. If you’re hoping to lower your tax burden in April, defer some income until the next calendar year.
There are two ways to defer income depending on which accounting method your business uses:
- Cash-basis accounting: Delay sending invoices, or extend the due date on the invoice until the new year. Your income tax rate is based on when you actually receive payment, not when you’ve sent out the invoice.
- Accrual-basis accounting: If your business doesn’t charge until after you’ve fulfilled the delivery of goods and services, delay until next year. Strict guidelines apply when a business is recording deferred income under accrual accounting, though, so it’s wise to check with your financial advisor to make sure you’re doing it correctly.
[Read more: 9 Commonly Overlooked Small Business Tax Credits]
Be proactive about procurement and depreciation
Equipment is one of the biggest expenses in a small business budget. Writing off new purchases and offloading old equipment can significantly help your tax burden. If you need to purchase a car, laptop, or other equipment, make that purchase before the end of the year. The earlier date of purchase can be declared as a higher expense, or even a full purchase price since the item will have had less time to depreciate. Likewise, you may be able to take advantage of business credits for things like solar panels, energy-saving upgrades, or other sustainable investments. Check the IRS list of business tax credits to see if there’s anything your business needs that you can claim.
In addition to moving up expensive purchases, now is the time to review depreciation rules. Follow these steps to maximize your expenses and reduce your tax rate in April:
- First, declare the entire expense in 2023.
- Use a shorter depreciation timeline.
- Use an accelerated depreciation method.
- “Decrease the residual value to allow a greater annual depreciation expense."
Read more about how to apply depreciation in IRS Publication 946.
Maximize contributions to your retirement plan
Adding to a retirement plan is not only an investment in your future, but it’s also good for your tax rate. Contributions to a 401(k) are made with before-tax income, meaning your monthly salary decreases each pay period, leading to a lower tax rate.
Individuals are eligible to contribute up to $22,500 to a 401(k) in 2023. If your account is set up as an IRA, you may contribute up to $6,500 in 2023. Business owners can also set up 401(k)s for their employees. Small businesses can claim the cost of setting up and administering each 401(k) plan, up to $500 a year for each of the first three years that the plan exists. Plus, it’s a great benefit to offer your employees.
Adding to a retirement plan is not only an investment in your future, but it’s also good for your tax rate.
Pay down your debt
Lots of small business owners take on debt to finance their growth. A loan won’t be taxed in the same way as business income, but you may be taxed on interest payments. Speak to a CPA or accountant who can tell you whether or not you can make your loan as tax-efficient as possible.
At the same time, make sure you write off any uncollectible debts you may have accumulated through the year. Uncollectible or bad debts are those that are owed to your business by a customer that you (the business owner) or a creditor has not been able to collect. The IRS permits you to write off bad debts before the year. Run your accounts receivable aging report to see who hasn’t paid. If the results show a customer who is no longer active, then you may be able to strike this person’s balance from your total sales figure. This reduces your income, lowering your income tax. The caveat here is that, unfortunately, if you do write off a bad debt and the person pays you later, you must reverse the write-off.
Consider making your business an LLC
Changing the structure of your small business can lead to tax savings, particularly at a time when top corporate income tax rates are low — sitting at 21%. Small business owners can benefit from making their company a limited liability company (LLC), which allows it to be taxed as a C corporation with the IRS Form 8832.
Furthermore, LLCs are pass-through businesses exempt from paying corporate income tax. Instead, they can reap tax-saving benefits as a company's net income is passed onto the owner's tax return, subject to a personal income tax rate upwards of 37%.
However, before making any structural changes to your business, it's best to consult with an expert who can conduct a cost-benefit analysis and ensure the right move for your business.
Track your receipts using software
Tracking receipts allows businesses to take advantage of tax deductions; however, businesses should develop an organizational system and ideally utilize tracking software.
To maximize your savings potential and ensure accurate record-keeping, create a system to track all of your expense receipts, both digital and physical. Ensure physical receipts are properly labeled — the IRS requires businesses to keep proof of receipts and supporting documents for up to three years — and hold them in a secure location until they can be digitized.
Store all digital receipts in one location, such as a secure folder or drive, and ensure you back them up. Many programs utilize built-in scanners that will input information and file receipts away automatically.
Pay for health insurance
Self-employed health insurance deductions offer small business owners a valuable tax break, mitigating the financial burden of high insurance costs and reducing overall tax liability. This deduction, available to self-employed individuals who cannot receive health insurance coverage from a spouse but meet all other requirements, allows eligible individuals to deduct some or all of their insurance premiums, including medical, vision, dental, and long-term care, depending on the net profits of the organization offering insurance.
Businesses can also reap tax-saving benefits by creating Health Savings Plans for employees. These plans offer an affordable option for businesses to put away money for their employees' future health care needs. These contributions and their growth are tax-free, and so are withdrawals if used for medical expenses.
Take advantage of the qualified business income deduction
Depending on your business’s structure, you can claim the Qualified Business Income deduction, also known as the Section 199A deduction, which allows eligible self-employed individuals and small business owners to deduct up to 20% of their business income.
Eligibility depends on the filer’s taxable income — single files must be below $182,100, and joint files below $364,200 — which includes the net income, gains, deductions, and losses from a trade or business. Those above this income will see a reduced deduction. However, the deduction is not available for specialized service trades or businesses, such as lawyers, doctors, and consultants, that make above a certain threshold.
Use your car for work
Leveraging a personal car for business use can yield significant tax advantages for small businesses. To calculate your deductible car expenses, you can opt for the standard mileage rate — 65.5 cents per mile for 2023 — or itemize your actual expenses.
Using the standard mileage rate method, the IRS permits you to deduct business vehicle operating and maintenance expenses based on miles driven. Alternatively, the actual expense method requires small business owners to add up all car-related business expenses, including fuel, maintenance, tires, registration, taxes, licenses, lease payments, insurance, etc. Then deduct the percentage of these costs that corresponds to business use versus personal use, if it offers a larger tax saving than the standard mileage rate.
Small businesses can also get a tax write-off of the total cost of the vehicle, up to $18,000, if it's used for business purposes and weighs over 6,000 pounds. Should the vehicle serve dual purposes — both personal and business — the deductible expense may reach up to 50%, aligning with the extent of its business use.
[Read more: 5 Things to Know About Company-Owned Vehicles]
This article was originally written by Emily Heaslip.
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