If your income comes from your small business, your annual tax liability can be shockingly large. From state and federal income taxes to self-employment taxes, your tax bill can be huge. Tax planning is an important part of running a successful business. Read on to learn how to minimize your annual small business tax.
The larger your business income, the more valuable active tax planning is. Most small businesses will need to take advantage of some of the following tax planning strategies.
1. Find ways to reduce adjusted gross income
What I’m saying here is obvious, but the first step in tax planning for your business is finding ways to reduce your adjusted gross income (AGI). I can’t tell you how often I review the tax returns of high-income business owners who have barely deducted tax on their income.
A lower AGI can keep your income in a lower tax bracket; it may help you benefit from more tax credits or avoid additional taxes, such as the Medicare surcharge.
Some of the ways to lower your AGI may affect your personal tax return. This includes itemized deductions (think mortgage deductions, property taxes, and charitable contributions), individual contributions to retirement accounts, and even contributions to health savings accounts (HSAs).
2. Take advantage of employee fringe benefit plans
We’ve recently seen wage increases for U.S. workers, leading to higher employment tax costs. One way to help reduce pressure on business budgets is to offer fringe benefits to employees.
When you increase your employees’ wages, you also incur higher employment tax costs. One way to address this is to offer fringe benefits as part of employee compensation.
Some tax-free fringe benefits you may want to consider include health insurance, group life insurance, child care assistance, transportation reimbursement, employee meals and even tuition reimbursement.
3. Optimize your retirement plan
Using the right retirement plan will allow for the largest pre-tax contributions. A larger donation means a larger tax deduction, resulting in a lower overall tax bill.
The plans you made years ago may not be optimized for your business today. I just spoke to a business owner with a seven-figure income who is still using a traditional IRA. A $6,000 donation is better than nothing, but it’s not a lot either. By developing a 401(k) plan and a cash balance plan, she exceeded the $600,000 contribution limit in 2021.
Even if you have an existing 401(k) plan, you can benefit by modifying your plan to ensure you can make the most of your contribution each year.
4. Add a cash balance plan
While a 401(k) plan will be an essential retirement planning tool for many business owners, a cash balance plan may make sense for high-income business owners.
If you are over 50 and earning more than $500,000, you should seriously discuss establishing a cash balance pension plan with your trust tax planning financial planner and CPA.
Pensions are complex to set up and run, and not all financial advisers are willing or able to set them up. Likewise, not all business owners are able or willing to contribute hundreds of thousands of dollars a year, no matter how large the tax savings may be.
5. Don’t ignore carryover deductions
You may not be able to use certain tax deductions or credits in certain years. If you cannot use certain tax deductions in a particular year, they may be carried forward to be used in a future year.
Some examples of tax deductions you can carry forward include home office deductions, net operating losses (with some limitations), business credit and even capital losses.
6. Use a responsible program
If you have employees, you may reimburse some of their expenses. This could include things like entertainment or even travel. Using a responsible plan allows you to reimburse employees for business expenses without reporting them as employee income. More employee earnings means more payroll taxes for you to pay.
7. Maximize Your Auto Tax Deduction
I’m a financial advisor in Los Angeles, where traffic congestion tends to make it time-consuming to drive any distance. Combined with the fact that many people drive expensive luxury cars, many business owner customers may benefit from deducting their actual car expenses.
On the other hand, I know people who live in other parts of the country and drive 100+ miles a day. By 2022, they may benefit more from using the IRS mileage allowance of 62.5 cents per mile.
9. Defer taxable income to future years
If you have a record year, you may want to try deferring a portion 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 other hand, assuming you have a large taxable income year, you may want to prepay some expenses by the end of the year.
10. Hire your family to work in the business
It takes a village to run a successful business. Are your spouse or your children helping in any way? Putting them on the work payroll can help save tax.
Children can work tax-free, assuming you follow the IRS income tax threshold. For extra credit, help them open a ROTH IRA with their earnings.
Adding your spouse to your payroll can double your retirement plan contributions. Likewise, it could help increase their future Social Security benefits. The downside is that you will owe payroll taxes on their earnings.
11. Are you using the correct business entity?
Utilizing the right business entity (for your specific business) can significantly improve the tax efficiency of your business. Most common business entities have advantages and disadvantages (sole proprietorship, S-Corp, LLC, partnership). Talk to your tax planning professional to make sure you’re using the right business structure for your business.
12. Are you eligible for the Home Office deduction?
The COVID-19 pandemic has led to more people working from home. If you qualify for this tax deduction, you should accept it.
More About Home Office Deductions
13. Stay informed about changes to small business tax laws
If you work with financial planners and certified public accountants (or other tax professionals) who specialize in tax planning, they can help you understand relevant tax law changes that may affect your business.
You don’t have to be a tax expert, but if you hear some headlines about a new or major tax law, try to see how it affects your taxes.
14. Consult a tax planner
Tax planning is not something you do once a year when you file your taxes. When tax season rolls around, it’s too late to take advantage of most tax planning strategies.
Tax planning is part of the business owner. Even if you enjoy complying with current tax laws and enjoy keeping your books, you will still benefit from working with a tax planning expert.
Understanding high-level tax laws and filing sales tax are very different things. The cost of a mistake can be astronomical, including additional taxes and penalties.