Tax strategies for small business owners help you protect as much of your business income as possible so that you can achieve your financial goals. Reducing your tax burden strategically should therefore be a high priority.
Reducing your tax liability comes in many forms, including taking advantage of tax deductions, knowing which tax credits are available to your small business, and identifying sources of tax savings. A CPA can help you with the tax planning strategies discussed here and potentially suggest other ways to reduce your tax bill as well.
1. Employ a Family Member
Hiring a member of your family to save money is an age-old trick. However, some may not realize that it’s also a way to reduce your tax bill. The Internal Revenue Service (IRS) offers various options that allow you to protect more of your income from taxes. This includes hiring your spouse and/or children.
Hiring Your Spouse
If you set up your small business as a sole proprietorship, you can hire your spouse as an employee and pay him or her a salary. This income will be subject to federal income tax and FICA taxes that cover Social Security and Medicare. However, if they’re a legitimate employee and not a business partner, they won’t have to pay the federal unemployment tax.
Hiring Your Children
Though all children have to pay federal income tax on their wages, there are a couple of taxes they won’t pay, depending on their age. If you run a sole proprietorship or both of the child’s parents are partners in the business:
- Children under 18 won’t pay FICA taxes
- Children under 21 won’t be subject to FUTA taxes
Hiring your children under the age of 18 therefore saves you the employer’s half of their FICA taxes, namely, the 6.2% for Social Security and 1.45% for Medicare that you would have to contribute for workers above the age of 18. You save on FUTA taxes if you hire your children and they are not yet 21.
(Important: These exemptions don’t apply if you set up your business as a corporation, estate, or a partnership in which one or none of the child’s parents are business partners. Normal taxation rules apply in these cases, regardless of the child’s age.)
Hiring your child also gives them the benefit of being able to start paying into an IRA for retirement. Though it may seem like a distant concern, paying into an IRA from the first possible moment sets them up for a sizable reward when their retirement comes around.
An Important Note About Hiring Children
When hiring family members, it’s essential to hire them to do a specific job for a reasonable rate. If you want to hire the baby, for example, you could “pay” him or her a reasonable rate to feature in an ad but couldn’t “hire” the baby as a full-time employee. If in doubt, consider what you would hire someone else’s child to do and how much you would pay him or her to do it.
2. Fund a Retirement Plan for Yourself and Your Employees
One benefit available to small business owners is access to some retirement plans that aren’t available to salaried employees. These can offer significant tax savings. Your CPA can explain the pros and cons of the following plans:
- One-participant 401(k) plan: You can contribute up to $66,000 of your income (for 2023) using this plan if you’re under 50. Over 50s are eligible for an additional catch-up contribution of up to $7,500 in 2023. This type of plan can cover both you and your spouse.
- If you have other employees, you can start a regular 401(k) plan.
- Simplified Employee Pension Plan (SEP): The main advantage of this plan is its simplicity. A SEP can be used to offer retirement benefits for your employees, unlike a one-participant 401(k). Contribution limits of this plan are either 25% of your compensation (or net earnings from self-employment) or $66,000, whichever is the lesser amount. Small business owners can contribute to their own accounts and also claim a deduction for the contributions made to their employees’ accounts.
- Savings Incentive Match Plan for Employees (SIMPLE) IRA plan: Small businesses that have 100 employees or fewer qualify to set up this type of plan. Both the employer and employee can fund SIMPLE IRAs. Under the rules of this plan, the employer must match up to 3% of their employees’ contributions, though this can’t exceed $15,500 or $19,000 including catch-up contributions. Alternatively, the employer can contribute 2% of compensation to the employee’s account regardless of how much the employee puts in.
3. Consider Changing Your Business Structure
How you structure your business has significant financial implications, and the original structure you chose for your small business isn’t set in stone. You may be able to save money in taxes by changing the structure. The main options are:
- Sole proprietorship
- Limited liability company (LLC)
- S corporation
- C corporation
It’s worth doing research—or asking your CPA—about the different outcomes you can expect and the pros and cons of each structure on a state and federal level. Some business structures are taxed on a corporate level, while others pass through their income to the owners who are subsequently taxed as individuals. It’s worth checking how “passing through” your business income affects your personal income tax rate and self-employment tax liability to make sure you’re not overpaying. Florida, for instance, doesn’t have a personal income tax but imposes a 5.5% corporate income tax on the profits of certain corporations and organizations.
4. Consult a Tax Professional
A 2019 study set up to gauge the effects of effective tax planning associated one standard deviation of this measure with a 19 percent increase in after-tax returns and a 31 percent decrease in tax risk (see page 3 of the linked document).
You, as a small business owner, can reap the benefits of hiring a tax professional to help you navigate the tax code far in advance of tax season. A CPA firm that offers tax planning services can support you as you grow your fledgling business and at every subsequent stage.
From helping you decide on a business structure to making sure you benefit from all the tax deductions available to you, a CPA can answer all of your questions and steer your business toward financial success.
5. Create an Accountable Plan for Employee Reimbursements
It is common to reimburse employees for expenses incurred while conducting business. Food, lodging, and travel expenses incurred while on a business trip are some of the most common items that your company should cover. Accountable plans document reimbursement criteria and set the reimbursed amounts apart from taxable income. This reduces both the employees’ income tax liability and your payroll tax withholding liability.
6. Reduce Your Adjusted Gross Income
Certain expenses can be deducted from your gross income (“above the line”) to reduce your adjusted gross income (AGI). This is before you deduct things like deductible dental and medical expenses and charitable contributions (which are deducted “below the line”) to arrive at your taxable income.
Self-employed business owners may be eligible to claim the following deductions to reduce their adjusted gross income:
- Interest paid on student loans
- Tax-deferred retirement plan contributions
- Contributions made to health savings accounts (HSAs) and Archer medical savings accounts (MSAs)
- Business expenses (such as those listed in the following section)
- Alimony payments made under an agreement made before (and not modified after) December 31, 2018
- Eligible early withdrawal penalties
- Eligible educator expenses
7. Take Advantage of Tax Deductions
Claiming all of the applicable tax deductions can make a huge difference to your tax return. The following are some of the most common tax deductions available to small businesses:
- Education and training: Training yourself and your employees in the essential skills of your industry is an important investment. Relevant education and professional development expenses are tax-deductible.
- Marketing: Your expenses related to marketing or promotional activities also qualify for tax deductions. This includes advertising campaigns, content creation, social media promotions, and other initiatives you use to expand your brand’s reach.
- Insurance premiums: Most business owners will understand the importance of having business insurance to safeguard their operations. Business-related insurance premiums are tax-deductible.
- Business meals: The IRS allows businesses to deduct a portion of business meal expenses when the meal is for a business purpose.
- Travel expenses: You can deduct your transportation, meals, accommodation, and even some of your home office expenses while you’re traveling for work.
- Home office expenses: Business owners and self-employed individuals can claim the home office deduction using either the regular method or the simplified option.
- Business interest expenses: Business owners can claim the interest paid on business loans and the portion of real estate used for business purposes as a tax deduction. Limits may apply, so consult a CPA to see how much you can deduct.
- Qualified Business Income deduction: This deduction allows eligible business owners to deduct up to 20% of their qualified business income plus 20% of their qualified REIT dividends and qualified PTP income. It is also known as the Section 199A deduction. The QBI or Section 199A deduction comes with several limitations, so it’s essential to consult a tax professional to see how much you can deduct.
Please note that other tax deductions may also apply depending on the nature of your business. An accountant can walk you through all of the deductions that are available to your small business and help you avoid costly mistakes.
8. Defer Business Income
Savvy tax planning can involve delaying the receipt of some sources of revenue to defer this income to the next tax year (especially if you expect it to be a lower-tax year). For example, you can intentionally bill in late December so that you will receive the payment in January of the following year.
9. Accelerate Business Income
Alternatively, it may be more advantageous to maximize your revenue before the end of the tax year—for example, if you foresee a tax increase the following year. You can accelerate income by stepping up billing and collections before the end of the year.
10. Acquire Assets Late in the Year
A related tax strategy that you can use is to estimate your business income toward the end of the tax year and acquire any tangible assets your business needs to lower your tax burden. These assets tend to be physical assets with a fixed monetary value.
Depending on the type of asset acquired and its value, it may need to be depreciated over its useful life rather than deducted all at once. Ask your accountant how you can maximize the tax benefits associated with each asset purchase you intend to make.
11. Claim the Work Opportunity Tax Credit (WOTC)
The Work Opportunity Tax Credit grants tax relief to small businesses that find and retain job seekers who may otherwise struggle to find regular, well-paid, and honest work.
Some of the targeted groups include:
- U.S. military veterans
- Members of households that are receiving public assistance
- People with physical or mental disabilities who qualify for vocational rehabilitation
- Designated Community Residents (DCRs) who live in Urban Empowerment Zones or Rural Renewal Communities
- People who receive nutritional assistance, long-term family assistance, unemployment compensation, or Social Security Disability payments.
Potential employees who you believe may qualify for WOTC tax credits must be screened by state and local workforce operatives approved by the IRS. Note that the tax credit can’t exceed your business’s overall tax liability or your payroll dues for Social Security.
Make the Tax Code Work for You
Nobody wants to pay more tax than they have to. Paying your fair share and not a cent more puts your small business in good stead to thrive financially, enabling you to invest more in your business’s future.
The tax code is a labyrinth that is best navigated with the help of a CPA. Work with an experienced accounting firm to put your business in the best financial position this tax year.