Most people who become small business owners do so because they have a great idea, service, or product that they want to share. If you are a small business owner, you probably know a lot about the subject matter of your business, whether that's a dental practice, a bookstore, a plumbing business or a bakery. Unfortunately, you may have less knowledge, and less interest, in other aspects of the business, and that can cost you money. A prime example is taxes. You know you need to prepare, file, and pay taxes. But the amount of taxes you pay isn't set in stone. With a little effort, you can lower the amount of taxes your small business pays, leaving more resources to pour back into the business.
Many small business owners are sole proprietors, or partners with one or two other people. But if your business is a sole proprietorship or partnership, you may be sacrificing the flexibility and tax benefits of a "pass-through" business entity like a limited liability company (LLC).
An LLC has options regarding how it is taxed. It can choose to be taxed as an S corporation, meaning the owner draws a reasonable salary, which, like any employee's salary, is subject to FICA taxes. The remainder of the LLC's income "passes through" the business and is distributed as business income, which is not subject to FICA taxes. If the LLC does not elect the tax treatment of an S corporation, the owner of the business must pay self-employment tax on ALL of the net earnings of the business.
Also, thanks to the Tax Cuts and Job Act, effective tax year 2018, owners of LLCs and other pass-through business entities can deduct 20% of their business income when filing their personal income tax returns, with certain exceptions and limitations.
Your employees are one of your most valuable resources, and compensating them well shows them that. How you compensate them can make a difference to your tax bill, without negatively affecting your employees.
Higher wages equal higher employment taxes for the business. However, if, rather than paying increased wages, the company offers fringe benefits, these taxes will not be triggered. Among the tax-exempt benefits a company may offer employees are:
In addition to reducing your business's employment tax burden, offering these benefits may make it easier to attract and retain quality employees. You can learn more about fringe benefit plans and their tax advantages in the IRS publication Employer’s Tax Guide to Fringe Benefits.
For an established business, it may make sense to deduct expenses for equipment and machinery up front in the year in which they are acquired.
Depending on your business’s circumstances, you may want to make different tax elections for business expenditures. For an established business, it may make sense to deduct expenses for equipment and machinery up front in the year in which they are acquired. For a newer business with less income against which to take those deductions, it might be a smart move to take deductions for depreciation over several years, meaning that in the future, when your business is in a higher tax bracket and those deductions are more valuable, it will be able to take advantage of them.
You may also want to talk to an accountant about vehicle expense deductions: should you deduct based on actual costs, or the IRS’ standard mileage allowance? If you have a home office, you can deduct expenses for that home office based on actual costs or a simplified rate offered by the IRS.
There are some tax deductions of which you may not be able to take full advantage in one tax year, but which can be carried over into future years. Failing to carry forward these deductions is like leaving money on the table and walking out of the room. If you use a professional tax preparer, he or she should already be on the alert for carryovers, and if you prepare your own taxes using tax preparation software, the program may automatically keep track of carryovers such as net operating losses, capital losses, general business credits, home office deductions, and charitable contribution deductions.
Your business may reimburse employees for expenses such as travel, entertaining clients, professional education, and other costs. If so, the business should be reimbursing employees using a plan that complies with IRS regulations. Such plans are called “accountable plans.” Accountable plans can save your business money because it can deduct the expenses, but reimbursed expenditures are not reported to the IRS as income to employees, This can both lower overall business income and reduce the employment taxes the company would have to pay if the reimbursements were treated as income.
Recent changes in federal tax law mean that employees cannot deduct certain unreimbursed expenses, so using an accountable plan helps both them and the business.
If you have more questions about how you can reduce the tax burden for your small business, please contact our law office.