5 ways to Lower Taxes for Small Business Owners: Part 1 – From John Young
As an avid, perpetual learner of new ways to help our clients buy or sell their businesses successfully and to the right person, I often seek out literature in the world of finance and taxes. Some articles are so efficiently helpful that I can’t help but want to share the knowledge within them.
With the 2019 tax season in full swing, my self-education led me to come across an article from The Hartford that described ways that small businesses could save money on taxes. As I am always trying to help my clients maximize profitability to help their businesses prepare for a sale, or trying to look at the best way to sell a business while paying the least amount of taxes on the transaction, I found this particular article’s information to be chick-full of good information.
Taxes for small businesses can be confusing and, as a small business owner, you likely have several questions: How much do I pay? Why do I have to pay this amount? How can I reduce taxable income?
Finding ways to lower your taxable income legitimately and avoiding pitfalls are important activities that can have great returns: 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. Considering the U.S. Tax Code is roughly 70,000 pages long, it’s understandable why small business owners and even accountants have trouble navigating it. 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 the first 5 ways of a two-part post on how to save money on your small business taxes:
1. Keep an eye on adjusted gross income.
Many tax breaks, limitations, and additional taxes tee off of adjusted gross income (AGI) or modified adjusted gross income (MAGI), which for most filers is the same as AGI. For example, you’ll avoid the .9% additional Medicare tax on earned income from a salary or self-employment if your AGI does not exceed $200,000 if you’re single or $250,000 if you’re married filing jointly.
2. Use accountable plans.
If you reimburse employees for travel, entertainment, tools, or other costs, consider doing so using a plan that meets IRS requirements, which is called an accountable plan. With this plan, the business deducts the expenses but does not report the reimbursements as income to employees, potentially saving the company employment taxes and lowering taxable income overall.
3. Make smart tax elections.
Caution. This area has two caveats. One is the IRS looks more closely at whether the deductions are legitimate. And two, if you are contemplating selling your business in the next three years, it may be better to eliminate these optional and gray areas, pay the taxes and receive two to three times their value added to your business value.
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 of $1,000,000 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
4. 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:
5. 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 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.
You 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.