Small business owners can often become frustrated when figuring their yearly taxes. While the process is complicated, the questions on the mind of the business owner are fairly simple. How much money must I pay? Why do I owe so much? Is there a way I can lower the amount of taxes due?
Discovering ways to legitimately lower the amount of taxes you pay as a business owner while avoiding common tax pitfalls is well worth the effort.
Many business owners pay more than they should each year at tax time. The main reason for this is a lack of understanding for the deductions available to them. Many business owners also mismanage other tax-related elements of their business. There are many complexities contained within the 70,000 page U.S. tax code. However, the right strategy can simplify the process and provide you with significant tax deductions.
If you choose to reimburse employees for expenditures like travel expenses, entertainment, tools, or other things necessary to complete their job duties, you are entitled to use an IRS approved accountable plan.
Employers are not required to pay federal employment taxes on money reimbursed through an accountable plan that meets IRS requirements. Employees also benefit by not being responsible for federal income tax on this money.
The four requirements for IRS approved accountable plans are as follows:
- Connection to business – Only expenses incurred by employees that are necessary to perform job duties are allowable.
- Substantiation – Receipts are required to document expenses.
- Excess Payment Return – Employees must return reimbursements that exceed the substantiated expenses.
- Time – Expenses must be substantiated and excess reimbursements must be returned within a reasonable frame of time.
Strategic Tax Elections
There are a handful of options available to the savvy business owner that wishes to affect their taxable income through strategic spending. For instance, business owners are allowed to deduct the full cost of acquiring equipment and machinery for their businesses. The maximum allowable deduction of this type increased to $1 million in 2018.
Some business owners may prefer instead to spread out the tax benefits of major purchases over a few years versus realizing the full deduction upfront. This second alternative may be especially beneficial if your business is new or has not yet reached the stage of profitability.
You should also talk to an accountant about available deductions for the yearly depreciation of the equipment. Depreciation expenses are also available for any vehicle used for business purposes.
Adjusted Gross Income
There are a number of tax breaks, tax fees, and tax limitations that are directly affected by the adjusted gross income of your business. One example of this concept is the 0.9% Medicare tax addition on your self-employment tax that can be avoided if your AGI is less than $200,000. This number goes up to $250,000 for business owners who are married and file their income tax return jointly with their spouse.
Tax-Free Business Income Extraction
All salaries and bonuses you receive from your business are subject to be taxed. This is also true of money gained by the sale or distribution of shares in your company. However, there may be ways to extract money from your business without paying a percentage of it to the IRS.
One possible way to do this is to make use of tax-free retirement and medical coverage plans. You may also be able to give a low or no interest loan to yourself from your business. If the interest rate on the loan is under a certain percentage, there may be some tax liability. However, the cost of this liability is likely to be extremely low.
The process is simple to set up a 401K or other retirement plan for the benefit of your employees. These tax-deferred retirement plans do not require taxes to be paid on money contributed to the plan. The taxes are deferred as the money in these accounts grow. The distributions are taxed only when withdrawn in the future. This will pay double benefit if the employee is in a lower tax bracket at the time of the withdrawal than when the money was contributed to the fund.
There are a number of plans to choose from but it is important to remember the plans must be offered on a non-discriminatory basis. This means that neither you as the business owner nor any members of your management team, can receive preferential treatment over other employees.
You benefit as an employer when you offer a qualified retirement plan to your
employees because the money you contribute to the plan is non-taxable. You may also benefit from a tax credit when you offer a retirement plan to employees.
Perform Year-End Planning
You should be conscious of tax planning throughout the year but significant tax deductions can be gained through certain actions taken at the year’s end.
One way to save on taxes is to delay the billing for services performed late in the year so that the money is received in the new year. This action shifts the tax liability for the money received away from the current year. It is important to remember that any actions taken should fit the reality of your particular situation. For instance, you would not want to defer accounts receivable while in the midst of a cash crunch.
Another year-end tax saving strategy is to purchase a piece of equipment and make immediate use of a portion of the depreciation.
A more fundamental strategy for the end of year tax savings is to complete tax filings on time. This will save on fees and penalties assessed for late filings.
Switch Business Structures
Business owners operating as a sole proprietorship or who are part of a partnership may benefit from a change in business structure. Operating as a Limited Liability Company provides more flexibility in the way taxed income can be handled.
An owner of an LLC has the option of paying taxes like an S Corporation. This would allow the business owner to pay himself a salary that would be subject to normal personal income tax codes. The other income generated by the company is considered business income distribution and FICA taxes are not required to be paid on these earnings. The tax deductions for the business owner lies in the fact a substantial amount of the income of the business will not be subject to self-employment taxes.
LLC owners are also allowed a 20 percent income deduction on their personal income tax return.
The Bottom Line
Many business owners associate the feelings of stress and anxiety with each approaching tax season. While U.S. tax codes are complex in nature, these negative feelings are unnecessary. A little careful planning and a common sense approach to tax season can result in big savings for the savvy business owner.
The seven tax tips mentioned above are a great place to start for the business owner in search of substantial savings for 2019.