Entrepreneurs often need to wear different hats. Juggling the many ups and downs of running a small business is time-consuming. A vital but often overlooked function, strategic tax planning, can slip through the cracks. Over time, this can eat away profits and slow business growth. To prevent this from happening, entrepreneurs need to understand corporate tax planning strategies and implement them during the early stages of their business.
This article will break down several tax planning strategies that small business owners can use to save on taxes and remain compliant in simple but effective ways.
Benefits of Tax Planning for Your Business
Considering the many benefits of small business tax planning, owners and employees should proactively plan for early and effective tax optimization and understand how to manage finances thoughtfully.
A few of the advantages of tax-planning strategies are listed below.
Reduced Tax Burden
The main advantage of strategic tax planning is minimizing the organization’s tax liabilities. By identifying deductions and exemptions, business owners can lower the taxes they must pay to the government, allowing them to keep the funds as profit, cover their expenses, or convert them into capital.
Better Cash Flow
A business can ensure better cash flow with better tax planning, allowing them to take advantage of growth opportunities at the right time. They can quickly meet their payment deadlines with suppliers and vendors and avail of early payment discounts.
Facilitate Expansion
With more funds, businesses can plan further investments, and allocate resources for expanding their operations, or distribute more significant profits to stakeholders.
Assured Tax Compliance
To take advantage of tax schemes, deductions, and exemptions, businesses must have a comprehensive understanding of the tax laws and regulations in their respective states. This ensures that the company stays compliant with the rules. In case you file your taxes in the wrong way, your business could be liable to pay heavy fines that would chip away at your profits.
Risk Reduction
Companies that pay attention to tax regulations will proactively identify and address any potential lacunae or risks related to tax filings and avoid problems in the future.
Competitive Edge
Tax planning strategies help companies retain a competitive edge in the market by decreasing tax burdens and increasing profitability. With more resources available for investment and employee compensation, businesses have more financial flexibility to attract and retain talented workers and offer better pricing to customers.
Building the Foundation for Tax Optimization
To ensure long-term business success, entrepreneurs need to equip themselves with the correct information and tools at the beginning. This allows them to maximize profits and minimize tax liabilities, leading to faster growth. Here are a few foundational steps that can result in a more effective tax-saving plan for small businesses.
Choose the Right Business Structure
Business owners should evaluate what kind of structure works best for their company. Factors like tax liability, personal liability, the involvement of business partners or investors, and the desired level of control will eventually play a role in their decision-making. Companies have the option to register as:
- Sole proprietorship
- Partnership
- Limited liability company (LLC), or
- Corporation (S Corp, C Corp, B Corp, Close Corp, Non-profit Corp)
Each option has its unique balance of legal protections and benefits. However, an LLC has many advantages, specifically in tax strategies for small business owners, some of which are as follows:
- Pass-Through Taxation: With an LLC, the company’s income can pass through to the business owner, which allows them to pay taxes at a personal income tax rate, which is lower than corporate income tax rates.
- Avoidance of Double Taxation: In corporations, profits are taxed at the corporate level, and the gains shared are taxed again on the shareholders’ personal income tax returns. However, income is taxed only at the individual level in LLCs, leading to tax optimization.
- Savings on Social Security and Medicare Taxes: While self-employment income is subject to these taxes, only the portion of LLC income classified as self-employment income is subject to them, which can result in potential tax savings.
Choose Tax-Friendly Locations
Another important factor for tax optimization is – location, location, location! Knowing the best and worst states for business taxes is essential when considering tax-planning strategies, as tax laws differ from state to state. This greatly affects how owners can expand or structure their businesses. For example, operating in a state with favorable tax laws can lead to more profits with tax savings, while setting up in a state with higher tax rates may lead to lower profits. Owners may require more robust tax planning strategies to reduce the impact on the company’s bottom line.
Mark Essential Tax Deadlines
Businesses should stay aware of the due dates for their tax forms. The important dates for tax filing are:
- March 15 for partnerships, multi-member LLCs, and S Corps
- April 15 for sole proprietorships, single-member LLCs, and corporations (including multi-member LLCs taxed as corporations).
Separate Personal and Business Funds
Owners should take the necessary steps to separate their personal and business finances. Combining the two leads to potential disorganization in tax filing. Creating a different bank account for the company simplifies tax filing, legitimizes the business, and prevents overspending.
Maintain Thorough Records
For an effective tax planning strategy, entrepreneurs should keep organized records to detail their business’s gains and losses accurately. Important records include:
- Receipts
- Bank statements
- Financial statements
- General ledger
- Invoices
- Credit card statements.
Utilize Accounting Software
Advanced electronic systems and accounting software help busy entrepreneurs keep track of their business expenses while managing and storing their records securely. This simplifies their preparation for tax filing. Some software also includes features like generating financial reports, invoicing and streamlining financial management tasks and facilitating smooth business operations.
18 Tax Tips for Small Businesses
The first step in an effective tax savings plan is critically evaluating the business and understanding which direction to take. A business owner should review their estimated net income and make the following adjustments to their strategy:
1. If their income is lower than expected, they should look into tax credits and other benefits they may not have qualified for when they were at a higher income level, thereby reducing their overall tax liability.
2. If their income is higher than expected, they should pursue aggressive deduction strategies.
Here are 18 tax planning strategies for small business owners that can help them reduce their tax liability.
Accounting for Business Losses
Keeping track of business losses, if any, allows owners to deduct the amount, reducing the overall taxable income. By accurately documenting and reporting business losses, owners can offset their income and potentially lower their tax liability. This can be particularly advantageous during challenging times when businesses face unexpected downturns. Maintaining proper records is crucial to ensure compliance with tax regulations and take full advantage of available deductions.
Deferring Taxable Income
Managing taxable income to minimize taxes is an effective tax planning strategy. Entrepreneurs can put recurring expenses on credit cards, mail checks at the end of the year, prepay costs within IRS limits, and delay invoice submissions until the new year.
Including All Business Expenses
Rent and utilities can be added to the business’s costs, making a considerable difference for small business owners working from a home office. Counting these expenses can lower taxable income.
Deducting Assets to Charity
Donating assets to charity is a tax reduction strategy with dual benefits. The charity can use the donation to improve the community, and the business enjoys the tax deduction. Apart from the financial gain, choosing a charity aligned with the brand, which benefits the community, can attract and retain loyal customers or attract investors looking at the company’s corporate social responsibility initiatives.
Recruiting Family Members
Small business owners can recruit family members to reduce their tax liabilities. Keeping children on their employee roster can help them benefit from lower tax rates. Their income may be considered tax-free if it is below the IRS threshold. Hiring a spouse is also beneficial because their earnings may be exempted.
Maximizing Retirement Plan Contributions
Small business owners can implement an effective tax-planning strategy by maximizing contributions to retirement plans, such as a 401(k). A 401(k) allows employees to save for retirement without paying taxes on the money they contribute immediately. Business owners can also contribute to their savings. However, when employees retire and withdraw money, they must pay taxes on those withdrawals.
Utilizing Startup Deductions
Small business owners starting a new enterprise can benefit from deductions specifically designed to assist with startup costs. These deductions are calculated based on the expenses incurred to start the business.
Deducting Vehicle Expenses
Business owners can write off the cost of vehicles weighing over 6,000 pounds or deduct a percentage if the car is used for business operations and personal purposes. However, there is a limit to this deduction, and records documenting the use of the vehicle need to be appropriately maintained in case of audits in the future.
Implementing HSAs for Employees
With the cost of healthcare reaching all-time highs, setting up Health Savings Accounts (HSAs) for employees can help reduce taxes while building employee loyalty. Contributions for medical expenses are tax-free and also ensure a healthier workforce within the small business, providing a win-win for all.
In addition, businesses that employ 25 full-time equivalent employees and pay at least 50% of their health insurance premiums qualify for the small business health care tax credit.
Taking Advantage of Disaster Relief
If a business has been impacted by a disaster, claiming losses on prior year tax returns instead of the year the disaster occurred can help reduce the tax liability and support the small business in getting back on its feet.
Programs like the employee retention credit, the Families First Coronavirus Response Act, and net operating loss (NOL) carrybacks for C corporations aim to provide relief for businesses affected by COVID-19.
Acquiring Assets at Year-End
If owners acquire new or used assets before the end of the year, they can help small businesses take advantage of the 100% bonus depreciation allowed by the Tax Cuts and Jobs Act of 2018.
Helping Employees with Student Loans
Employers can help employees with student loans to take advantage of the provisions under the CARES Act. This act allows companies to receive a tax exemption on payrolls to repay the student loan.
Offering a Fringe Benefit Plan for Employees
Companies can offer fringe benefits as part of employees’ compensation to reduce employment tax costs. A few tax-exempt benefits include insurance plans, childcare assistance, and tuition reimbursement.
Taking a Tax-Free Loan From the Business
Owners can take low- or no-interest loans from their businesses. They can also avoid reporting interest if the amount falls below the Applicable Federal Rates set by the IRS.
Paying Attention to Carryover Deductions
Although some tax deductions and credits have limitations, they can be carried over to future years. A few examples that can be used to bolster a tax-planning strategy for small businesses include capital losses, general business credits, home office deductions and net operating losses, and charitable contributions.
Keeping Track of New Tax Laws for Small Businesses
The Inflation Reduction Act (August 2022) introduces a 15% corporate minimum tax, which applies to companies with more than $1 billion in profits, and a 1% excise tax on shares repurchased by companies after December 31, 2021. Base Erosion and Anti-Abuse Tax (BEAT) and Global Intangible Low-Tax Income (GILTI) may be developed and implemented in the future.
Keeping Track of Tax Credits
Owners may be eligible for tax credits if they hire people who have trouble gaining employment, like qualified veterans or former prisoners, vocational rehabilitation referrals, SNAP recipients, and long-term family assistance recipients.
Tracking Business Travel Expenses
Transportation costs related to business activities like airfare, rides, mileage, accommodations, and meals are tax-deductible expenses that businesses can take advantage of. However, maintaining detailed expense records is vital to support these deductions and safeguard them from future audits.
Conclusion
In conclusion, implementing effective tax-planning strategies is crucial for small business owners to optimize their profits, ensure compliance with tax laws, and foster business growth. After all, every dollar saved is a dollar earned!
