Every business owner must mitigate the tax bite. Taxes eat into profit margins and decrease personal income. Reducing the tax burden often makes the difference between a comfortable- and tight budget.
For business owners, many strategies exist for reducing both business- and personal income tax, including the following:
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- Restructure the business as an LLC
- Maximize tax credits
- Take bonus depreciation
- Time income, expenses, and bad debt write-offs
Restructure the Business as an LLC
You have fewer options for reducing taxes when you run a business as a sole proprietor or partnership. To cut your tax bill, consider restructuring your business as an LLC, a move that creates the flexibility of a “pass-through entity.”
Using an LLC to Reduce Self-Employment Tax
One disadvantage of working for yourself or owning a small business is self-employment taxes. W2 employees pay roughly half the taxes for Social Security, Medicare, and Medicaid (FICA) than self-employed people and business owners because employers cover half of the FICA tax.
Restructuring a business as an LLC gives you the option of paying taxes as an S corporation. When you select this option, you pay yourself a set salary rather than declaring your business’s net income as your personal income.
As a result, the non-salary portion becomes a pass-through distribution, not subject to FICA taxes. Also, the business then covers half of the FICA tax, leading to considerable savings at tax time.
For example, your business might generate $150,000 in net profit. You could then elect to pay yourself a salary of $75,000, halving the amount subject to FICA taxes. In addition, you would pay 7.5% FICA tax on the $75,000 rather than the nearly 15% self-employment tax.
Pass-Through Tax Deduction
The Tax Cut and Jobs Act (TCJA) permits owners of an LLC to deduct up to 20% of their business’s income on their personal tax returns. For example, if your business generated a net income of $75,000, you can take a pass-through deduction of $15,000!
Some limits apply. For example, the tax code phases out the pass-through deduction for service business owners that make over $157,500 for single filers and $315,000 for married filing jointly.
Maximize Tax Credits
The federal government (and some state and local governments) seek to advance policy agendas by offering tax credits to businesses. These financial incentives encourage business owners to take specific actions that policymakers deem better for society—for example, hiring the disabled or reducing pollution.
Common examples include the following:
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- Increased hiring
- Buying environmentally friendly equipment
- Installing handicap accessible equipment
- Serving a minority community
What tax credits your business qualifies for depends on its industry, location, size, and other factors. A tax professional can examine your business to determine all the credits that may offset a portion of your taxes.
Bonus Depreciation
The TCJA provides business owners with additional tax savings opportunities concerning depreciation. Under the Act, businesses can claim more significant tax write-offs on business-related equipment, machinery, vehicles, and real estate for the first year management places them in service.
Section 179 of the tax code governs these accelerated depreciation deductions, also known as bonus depreciation. It limits capital equipment write-offs to $1 million per tax year. Bonus depreciation ranges from 50% to 100% of the equipment’s cost.
Time Income, Expenses, and Bad Debt Write-offs
To maximize deductions, look for opportunities to time income and expenses to coincide with the upcoming tax filing. By moving income and expenses into the most advantageous tax year, you can reduce your business’s taxes by taking an expense against a year with higher income or booking more income in the year you take a significant expense. This type of tax planning allows you to keep taxes more even and avoid surprises.
Most businesses experience bad debts. While not getting paid is anathema to margins, you can turn these lemons into lemonade by timing bad debt write-offs. As the end of the tax year approaches, review all past due accounts and determine which are hopeless or unlikely to pay. Bad debts may include unpaid invoices but also loans made to clients, vendors, or employees. By maximizing the write-off, you can blunt the impact of these losses.
Visit a CPA
Certified public accountants are tax experts. They know how to apply the tax code to your unique situation to achieve the best tax outcome. In addition to preparing tax returns, they assist with long-range tax planning, business structuring and represent clients before the IRS. With a CPA on your side, you keep the maximum percentage of your earnings.
Tax Avenger located in Canton is a full-service tax and accounting firm helping individuals and business throughout Michigan for 20 years. Our services include tax preparation and remote filing, business startup, small business accounting, bookkeeping and more. Call and set up your Free Consultation today!