Tax can be a nightmare for most small businesses. However, complying with IRS tax requirements is critical to ensure your operations run smoothly. Managing your tax liabilities allows you to make significant savings.
As a business owner, you are responsible for daily operations. It can be easy to put taxes on the back burner as you focus on managing your business. However, with proper tax efficiency, you can lower your tax dues and reinvest the money saved back into your business.
Here, we look at tax saving strategies that can help you reduce your tax bill.
Health Insurance
Health insurance is costly. Thankfully, the IRS offers special advantages if you pay your own health insurance. As a small business owner, you work for yourself, and paying your health insurance can lower your tax bill.
As a self-employed person, freelancer, or independent contractor, you can claim the health insurance tax deduction if you are not covered by your spouse.
However, employees who receive health insurance must share the cost of their premiums with the employer.
If you meet the requirements to claim a tax deductible on healthcare insurance, you can make maximum savings on your tax bill by deducting all or part of your premiums.
Typically, the adjustment you can claim is limited to your business’s net profit. This lowers your tax bill annually.
The deductible applies to dental, vision, medical, and long-term care insurance. It can also be extended to your spouse and qualifying dependents under 26.
You can also use a Health Savings Account to put money aside for healthcare needs if you have a high-deductible health plan. This allows you to save money on pre-tax, your savings grow tax free, and you do not have to pay tax for any withdrawals for medical expenses.
Start a Retirement Plan
Small business owners get access to tax-advantaged retirement savings plans. For instance, the Solo 401(k) plan, which is also referred to as a single-participant 401(k). Under this plan, you can save all your income as an employee up to the current annual limit.
Employees under 50 can save up to $20,500, while employees over 50 years can save up to $27,000. Your employer contributes 25% of your income.
You may also be eligible for the employer contribution based on your annual net income from self-employment as a business owner.
Another retirement savings plan to consider is the Self-Employed Person Individual Retirement Account, also known as SEP IRA. This plan allows you to save up to a quarter of your income and offers similar limits to the Solo 401(k).
Consider using the Solo 401(k) plan if you are self-employed or work as an independent contractor in addition to your main employment.
This allows you to save more money through your employer’s retirement plan. You can also contribute to Roth IRA and Traditional IRAs to further lower your tax bill.
Self-employed business owners also qualify to claim Saver’s Credit worth up to $1,000, or $2,000 if you are married and file jointly, for contributing to a retirement plan.
You may be eligible to claim Saver’s Credit if you contribute to a Traditional IRA, Roth IRA, 401(k), 403b, 457, SEP IRA, or Simple IRA.
Restructure Your Business
Small business owners do not enjoy the benefit of having an employer pay a percentage of their taxes. You have to pay your own Medicare and Social Security taxes. However, your business structure can significantly influence how much you pay in taxes.
A limited liability company may be able to eliminate the employer portion on Medicare and Social Security taxes.
For some small businesses, switching the business structure to a limited liability company can reduce your tax bill.
Some businesses can also claim the eligible business income deduction or the Section 199A Deduction. Eligible businesses include:
- Sole Proprietorships
- Partnerships
- S corporations
- Limited Liability Companies.
Small business owners and self-employed individuals can deduct up to 20% of qualified business income on the tax bill.
If your income falls under $170,050 as a single filer, or $340,100 for joint filers, you may be eligible for the qualified business income deduction. However, if you earn more than the applicable limit, you may apply for a prorated deduction.
The IRS defines qualified business income as the net amount of qualified items of gain, income, deduction, and loss concerning a trade or business. This includes all gains, income, losses, and expenses your business incurs.
However, qualified business income does not include the following:
- Dividends
- Capital gains/losses.
- Interest income
- Income earned outside the US.
- Wages and guaranteed payments issues to shareholders and partners
The Section 199A deduction does not apply to businesses classified under a specified service trade if their income exceeds $440,000 for joint filing and $220,050 for others.
Specified service trade businesses include doctors, financial planners, lawyers, consultants, and other professionals.
You may also claim this deduction partially of your total taxable income is between $340,100 – $440,100 for joint filers and $170,050 – $220,050 for others.
Depreciation Expense
Business equipment is essential for most small businesses. However, these assets age and experience wear and tear with use, decreasing their value.
The IRS allows you to cancel some of your income in the amount equivalent to the asset’s depreciation value.
Depending on the asset, there are different methods of claiming a tax deductible for depreciation.
- Section 179 deduction: This deduction allows you to make a large deduction in the asset’s first year of use. The deduction limit in 2022 was up to $1,080,000.
- Bonus depreciation: This allows you to deduct a large percentage of an eligible asset’s purchase value. The Tax Cuts and Jobs Act made it possible to deduct up to 100% of the purchase price in 2017.
- Modified Accelerated Cost Recovery System depreciation: MACRS allows you to make larger deductions during the early years of an asset’s useful life and smaller deductions later. Consequently, businesses reduce their taxable income in the present, lowering the tax bill.
Invest in your business by purchasing assets that allow you to claim tax deductions. Such assets may also include vehicles used for business purposes. However, the IRS has rules in place for business vehicles.
In 2022, new and pre-used cars used for business got a maximum depreciation write-off of $11,200 in the first year and $8,000 in bonus depreciation. SUVs with a loaded weight of over 6,000 pounds but less than 14,000 pounds can be expensed by 100% in the year of acquisition.
Employ Family Members
While not all small businesses can employ family members, you can reduce your tax bill by hiring a spouse or children. You are not required to pay unemployment (FUTA) taxes for a spouse or employment (FICA) taxes for your children.
Summary
With some careful purchases and smart business decisions, you can make significant savings on your tax bill. Get in touch with a tax professional to learn more ways to reduce your tax bill as a small business owner.
