According to a 2018 survey from Clutch, a B2B research, ratings, and reviews company, 30% of small businesses believe they overpay their taxes. And, they also think that they could claim more deductions and credits.
Why’s that a big deal? Because small businesses already run on tight margins. They’re also in survival mode, thanks to COVID.
So, wherever you can save money, the better it is for your small business. And, you can get started by exploring the following 10 tax-saving hacks.
1. Know your deductible expenses.
“The United States tax code has some great advantages for business owners,” writes Eric Rosenberg in a previous Due article. “Millions of business owners leave dollars on the table that should be in their pocket every year when filing their personal and business taxes.”
Regardless if “you operate as a sole proprietor, an LLC, or a corporation, you can lower your taxes and save money by deducting, also called writing off business expenses,” adds Eric.
But, first, how exactly do deductions work?
“Every dollar your business earns is considered revenue,” explains Eric. “Revenue is the big number that represents total sales and receipts, but thankfully we don’t have to pay taxes on our revenue.” That’s because Uncle Sam “allows us to deduct our qualified business expenses from our revenue to calculate our net income. Taxes are based on your business net income.”
“Not all expenses related to your business can be 100% deducted,” he adds. Assets, such as “vehicles and computers, must be deducted over time through a process known as depreciation.” Since “you have to eat anyway, meal deductions are limited to a percentage of the total cost.”
The good news? If you play by the rules, “there is no limit to how much you can save on your taxes through deductions,” says Eric. “As long as you earn more than your expenses, you can deduct the expenses on your taxes.”
With that out of the way, here are some of the most common business deductions you can write-off;
- Business computers, printers, routers, and general office supplies.
- Online and offline services ranging from virtual assistants to accountants.
- Business travel, meals, and entertainment.
- If you work from home, “you can calculate the percentage of your home that the office occupies and write off that percentage of your rent or mortgage and power bill as a business expense.”
- Business vehicles.
But, wait, there’s more. You may also be eligible to deduct;
- Advertising costs
- Business interest and bank fees
- Bad debts
- Child and dependent care
- Education and development
- Health insurance premiums
- Retirement contributions
- License, permit, and tax fees
- Payroll deductions, such as federal income, state and local, and FICA taxes
And, don’t overlook Section 179 deductions. Via the IRS;
“Section 179 allows taxpayers to deduct the cost of certain property as an expense when the property is placed in service. For tax years beginning after 2017, the TCJA increased the maximum Section 179 expense deduction from $500,000 to $1 million. The phase-out limit increased from $2 million to $2.5 million. These amounts are indexed for inflation for tax years beginning after 2018.”
Usually, these purchases fall into the following categories;
- Business furnishings
- Improvements like HVAC and security systems
- Real estate
- Vehicles that way over 6,000 pounds
2. Start gathering your receipts.
Perhaps one of the simplest tax-saving hacks is gathering and organizing tax documents and receipts. These include;
- Mortgage interest statements
- Investment income statements
You should have received these in the mail by January 31. If you haven’t, contact the issuer.
Next up, you need to round-up your receipts. Before getting carried away, this will depend if you’re going to itemize your deductions or claim the standard deduction. Generally, you really only need to keep receipts if you’re claiming a deduction. For example, if you want to deduct childcare expenses, then you’ll need to have documentation like a receipt from your child’s daycare.
You can make this easier on yourself in the future by implementing an organizational system. A tried and true way is to have categorized folders and immediately placing a bill, receipt, or any important tax document there when you get it.
A filing cabinet works just fine. But, if you want to save space, you can go electronic and scan these documents using apps like Shoeboxed.
3. Pay for your retirement now.
Did you know that you can reduce your taxable income just by putting more money into a retirement account? The reason? These funds aren’t taxed until they’re withdrawn in retirement.
For example, you can make tax-deductible contributions to a Traditional IRA. But, a Roth IRA, permits after-tax contributions. Just note the contributions “did not see a change from 2020 to 2021,” writes Alicia Dion in a previous Due article. “You can contribute up to $6,000 per year or $7,000 per year if you are over age 50.”
4. Change your business structure.
You may not have realized this before, but how your business is structured does impact your taxes. I would speak with your attorney or accountant before making any changes. But, here’s a brief rundown of what to expect;
- Sole Proprietorship is the default for most businesses. “You and your business aren’t separated for tax purposes or liability purposes,” explains Miranda Marquit in another Due piece.
- LLC or Some Type of Partnership: “There are different ways to set up your business as a partnership,” says Miranda. “You can do this to limit liability, and to distribute your money in different ways. For example, a single-owner LLC is treated as a sole proprietorship for tax purposes. That means the LLC does not pay taxes, nor does it have to file a return.
- S-Corp.: “Many entrepreneurs like this business structure because it is a ‘pass-through’ where the business itself isn’t taxed,” she adds. “However, you need to maintain payroll and give yourself a salary.”
- C-Corp.: “When you organize this way, there are some advantages, but your company also pays taxes, and you pay taxes on your own income.”
“Understanding the implications of these structures is important,” Miranda suggests. “Get an idea of what to expect in taxes before you move forward.” Also, make sure to take into the scalability of each structure and what state you live in to make sure you’re using the right business structure.
5. Take the qualified business income deduction.
“The qualified business income deduction (QBI) is a tax deduction that allows eligible self-employed and small-business owners to deduct up to 20% of their qualified business income on their taxes,” clarify NerdWallet’s Andrea Coombes and Tina Orem.
“In general, total taxable income in 2020 must be under $163,300 for single filers or $326,600 for joint filers to qualify,” they add. “In 2021, the limits rise to $164,900 for single filers and $329,800 for joint filers.”
You’re eligible for the QBI if you’re a sole proprietorship, LLC, partnership, or S Corporation. You must also have “qualified business income,” which is “the net amount of qualified items of income, gain, deduction and loss concerning any trade or business.” In other words, your business’s net profit.
“If your total taxable income — that is, not just your business income but other income as well — is at or below $163,300 for single filers or $326,600 for joint filers, then in 2020, you may qualify for the 20% deduction on your taxable business income,” state Coombes and Orem. “In 2021, the limits rise to $164,900 for single filers and $329,800 for joint filers.”
Things get tricky if you’re over that limit. But, one test you can run is asking if your business is a “specified service trade or business.”
“If you’re a doctor, lawyer, consultant, actor, a financial planner — and the list goes on — then your business is deemed a “specified service trade or business,” and many high earners in these fields won’t qualify for this tax break, because it disappears once you hit the total taxable income of $213,300 if you’re single, and $426,600 if you’re married filing jointly,” the authors explain.
6. Find a health savings account.
Another way to reduce your taxable income? Contribute to a health savings account (HSA). Note that you’ll actually need a high-deductible health plan to qualify.
Not only can these contributions reduce your income-eligible for taxation, but they could also be helpful with planning future medical costs. And, that’s a great start to protecting your financial future.
- If you’re single, you can contribute up to $3,500 (rising to $3,600 in 2021).
- For couples and families, the limit is $7,100 (increasing to $7,200 in 2021).
- If you’re 55 or older, you can “catch-up” by adding an extra $1,000 per year.
Moreover, since HSAs are pre-taxed, and contributions are tax-deductible, they’re a great source of emergency funding or a longer-term IRA replacement.
7. Work with contractors, freelancers, and family members.
Sure. You may be paying contractors or freelancers (IC’s) more per hour; this can still save you money. “When you hire an employee, you will have to pay many expenses that you don’t have to pay for ICs, including employer-provided benefits, office space, and equipment,” explains Stephen Fishman, J.D.
“You will also have to make required payments and contributions on behalf of your employees, including:
- your share of the employee’s Social Security and Medicare taxes, which totals 7.65% of the employee’s compensation
- state unemployment compensation insurance, and
- workers’ compensation insurance.”
When added up, “these expenses can easily increase your payroll costs by 20% to 30% — or more,” adds Fishman.
Additionally, if you have family members, you can hire them as well. For example, if you hired your teenager, you’ll pay a lower marginal rate. You may even eliminate the tax on the income paid to them.
How is this possible? If you’re a sole proprietorship, you don’t have to pay social security and Medicare taxes on the wages to your child. You also don’t have to worry about the Federal Unemployment Tax Act (FUTA) tax either. If you hire your spouse, you’re also not subject to the FUTA tax.
8. Keep track of your carry-forwards.
“Small businesses usually operate at a loss for the first few years,” writes SMB accounting expert Ryan Lasker. “When your business starts to earn a profit, you can use prior business losses to lower your tax bill with the net operating loss (NOL) deduction.”
Let’s say that your business opened in 2019. You “brought in $100,000 in revenue and incurred $150,000 in operating expenses, creating a $50,000 NOL.” You don’t have to pay income taxes on losses. But, “you can take a deduction up to $50,000 to offset income in years when you turn a profit.”
“If your business subsequently has taxable income of $75,000 in 2020, you’ll pay income tax on $25,000 ($75,000 taxable income – $50,000 NOL deduction,” he adds.
Because of COVID-19, the NOL deduction rules were loosened. “In 2020, you may carry back a loss, allowing for an immediate tax refund for a portion of taxes paid in the last five years,” Lasker explains.
9. Be aware of (tax) bomb threats.
Speaking of the pandemic, there is some uncertainty regarding the Paycheck Protection Program. If you were a recipient, the federal government has granted tax-free forgiveness of the loan. You may also be able to deduct expenses, such as payroll.
Unfortunately, not all states have made it clear if their deductions will also be available on state returns. That could result in a nasty surprise this year.
One solution is to request an extension until you have the answer.
For more on how COVID-19 may impact your taxes, check out this Due article from Kate Underwood.
But, there’s another lesson going forward. Always stay on top of tax changes so that you aren’t getting hit with penalties or fees. That might be a lot to ask for when you’re crunched for time. If so, that’s another reason why you hired a financial advisor or tax preparer.
10. Add tax deadlines to your calendar.
Want to avoid penalties? Then you obviously need to have been aware of deadlines. The most glaring is April 15. But, small business owners must also pay quarterly taxes.
With all of your other responsibilities, it’s easy to miss these critical deadlines. Thankfully, the IRS has an online calendar that you can subscribe to. When do these dates will be added to your calendar.