After investing years of sweat, tears, and sleepless nights to get their venture off the ground, no small business owner wants to jeopardize profitability by overpaying their taxes. Nevertheless, according to a survey from leading B2B research company Clutch, 30 percent of small business owners admit that they fail to claim all the deductions and credits they are entitled to. However, according to the same poll, 95 percent of business owners rate themselves as “somewhat confident” or “very confident” in their tax filing capabilities. With 9 out of 10 US small businesses overpaying on taxes, according to a report by Forbes, we look at six top tips to reduce the tax liability of your small business and increase profitability.
1. Maximize and Optimize Deductions
An experienced tax professional could potentially save a small business owner thousands in unnecessary taxes. From marketing to travel to office supplies, many small business owners neglect to maximize their available tax deductions.
To claim these deductions, business owners must keep meticulous records, setting up their books and expense management processes to categorize tax-deductible expenses, capturing receipts for future access. The same principles apply to tax credits.
Business owners must claim all credits and deductions they are eligible for to minimize their tax liability. In some instances, they can choose between two different ways of deducting a particular business expense, creating further savings by claiming the more advantageous option. For example, for travel and cars, you can either claim the exact cost or use the IRS standard mileage rate to calculate the deduction. Keeping careful records enables you to compare the advantages of each method and choose the one that offers the greatest return.
2. Invest in Employees
One of the most effective ways of reducing taxable income is to invest the profits back into the business, specifically employees. This not only incentivizes teams, boosting morale by showing workers that you appreciate them, but it could significantly reduce your business tax burden.
Wages, salaries, bonuses, and other forms of staff compensation are tax deductible provided that they fit the following criteria:
- The amount is reasonable.
- The compensation is necessary and ordinary.
- The funds were paid for services actually given.
- They were incurred or paid for in the current tax year.
3. Contribute to a Retirement Plan
If a business is profitable, its owners can shelter their income by investing in a qualified retirement plan. This provides them with tax deductions on contributions, effectively deferring tax on income.
Employee retirement contributions are also a tax-deductible expense for employers. According to the IRS, an employer is entitled to deduct 401(k) contributions if they do not exceed the limitations stipulated in section 404 of the Internal Revenue Code.
Operating a profit-sharing, matching, or safe harbor contribution scheme is a great way to boost staff morale, as it can attract top talent to join and stay with your business. Research shows that happy workers are more productive, potentially boosting your business’ bottom line even further.
Meanwhile, business owners who draw a salary from the business could create a retirement savings plan for themselves, matching contributions to maximize tax deductions. It is important to note, however, that the IRS implements nondiscrimination rules requiring businesses to ensure that company matches do not favor management over “rank-and-file” staff, ensuring that all employees benefit equally.
4. Employ Family Members
One of the most effective ways of reducing your small business’ tax liability is to hire a family member. The IRS provides for a variety of options, including hiring children, to potentially shelter business income from taxation.
Sound Accounting founder and Certified Public Accountant Scott Goble advocates employing family members, explaining that the tactic enables small business owners to pay a lower marginal rate and eliminate tax on income paid to their children.
5. Make Charitable Contributions
Making charitable contributions is a great way for small businesses to pay back to society; it elevates the company profile while achieving significant tax savings. With the ability to deduct up to 25 percent of total taxable income in charitable donations, small businesses can achieve some significant savings, although as with other deductions, owners must keep careful records of donations and retain receipts.
6. Optimize Your Business Structure
All business structures were not created equal. The choice of structure can have a direct and profound impact on business tax liabilities.
Without an employer to handle a portion of their taxes, small business owners are liable for the full amount of their Medicare and Social Security taxes. However, if the business is taxed as an LLC, this may enable the owner to eliminate the employer half of both tax burdens, making this a wise switch for some small businesses.
Seeking out the advice of a seasoned accounting and legal professional can help you identify and transition to the optimum structure for your business, potentially creating some attractive tax savings.