Effective tax planning can make a significant difference in the financial health of a small business. Small business owners who proactively manage their taxes can reduce their tax liabilities and reinvest those savings into growing their business. Below, I’ll explore 10 key tax strategies that every small business owner should consider, offering practical ways to lower tax burdens and optimize your financial future.
1. Maximize Section 179 Deduction
The Section 179 deduction allows small businesses to immediately deduct the full cost of qualifying property such as equipment, vehicles, and software purchased during the tax year, rather than depreciating these assets over several years. For 2023, the limit for Section 179 deductions is up to $1,160,000, making it a powerful tax-saving tool. This deduction is particularly helpful for businesses looking to expand by purchasing new machinery, office equipment, or vehicles.
For example, if your business buys new machinery costing $100,000, you can deduct the full amount in the same year, significantly reducing taxable income. Utilizing Section 179 helps you get immediate tax relief, improve cash flow, and reinvest in the business.
2. Utilize Bonus Depreciation
Bonus depreciation is another useful tax tool for small businesses. In 2023, businesses can deduct 80% of the cost of qualifying assets in the first year they are placed into service. Bonus depreciation applies to many types of property, including vehicles and equipment, and can be used in conjunction with the Section 179 deduction to maximize tax savings.
For example, if you purchase an asset costing $200,000 and use Section 179 to deduct $100,000, you can apply bonus depreciation to deduct an additional 80% of the remaining $100,000. This results in substantial tax savings and is especially useful for businesses making significant capital investments.
3. Claim the Qualified Business Income (QBI) Deduction
Small business owners who operate as pass-through entities, such as sole proprietorships, partnerships, and S-corporations, can take advantage of the Qualified Business Income (QBI) deduction, which allows you to deduct up to 20% of your business income. This deduction can significantly reduce your taxable income, but there are income limitations and restrictions, especially for certain types of service-based businesses.
For instance, if you own a consulting business with $100,000 in income, you may be eligible for a $20,000 deduction. It’s a great way to lower your taxable income while staying compliant with IRS rules. However, because of the income thresholds, it’s crucial to work with a tax advisor to determine if you qualify and how much of a deduction you can claim.
4. Contribute to a Retirement Plan
Setting up a retirement plan helps secure your future and provides valuable tax benefits. Business owners can contribute to retirement plans like a SEP IRA, Solo 401(k), or a SIMPLE IRA, all of which allow you to deduct contributions from taxable income. In 2023, small business owners can contribute up to $66,000 to a Solo 401(k) or $61,000 to a SEP IRA, depending on their income.
For example, contributing $20,000 to a retirement account can lower your taxable income by the same amount, resulting in significant tax savings. Additionally, offering retirement benefits can attract and retain employees, boosting your business’s competitiveness.
5. Hire Family Members
Hiring your spouse or children to work in your business is a tax strategy that can reduce your overall tax liability. Wages paid to your children under the age of 18 are not subject to Social Security or Medicare taxes, which means you can lower both your payroll taxes and taxable income.
For instance, if you hire your 17-year-old child to work in your business and pay them $12,000 per year, you can deduct that salary as a business expense. This reduces your taxable income and allows your child to earn income that can be saved or invested in a tax-advantaged account like a Roth IRA.
6. Defer Income and Accelerate Expenses
If your business operates on a cash basis, deferring income to the following year while accelerating expenses into the current year is a great way to reduce taxable income. By delaying sending invoices until late December and prepaying expenses like rent or supplies, you can shift income and deductions between tax years to your advantage.
For example, if you expect a higher income in the following year, you can delay receiving payments or advance expenses to reduce your current year’s taxable income. This strategy helps smooth out tax liabilities over time and can be especially useful if you anticipate fluctuations in revenue.
7. Home Office Deduction
If you use part of your home exclusively for business purposes, you may be eligible for the home office deduction. This deduction allows you to write off a portion of your home expenses, such as mortgage interest, utilities, and maintenance, based on the square footage used for business.
For example, if your home office occupies 15% of your home’s square footage, you can deduct 15% of qualifying home expenses. The IRS provides both a simplified method and a regular method for calculating the deduction, so be sure to choose the option that provides the most tax savings.
8. Deduct Health Insurance Premiums
Self-employed business owners can deduct 100% of health insurance premiums for themselves, their spouse, and their dependents through the Self-employed Health Insurance Deduction. This deduction reduces your adjusted gross income, which lowers your taxable income.
For instance, if you pay $12,000 annually for health insurance, you can deduct that amount from your taxable income. This is an important tax-saving tool, especially for small business owners who purchase their own insurance.
9. Create an Accountable Plan for Employee Reimbursements
An accountable plan allows businesses to reimburse employees for business-related expenses, such as travel or office supplies, without counting the reimbursements as taxable income. The business can deduct these reimbursements, reducing its tax liability.
By having a formal accountable plan in place, you ensure that reimbursed expenses are not treated as income for the employee, which saves both the employee and the business money. It’s a win-win strategy for managing business expenses efficiently while staying compliant with tax laws.
10. Take Advantage of Tax Credits
Small businesses can benefit from several tax credits, such as the Work Opportunity Tax Credit (WOTC), which rewards businesses for hiring individuals from certain target groups, like veterans or long-term unemployed individuals. Other credits include the Research and Development (R&D) Tax Credit, which provides incentives for businesses investing in innovation.
For example, the WOTC allows you to claim up to $2,400 per qualified employee, which can add up to significant tax savings if you hire multiple qualifying workers. These tax credits reduce your overall tax liability and incentivize business practices that contribute to broader economic goals.
Top Tax Planning Strategies for Small Business Owners
- Maximize Section 179 and bonus depreciation deductions
- Take advantage of the Qualified Business Income deduction
- Contribute to retirement plans like Solo 401(k) or SEP IRA
- Hire family members to reduce payroll taxes
- Create an accountable plan for employee reimbursements
In Conclusion
Tax planning is an essential aspect of running a successful small business. By leveraging these 10 tax strategies—ranging from maximizing deductions like Section 179 and bonus depreciation, to implementing retirement plans and hiring family members—you can significantly reduce your tax burden while positioning your business for future growth. Working closely with a tax advisor ensures that you’re compliant with tax laws and maximizing all available deductions and credits.