What is Small Business Tax Planning?
As a small business owner, you’re likely aware that taxes are one of your company’s most significant expenses. A small business tax planning strategy helps you minimize your tax liability with various tax benefits and timing your revenue and expenses when applicable.
Reducing Your Adjusted Gross Income (AGI)
One of the main goals in tax planning is to reduce your AGI. There are several ways to do this. You can adjust your AGI on your personal tax return or reduce your business’s income.
Reducing income on personal tax returns includes finding eligible deductions and credits. Examples include retirement plan contributions, mortgage interest, or student loan interest.
Finding deductions or tax credits to reduce business income includes various expense deductions, employee credits, and more.
Should you change your Tax Status?
There are several options for how to structure your business. You can form a sole proprietorship, general partnership, limited liability company (LLC), C-Corporation, or S-Corporation.
The type of structure determines how your business gets taxed. If you’ve outgrown your current structure, you could time changing your status to help with taxes.
Pass-Through Entities & Corporations
Sole proprietorships, partnerships, and LLCs are pass-through businesses, meaning the company’s income passes through the business to the business owner(s), who then report the income on their individual tax returns. Corporations are taxed at the business level, and then each owner includes their income from the business on their personal tax returns.
For many years, it was considered better to avoid the double taxation of a corporation. However, the Tax Cuts and Jobs Act of 2017 lowered the corporate income tax rate from 35% to 21%. Meanwhile, the highest tax bracket for personal income is 37%.
As such, changing your structure could result in significant tax savings for the highest earners. But consult a tax professional and ensure the change is right for your business. There are many considerations for a business’s structure besides tax status.
What Tax Deductions are available for Small Business?
Many tax deductions are available for different business expenses or types of business. Some deductions are industry-specific or only apply to companies of a specific size.
A tax deduction reduces your reportable income, resulting in a lower tax bill. Here are some deductions that you might be able to claim.
Qualified Business Income Deduction
The Qualified Business Income (QBI) Deduction allows business owners who report business income on personal tax returns to deduct up to 20%. That means most small business owners for pass-through entities can claim this deduction.
However, the QBI deduction has limitations depending on your total reported income and the type of business income. For example, the deduction does not include:
- Capital gains or losses.
- Interest income.
- Income earned outside the US.
- Certain wages and guaranteed payments to partners and shareholders.
Generally speaking, you can qualify for the full deduction if your taxable income is less than $164,900 for single filers or $329,800 for joint filers. It begins to phase out at prorated deductions when your income is higher.
In addition, if the business is considered a specified service trade or business (SSTB), you can’t claim the deduction if your income is over $220,050 for single filers or $440,100 for joint filers.
The exact rules and qualifications can get confusing. Consult with a tax professional to see what deduction you can get.
The US Tax Code includes deductions to incentivize companies to participate in various economic activities. Here are some potential ways to deduct expenses related to running a business:
- Marketing or promotional activities to expand your reach and customer base.
- Insurance that protects against hardships or liabilities that occur in the regular course of business.
- Legitimate business travel or business meals.
- Paying for employee education, whether at a degree program or industry training and certification.
Home Office Deduction
Business owners operating out of their residency might qualify for a home office deduction. You can take the simple deduction, allowing you to deduct $5 per square foot (up to 300 square feet).
The other option is the actual expense method. This method requires calculating the percentage of your home’s square footage used for the office and then deducting that percentage from your total home expenses (mortgage interest or rent, real estate taxes, utilities, and repair costs).
The space must be used exclusively for business purposes to qualify.
Many businesses require equipment to perform their essential duties and deliver goods or services. Essential business equipment is also one of the largest expenses you might incur.
The IRS allows you to offset some of that cost with various equipment depreciation deductions. Those include:
- Section 179 deductions.
- Bonus depreciation.
- The Modified Cost Recovery System (MARCS) deduction.
When it makes sense for your business, you may want to delay asset purchases until the end of the tax year to maximize your available deductions.
Business Vehicle Deductions
You may be able to deduct automobile costs if your business requires using a vehicle. The standard mileage rate and the actual expense method are the two main methods for calculating business vehicle expenses.
Financing Expense Deductions
Most businesses require financing help at some point, whether it’s a small business loan, a business line of credit, or a business credit card. The IRS allows small business owners to deduct financing costs, such as loan interest and fees.
There are some exceptions, such as not being able to deduct interest on loans with non-deductible interest. When considering small business financing, you should speak with your tax professional about your tax deduction options.
Retirement Plan Deductions
Creating or contributing to a retirement plan can help reduce your AGI and tax liability. You can set up a 401(k) plan, pension plan, or IRA. Most retirement account contributions are taken from your pre-tax income. That means the larger the contribution, the lower your taxable income.
Consider hiring a financial advisor to assist with setting up a retirement plan. Financial advisors can help you determine the best options for maximum retirement savings and tax benefits. They can also help you understand how much you can deduct using employer contributions.
What Tax Credits are available for Small Business?
While tax deductions lower your reportable income, tax credits reduce the taxes you owe or increase your refund. Here are some available business tax credits.
Work Opportunity Credit
The Work Opportunity Tax Credit (WOTC) helps incentivize employers to hire and retain employees from target groups that traditionally have trouble finding employment. Examples include felons, veterans, and individuals from families receiving Temporary Assistance for Needy Families (TANF) program benefits.
Small businesses can receive a credit of up to $2,400 per qualified employee. To receive the credit, complete and submit Form 8850 within 28 days of the hire. The business can claim the credit on its next scheduled filing date after the state confirms the employee is eligible for the credit.
Disabled Access Credit
Businesses that invest in increasing accessibility for disabled individuals could potentially receive the Disabled Access Credit (DAC). The credit is worth 50% of eligible expenses up to the $10,000 limit.
To qualify, businesses must have not more than 30 full-time employees, and annual revenue cannot exceed $1 million. Examples of DAC-eligible expenses include installing wheelchair ramps, offering Braille, providing a sign language interpreter, or purchasing adaptive equipment.
Health Insurance Credit
Some small businesses may be able to claim a tax credit for the cost of employee insurance premiums. Qualifying businesses must meet these conditions:
- Fewer than 25 full-time employees.
- Pay average wages of less than $58,000 (requirement for 2022; the amount is indexed to inflation, so it changes each year).
- Purchased group health insurance through SHOP (Small Business Health Options Program Marketplace).
- Pay at least 50% of the employee premium.
Eligible businesses can receive a credit of up to 50% of premiums paid during the year. Businesses can claim the credit in two consecutive tax years.
Employee Retention Tax Credit
Businesses that retained employees during the COVID-19 pandemic (all of 2021 and the last three quarters of 2020) can still retroactively apply for the Employee Retention Tax Credit (ERTC). The credit was designed to preserve employee income during the pandemic.
When should I Defer or Accelerate Income?
Businesses that use the cash method of accounting could strategically defer or accelerate income to lower taxes.
Businesses that expect to be in a lower tax bracket could potentially defer taxable income to the following year when they will pay taxes in the lower bracket. For example, if your business delivered goods to a customer in December, you could wait until January to invoice them. That way, you’ll receive the money in a different tax year than when you delivered the goods.
On the other hand, if you expect your tax rates to increase, you might want to accelerate income to ensure it’s taxed in the current lower bracket year. You would want to send the invoice immediately and try to collect it before year-end.
The same process works for expenses. If you’re in a higher tax bracket, you might want to pay more expenses this year to reduce your overall tax liability.
Frequently Asked Questions
Here are the most common questions about tax planning for small business owners.
What are the Important Filing Dates for Business Taxes?
Here are the important dates to know for filing taxes in 2023:
- January 17: 2022 Quarter 4 estimated tax payments due.
- March 15: S-Corporation and Partnership tax returns due for 2022.
- April 18: Last date for individual IRA contributions/Individual and C-corporation 2022 tax returns due/2023 Quarter 1 estimated tax payments due.
- June 15: 2023 Quarter 2 estimated tax payments due.
- September 15: Quarter 3 estimated tax payments due/Extended partnership and S-corporation tax returns due.
- October 16: Extended individual and corporate tax returns due.
- January 16, 2024: 2023 Quarter 4 estimated tax payments due.
What Deductions are available if I’m filing a 1099?
Self-employed individuals and independent contractors who file Form 1099 have several deduction options. Many of the deductions for self-employed taxes are similar to other business deductions.
- Business insurance premiums.
- Business car expenses.
- Business cell phone costs.
- Commission and fees.
- Asset depreciation (Section 179).
- Health insurance premiums.
- Home office deductions.
- Business expenses.
See our Essential Guide on 1099 Deductibles for more information.
Do I need an accountant to File Small Business Taxes?
Legally speaking, small businesses do not need to hire an accountant or tax professional to file business taxes. You can file your own tax returns to save on those costs.
However, it’s highly recommended that you consult a Certified Public Account (CPA) or tax service. Business taxes and the laws that govern them are pretty complicated and updated each tax season.
As you can see from the above, business tax deductions and credits are equally complicated. A CPA or tax pro can help you avoid costly mistakes and assist in finding all legal and eligible ways to lower your tax burden. CPAs can also offer audit support and keep you apprised of changes in small business tax law.
On the other hand, hiring a CPA is expensive. In addition, you’ll still need accurate bookkeeping. There is also less availability.
Hiring a CPA Pros & Cons
- Provides a deep knowledge base on tax rules.
- Can help with tax planning and financial modeling.
- Reduces chances of errors.
- Provides additional audit support.
- Can be expensive.
- Limited availability.
- You must still have accurate bookkeeping.
Tax Planning for Small Business – Final Thoughts
Increasing tax savings requires understanding the available deductions and credits and devising a plan to maximize them. The rules governing small business tax breaks can get complicated, so always ensure you know if your company qualifies.
You should try to stay up-to-date with tax law changes. Knowing the rules can help reduce tax obligations and your overall tax burden.
As mentioned, the above information is intended to provide general information on small business tax planning. Consult an accountant, tax advisor, or tax professional when filing for a deduction or credit to ensure eligibility and prevent errors or a tax audit.