12 Tax Tips for Your Small Business
by Ryan Lasker | Updated Aug. 5, 2022 - First published on May 18, 2022
It’s everyone’s favorite topic: taxes. Oh, just me?
Whether you’re reading this on April 15 or December 31, it’s always an excellent time to learn strategies to reduce your business tax bill. Take a look at these 12 tax tips for your small business.
1. Research small business tax credits
Tax credits are as close to free money as you’ll get. One of the most effective ways to lower your small business tax bill, tax credits offer dollar-for-dollar reductions in your tax liability. Say your tax bill comes out to $5,000 before credits, and you have a $2,000 tax credit. Your final tax liability is $3,000 ($5,000 preliminary tax liability – $2,000 tax credit).
You might qualify for a tax credit when you offer employees subsidized health insurance or a retirement plan. Explore our list of 10 small business tax credits.
Owners of pass-through entities -- sole proprietorships, partnerships, limited liability companies, and S corporations -- may also use personal tax credits, like the child tax credit, to reduce their business income tax liability.
Tax credits offer more bang than tax deductions, which we’ll cover next.
2. Save every receipt
Don’t get lazy about expense tracking. You’re essentially throwing out money when you neglect to record a business expense in your accounting software.
Business expenses qualify as business tax deductions when they’re “ordinary and necessary.” So while throwing a birthday party for an employee’s pet snail won’t count as a business deduction, the $100 you spent on a rush-hour taxi ride to make it to a business dinner would.
Deductions, also called tax shields, don’t offer the same dollar-for-dollar tax bill reduction as credits. Instead, they lower taxable income.
You pay business taxes based on your company’s taxable income, which is the difference between revenue and deductions. Maximizing deductions is a key way to reduce your taxable income, and, ergo, your tax liability.
Say your business has $100,000 in revenue and $70,000 in deductions, yielding $30,000 in taxable income. Your tax liability is $30,000 multiplied by your effective tax rate, which fluctuates based on your income level.
If you’re unsure whether an expense counts as a business deduction, save the receipt, do some research, and talk to a tax professional.
3. Take the qualified business income (QBI) deduction
The qualified business income (QBI) deduction trims eligible taxable income by 20%. It’s the ultimate self-employed tax deduction because you don’t have to do anything special to qualify. You just need a pass-through business.
The QBI spurs entrepreneurship by reducing a business owner’s taxable income. Check out the Ascent guide to the qualified business income deduction.
4. Carryover losses
Small businesses usually operate at a loss for the first few years. 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.
You opened your business in 2019 when it brought in $100,000 in revenue and incurred $150,000 in operating expenses, creating a $50,000 NOL. You don’t 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).
The NOL deduction rules were loosened due to the COVID-19 pandemic. 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. Check out our guide to the NOL for a how-to and other restrictions for future tax years.
5. Set up a retirement account
Whether you’re a solopreneur or have employees, you can get a tax benefit for contributing to or offering a retirement plan, like a 401(k) or IRA.
Solopreneurs are eligible to open a solo 401(k), also called a one-participant 401(k). Your contributions are tax-deductible up to a limit, but you’ll pay income tax on the contributions upon withdrawal in retirement.
Business owners can also participate in the same traditional 401(k) they offer to employees. Employee retirement plans can save your business on employer payroll taxes because they lower the amount of employee wages subject to the Federal Unemployment Tax Act (FUTA).
6. Take a home-office deduction
If you’re like me and working from home, you can qualify for another special deduction when you dedicate a portion of your home to your business.
There are two methods for calculating the home office deduction. The simpler way is multiplying the square footage used as your home office -- not to exceed 300 square feet -- by $5.
Alternatively, calculate the home office deduction by multiplying eligible home expenses by the portion of your home used for business. If your home office is 500 square feet of a 5,000 square-foot home, you could deduct 10% of eligible home expenses.
The biggest catch here is your home office can’t be multipurpose. You can use a velvet rope, silk room divider, or imaginary wall to cordon off a portion of your guest bedroom or basement to qualify as a home office, as long as you keep the office area strictly for business. Our guide to the home office deduction walks you through the rules, calculation, and filing process.
7. Deduct the business use of your car
A personal car -- leased or owned -- used for business is tax-deductible, just like your home.
The simpler method of calculating the deductible amount is multiplying the number of business miles driven by the IRS mileage rate, which fluctuates each year. In 2020, it’s $0.575.
Otherwise, deduct your car expenses in proportion to miles driven for business. If you put 20,000 business miles and 10,000 personal miles on your car in a year, you can deduct two-thirds of eligible car expenses.
Another disclaimer is necessary: Your daily commute is not deductible. The IRS views the commute between home and work as a personal trip. Don’t shoot me; I’m just the messenger.
8. Donate old business equipment
Here’s a stupendous end-of-year tax tip: Take a look around your office and donate what you’re not using. That printer in the corner you haven’t used since you went paperless? That desk chair that’s perfectly fine but no longer raises your vibrations? They’re tax-deductible.
You can deduct the fair value of your old office furniture and equipment when you donate it to a 501(c)3 nonprofit. Follow our guide to fair value accounting to appraise your donation.
If your old equipment is too crummy to donate, you can claim a Section 1231 loss for throwing it out. Talk to a tax professional about taking a loss for abandoning equipment.
9. Depreciate fixed assets
You learned in Bookkeeping 101 that you depreciate fixed assets over their useful lives instead of expensing them when purchased. For financial reporting purposes, that’s all true. Of course, taxes like to complicate things.
To roughly match your financial reports, follow the IRS’s proprietary depreciation method, the modified accelerated recovery cost system (MACRS). If you’d prefer to deduct the entire purchase in its first year, read on.
The IRS allows you to deduct your entire fixed asset purchase in the year it was placed in service with a Section 179 deduction or bonus depreciation. Be aware that not all assets qualify for Section 179 or bonus depreciation treatment, and like with all tax laws, there are restrictions.
Talk to a tax expert to figure out your depreciation strategy.
10. Consider changing your business structure
Choosing the right business structure can lead to significant tax savings.
Small businesses generally fare best as pass-through entities, where you and your business are considered one taxpayer. In most pass-through types, all business income is subject to self-employment taxes, which will eat up 15.3% of your earnings. Your business income is taxed at your individual tax rate.
You can cut down on payroll taxes by selecting S corporation taxation. S corp owners who participate in management are considered employees and get paid through salaries and dividend distributions. What’s notable here is that dividend distributions aren’t subject to payroll taxes. The IRS prevents you from avoiding payroll taxes altogether by requiring that you earn a reasonable salary before taking distributions.
Your non-pass-through option, the C corporation structure, adds a 21% entity-level tax to all business income before it gets passed on to owners, called shareholders. The business type comes with a heap of administrative requirements, too, so I wouldn’t recommend it for most small businesses.
It’s a big deal to elect a new tax status or business structure. You’ll want to consult a tax attorney or CPA before changing your business structure.
11. Take year-end tax planning seriously
Before you close the books, take time to consider year-end tax planning. You might pick up some great tax tips, like waiting until next year to send invoices to customers. Cash-basis taxpayers only pay tax on cash received, so you’re deferring taxable income until next year when you delay collections.
12. Use tax software
Tax software is designed to save you money. From offering small business tax advice to helping you calculate deductions, you should never go without a trusted tax practitioner or software when filing your business tax return.
It’s always tax season at The Ascent
April shouldn’t be the only time you’re thinking about taxes. Keep these tax tips at the top of your mind during the year, so you’re prepared to maximize your deductions and credits on your tax filings.
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