As a business owner, understanding tax planning is crucial to ensuring you’re maximizing savings and minimizing your tax liabilities. Many business owners overlook tax planning until it’s too late, but by taking proactive steps, you can make a significant difference. Here are 12 strategies that can help you lower your tax bill.
1. Choose the Right Tax Election
Many business owners misunderstand the significance of their tax election. Being an LLC is not a tax status—it’s a business structure. You can choose from various options such as a C Corp, S Corp, Sole Proprietorship, or Partnership.
For many businesses, electing to be an S Corp can offer significant tax savings. This structure allows you to pay yourself a reasonable salary, which is subject to self-employment taxes, while the remaining profits are not, saving you the 15.3% tax on self-employment income. However, this option requires additional administrative work, including payroll and tax filings. Weigh the pros and cons before making this decision.
A C Corp may be beneficial for those planning to scale and eventually sell, as it allows you to qualify for Qualified Small Business Stock (QSBS) tax benefits, which can help you avoid capital gains taxes.
2. Maximize the QBI Deduction
The Qualified Business Income (QBI) deduction allows eligible business owners to deduct up to 20% of their qualified business income or 50% of their wages. This deduction can significantly reduce your taxable income, which is a valuable strategy for self-employed individuals. However, it can be complex, so it’s worth consulting a professional to make sure you’re optimizing this deduction.
3. Set Up a Business Retirement Plan
Establishing a retirement account for your business is an excellent way to reduce your taxable income and save for retirement. There are various retirement accounts available, depending on your business structure:
- Solo 401(k): Perfect for solo owners or small businesses with a spouse as an employee.
- 401(k): Best for businesses with multiple employees.
- SEP IRA: Ideal for businesses with a few employees, particularly if they earn lower income.
These plans not only help with retirement planning but also offer tax deductions, and can even serve as a great way to retain employees. Additionally, tax credits may help offset the costs of setting up a plan.
4. Hire Your Spouse or Older Children
Hiring your spouse or older children can provide significant tax benefits. By hiring your spouse, you create a legitimate deduction for the business, and they may be able to contribute to retirement accounts, reducing taxable income.
For your children, the first $15,000 of earned income is tax-free, which can help reduce your business’s profits and move money to them with minimal tax. They can even contribute to a Roth IRA, giving them a head start on their retirement savings.
5. Accelerate or Defer Income
Strategically timing when you receive payments can help lower your tax bill. If you’re having a lower-income year, consider accelerating income by asking clients to pay early. Conversely, if you’ve had a particularly profitable year, you might delay income to the following year to reduce your current year’s tax liability. This simple strategy can be very effective in managing your taxable income.
6. Invest in Opportunity Zones
If you’ve recently sold your business and are facing a large capital gain, consider investing in a Qualified Opportunity Zone (QOZ). These investments allow you to defer taxes on the gain until 2026 and potentially enjoy tax-free growth if the investment is held for 10 years or more. Be sure to evaluate the investment carefully, as not all opportunity zones are good investments.
7. Donate to Charity
Charitable donations are an excellent way to lower your taxable income while supporting causes you care about. You can use donor-advised funds, charitable remainder trusts, or simply donate appreciated securities to avoid paying capital gains taxes. To maximize the benefit, donate before you sell appreciated assets, so you don’t incur capital gains taxes.
Additionally, consider “bunching” charitable donations every other year to boost your itemized deductions.
8. Utilize an HSA (Health Savings Account)
If you’re eligible for an HSA, take full advantage of this powerful tax-saving tool. Contributions to an HSA reduce your taxable income, and the funds grow tax-free. You can use the account tax-free for qualified medical expenses, and in the future, you can use it for long-term care insurance premiums. This is one of the most tax-advantaged accounts available, so make sure you contribute the maximum allowed.
If you don’t have an HSA, an FSA (Flexible Spending Account) can also help lower your taxable income, though it’s a use-it-or-lose-it benefit for the year.
9. Consider Roth Conversions
During years of lower income, it can be a smart strategy to convert pre-tax retirement accounts to Roth IRAs. This allows you to pay taxes at a lower rate now and enjoy tax-free growth in the future. Roth conversions can be particularly beneficial during market downturns when your portfolio value is lower.
10. Leverage Real Estate Investments
Real estate offers significant tax advantages through bonus depreciation, cost segregation studies, and 1031 exchanges. These strategies can help you reduce your taxable income by accelerating depreciation deductions.
If you or your spouse qualify as a real estate professional or use the short-term rental loophole, you may be able to offset active income with real estate losses. However, these strategies require careful planning, so work with a tax professional to ensure compliance.
11. Use PTET (Pass-Through Entity Tax)
The Pass-Through Entity Tax (PTET) was created to bypass the $10,000 cap on state and local tax deductions. By electing to pay state taxes at the business level, you can claim a federal deduction for the full amount of state taxes paid, which can lead to significant tax savings.
12. Non-Qualified Deferred Compensation Plans
For businesses with high-income owners, a non-qualified deferred compensation (NQDC) plan can be a great way to defer income to a later date. This allows you to receive more income without being taxed on it until a future year, which can help reduce your current tax bill.
Conclusion
These tax planning strategies can provide substantial benefits to business owners who take the time to implement them. It’s essential to work with a tax professional to ensure that you’re using the right strategies for your unique situation. With the right planning, you can minimize your tax liability and maximize your savings for the future.