Every penny counts when you’re an entrepreneur. One strategy to save money is to optimize federal, state, and local tax payments. There are a number of tax tips small businesses owners can use that can lower their taxes significantly, increasing their bottom line and giving them more money to invest in growing their business.
* This information is not a replacement for personal, professional advice or assistance regarding your legal tax obligations.
9 Tax tips for small businesses
Take taxes into consideration when you choose the business entity that’s right for you. You should speak with an attorney, accountant, or other professional who works with small businesses to determine the best options for your business.
1. Learn types of business taxes you may be responsible for
Income tax
Income taxes are based on your business profits. The way business profits are taxed depends on how you organize and operate the enterprise. In choosing the type of entity, you should consider issues such as double taxation and tax rates.
Estimated taxes
Estimated taxes, or quarterly taxes, are based on what you expect your taxable income to be during the year. For estimated tax purposes, the year is divided into four payment periods. Use form 1040-ES. In most cases, you must pay estimated tax if both of the following apply:
- You expect to owe at least $1,000 in tax for 2022, after subtracting your withholding and refundable credits
- You expect your withholding and refundable credits to be less than the smaller of:
- 90% of the tax to be shown on your 2022 tax return; or
- 100% of the tax shown on your 2021 tax return
Self-Employment tax
Generally, you’ll pay Social Security and Medicare taxes even if you work for yourself. Again, your choice of business entity affects whether you pay self-employment taxes. The IRS treats partners, sole proprietors, and members of LLCs as self-employed individuals.
By choosing to incorporate rather than form an LLC or partnership or operate as a sole proprietor, you avoid the self-employment tax. Instead, the corporation withholds the Social Security and Medicare taxes only from employee’s wages.
If you organize, especially as a closely-held corporation, you might pay yourself or others -- including employees -- a salary. Of course, you and other employees pay income tax, but it might eliminate the self-employment taxes.
Excise tax
The federal government taxes businesses that manufacture or sell certain products. If your business uses various types of equipment, facilities, or other products, you may need to pay an excise tax. An excise tax is included in the price of certain products or services.
Excise taxes are taxes that are imposed on various goods, services and activities. These taxes may be imposed on the manufacturer, retailer or consumer, depending on the specific tax. Form 720, Quarterly Federal Excise Tax Return, is available for optional electronic filing. Learn more about the most updated form on the official IRS website.
Unemployment taxes
Businesses pay federal unemployment taxes and state unemployment taxes to fund an unemployment insurance program. Unemployment insurance affords benefits to those who lose jobs through reasons such as a layoff, a resignation for health reasons, or a termination otherwise through no fault of their own.
2. Choose a business entity
In order to do your taxes correctly, you must decide how your business will be structured. Tax forms and rules are different for each outlined below.
Sole-proprietorship
If you’re a sole proprietor, you own the business yourself and in your own name (or an assumed name that you register). The profits from the business represent part of your income and are taxed at the same rates as salaries, wages and other ordinary income.
Corporation
A corporation is a separate legal entity from its shareholders. By default, corporate profits face taxation at the corporate level and when the corporation distributes it to the shareholders. With an “S” corporation election, qualifying corporations can avoid this double taxation and have profits taxed only when distributed to the shareholders.
Partnership
A partnership forms from two or more people engaged in business for a profit. The partners pay taxes on their share of the profits, but the partnership entity itself does not pay. Each partner gets a “K-1” to report the partner’s share of profits.
Limited liability company (LLC)
LLCs allow the owners to avoid personal liability for business debts and avoid double taxation. How profits pass through the LLC depends on the number of owners, or “members.” A single-member LLC is treated by the IRS as a sole-proprietorship, while profits from a multi-member LLC get treated the same way as those for partnerships.
3. Choose an accounting method and stick to it
There are generally two popular ways to structure your business accounting. Here’s a short description of each. No matter which one you use, the goal is to be consistent.
Cash method
The cash method recognizes revenues when cash is received, and expenses when they are paid. This method does not recognize accounts receivable or accounts payable.
Many small businesses opt to use the cash basis of accounting because it is easier to maintain and determine when a transaction has occurred and funds are in or out of the bank. There is no need to track receivables or payables.
The cash method helps determine how much cash the business has at any given time and your bank balance reveals the money you have on hand.
Accrual method
Accrual accounting records revenues and expenses when they are earned, regardless of when the money is actually received or paid. For example, you record revenue after project completion, not when you actually get paid. This method is more commonly used than the cash method. A downside is that this method doesn’t give an overview of cash flow. Your business may appear profitable but actually have empty bank accounts.
4. Take advantage of tax breaks
Work Opportunity Credit
The Work Opportunity Tax Credit (WOTC) is a Federal tax credit available to employers for hiring individuals from certain targeted groups who have consistently faced significant barriers to employment. WOTC was created to incentivize workplace diversity and facilitate access to good jobs for American workers. More information is available on the IRS website.
Disabled Access Credit
The Disabled Access Credit provides a non-refundable credit for small businesses that incur expenditures for the purpose of providing access to persons with disabilities. An eligible small business is one that earned $1 million or less or had no more than 30 full time employees in the previous year; they may take the credit each and every year they incur access expenditures. Refer to Form 8826, Disabled Access Credit (PDF), for information about eligible expenditures.
Alternative Motor Vehicle Credit
The alternative motor vehicle credit is a tax credit given to individuals who purchase vehicles that derive their power from alternative energy sources. Taxpayers are eligible to receive this nonrefundable alternative motor vehicle tax credit if they are the original purchasers of a vehicle after January 1, 2006. Instructions to file are found here.
5. Examine all deductions available
Home office deductions
Claiming home office tax deductions was once considered a great way to treat yourself to an audit. Thankfully the IRS has simplified the rules and home office deductions are more common and simpler to claim than many people realize.
If you’re a small business owner who could be taking this deduction but you aren’t, you’re missing out on a great money-saving opportunity. Learn more on the SmartBiz® Small Business Blog: How to Take the Home Office Tax Deduction.
Technology purchases
The Tax Cuts and Jobs Act increases deductions for hardware and software purchases, among many changes. Businesses can write off the entire cost of hardware, off-the-shelf software, and other equipment during the year they make their purchases, rather than spread out the deduction over a normal depreciation schedule
Travel costs
Most of the regular costs of business travel are tax deductible. Additionally, as long as the trip is primarily for business, travelers can tack on a few vacation days and still deduct the trip from your taxes. Learn how to leverage the process to save on your taxes on the Bench Blog: Deductible Travel Expenses.
6. Keep good books and records
If you spend time organizing your paperwork, specifically tax information, preparing your return will be much easier. Here are some tips to easily organize your tax information:
Designate an easy-to-access place for tax documents
Designate a real folder or a virtual folder on your computer to store tax documents. You should be able to upload and later readily access the information and forms needed for tax preparation.
- Organize tax documents
If you work with a bookkeeper or an accountant, ask if they have a preferred method of organization for tax documents. If you face an audit, you’ll have a much easier time producing paperwork.
- Find last year’s return
A great first step before you jump into this year's tax returns is to locate last year’s return. You'll be able to determine what will likely be required for the current year.
7. Make quarterly estimated payments
If you are in business for yourself, you generally need to make estimated tax payments. Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and alternative minimum tax.
If you don’t pay enough tax through withholding and estimated tax payments, you may be charged a penalty. You also may be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.
8. Separate business from personal expenses
A big financial mistake is thinking it’s okay to use your personal checking account for business expenses. This makes it difficult to separate out which expenses are which, and you need to know your business expenses so you can properly file your taxes. Also, should you ever be audited by the IRS, having your expenses combined will create a logistical nightmare.
It’s better to open a business checking account (and savings too) so that all your business expenses are in one single account. Check out this blog post for some more information about business credit cards: Six Benefits of a Business Credit Card.
9. Understand the difference between net and gross income
When you prepare an income statement for your business, you must calculate both gross and net figures, so it is important to be clear on the difference between these two fundamental accounting terms.
- Net income is the residual amount of earnings after all expenses have been deducted from sales
- Gross income is an intermediate earnings figure before all expenses are included, whereas net income is the final amount of profit or loss after all expenses are included
Self-file business taxes or use a professional?
Tax law can be complicated – if done wrong, you could miss out on deductions and even be subject to an audit or penalties. Many small business owners choose to work with a tax professional, accountant, or bookkeeper to get organized and file. Consider these circumstances:Small Business Taxes: Self-File or Use a Professional?
Filing business taxes and applying for a loan
Just like your personal and business credit scores, lenders will use your tax returns to evaluate the health of your personal and business finances and verify your revenue, profit, and expenses.
This is to determine that you can afford and make all payments for the life of the loan. Generally, you’ll need to provide the past two years of your personal tax returns. This is especially important if you are a sole proprietor or operate a partnership, or S-corp where you report your business’s profits and losses on your personal tax return.
If you’ve filed your taxes and need working capital or to refinance expensive business debt, the SmartBiz team is standing by. They can help you navigate the SmartBiz online application and answer questions you may have. Visit the SmartBiz website to learn more about the SBA loans, Bank Term loans, and custom financing offered through partner banks.
