Every penny counts when you’re an entrepreneur. One strategy to save money is to take advantage of the opportunity to pay less in federal, state, and local taxes. 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.
* Use of this information is not a replacement for personal, professional advice or assistance regarding your legal tax obligations.
Types of Business 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, or quarterly taxes, are based on what you expect your taxable income to be during the year.
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 -- as salary. Of course, you and other employees pay income tax, but it might eliminate the self-employment taxes.
An excise tax is included in the price of certain products or services. Both the federal and state governments levy excise taxes on goods such as alcohol, motor fuel, and tobacco products.
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 your own.
Tax tips for small businesses
Take taxes into consideration when you choose the business entity that’s right for you. It’s a good idea to speak with an attorney, accountant, or other professional who works with small businesses to determine the right direction.
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.
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.
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
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.
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, be consistent and stay with it.
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 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.
Know what tax breaks are available to you
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.
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.
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
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.
Keep good books and records
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.
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 more in-depth information about business credit cards: Six Benefits of a Business Credit Card.
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.
Special note regarding Paycheck Protection Program Loans and taxes
The IRS has released guidance stating that expenses related to forgivable loans through the Paycheck Protection Program (PPP) won't be tax-deductible. Under the PPP, a small business loan program created as part of the coronavirus relief bill, small businesses wouldn't have to repay the low-interest loan they received as long as the loan went to essential expenses such as maintaining payroll. Usually, wages are deductible expenses and forgiven debt counts as taxable income. But under the coronavirus relief law, the PPP loan forgiveness is not counted as taxable income. The IRS said in its guidance that expenses that result in forgiveness of a PPP loan are not tax deductible in order to prevent a "double tax benefit."
Small Business Taxes: Self-File 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?