Tax Strategies for Business Owners
Find perfectly legal tax deductions that you may be missing.
Tax Planning For Small Business Owners
Tax planning is the process of looking at various tax options to determine when, whether, and how to conduct business and personal transactions to reduce or eliminate tax liability.
Many small business owners ignore tax planning. They don't even think about their taxes until it's time to meet with their accountants, but tax planning is an ongoing process, and good tax advice is a valuable commodity. It is to your benefit to review your income and expenses monthly and meet with your CPA or tax advisor quarterly to analyze how you can take full advantage of the provisions, credits, and deductions that are legally available to you.
Although tax avoidance planning is legal, tax evasion - reducing the amount of tax owed through deceit, fraud, or concealment - is not. Frequently what sets tax evasion apart from tax avoidance is the IRS's finding that there was fraudulent intent on the part of the business owner. The following are four of the areas the IRS examiners commonly focus on as pointing to possible fraud:
Failure to report substantial amounts of income such as a shareholder's failure to report dividends or a store owner's failure to report a portion of the daily business receipts.
Claims for fictitious or improper deductions on a return, such as a sales representative's substantial overstatement of travel expenses or a taxpayer's claim of a large deduction for charitable contributions when no verification exists.
Accounting irregularities such as a business's failure to keep adequate records or a discrepancy between amounts reported on a corporation's return and amounts reported on its financial statements.
Improper allocation of income to a related taxpayer in a lower tax bracket, such as where a corporation makes distributions to the controlling shareholder's children.
Tax Planning Strategies
Countless tax planning strategies are available to small business owners. Some tax strategies target the owner's individual tax situation, and some target the business itself. Regardless of how simple or how complex a tax strategy is; however, it will be based on structuring the tax strategy to accomplish one or more of these often-overlapping goals:
Reducing the amount of taxable income
Lowering your tax rate
Controlling the time when the tax must be paid
Claiming any available tax credits and deductions
Controlling the effects of the Alternative Minimum Tax
Avoiding the most common tax planning mistakes
To plan effectively, you'll need to estimate your personal and business income for the next few years. Many tax planning strategies will save tax dollars at one income level but create a larger tax bill at other income levels. You will want to avoid having the "right" tax plan made "wrong" by erroneous income projections. Once you know your approximate income, you can take the next step: estimating your tax bracket.
You should already be projecting your sales revenues, income, and cash flow for general business planning purposes. The better your estimates are, the better the odds that your tax planning efforts will succeed.
Maximizing Business Expenses
Business meal expenses are legitimate deductions that can lower your tax bill and save you money, provided you follow certain guidelines. Business must be discussed before, during, or after the meal to qualify as a deduction. Furthermore, the surroundings must be conducive to a business discussion. For instance, a small, quiet restaurant would be an ideal location for a business dinner. A nightclub would not.
Under the Tax Cuts and Jobs Act of 2017, the deduction remains at 50 percent for taxpayers who incur food and beverage expenses associated with operating a trade or business. Employee meals while on business travel also remain deductible at 50 percent. For tax years 2018 through 2025, the 50 percent deduction expands to include expenses incurred for meals furnished to employees for the employer's convenience. Amounts after 2025 are not deductible, however.
Under the TCJA, the deduction for business entertainment expenses was eliminated. Meals still qualify at 50 percent (except for tax years 2021 and 2022), but costs must be listed separately.
Important Business Automobile Deductions
If you use your car for business, such as visiting clients or going to business meetings away from your regular workplace, you may be able to take certain deductions for the cost of operating and maintaining your vehicle. You can deduct car expenses by taking either the standard mileage rate or using actual expenses. The mileage reimbursement rate for 2023 is 65.5 cents per business mile.
If you own two cars, another way to increase deductions is to include both cars in your deductions. This deduction works because business miles driven is determined by business use. To figure business use, divide the business miles driven by the total miles driven. This strategy can result in significant deductions. Whichever method you decide to use to take the deduction, always keep accurate records such as a mileage log and receipts.
Increase Your Bottom Line When You Work At Home
The home office deduction is quite possibly one of the most difficult deductions ever to come around the block. Yet, there are so many tax advantages it becomes worth the navigational trouble. Here are a few common tips for home office deductions that can make tax season significantly less traumatic for those of you with a home office.
Strategies such as prominently displaying your home phone number and address on business cards, having business guests sign a guest log book when they visit your office, as well as deducting long-distance phone charges, keeping a time and work activity log, retaining receipts, and paid invoices all help make a case for a home office. Keeping these receipts makes it so much easier to determine percentages of deductions later on in the year.
Section 179 expensing for tax year 2023 allows you to immediately deduct, rather than depreciate over time, $1,160,000 of the first $2,890,000 of qualifying equipment placed in service during the current tax year. Equipment can be new or used and includes certain software. All depreciable equipment in a home office meets the qualification. Indexed to inflation for tax years after 2018, the deduction was enhanced under the Tax Cuts and Jobs Act of 2017 to include improvements to nonresidential qualified real property such as roofs, fire protection, alarm systems, security systems, and heating, ventilation, and air-conditioning systems.
The "Bonus Depreciation" for qualified assets (new equipment only - no used equipment and no software) placed in service for tax years 2015, 2016, and through September 26, 2017, is 50 percent. Businesses with eligible property placed in service after September 27, 2017, and before January 1, 2023, are allowed to deduct 100 percent of the cost immediately. The bonus depreciation will be phased downward over four years: 80 percent in 2023, 60 percent in 2024, 40 percent in 2025, and 20 percent in 2026.
Some deductions can be taken whether or not you qualify for the home office deduction itself. Consider meeting with a tax professional to learn more about home office deductions.
7 Biggest Misconceptions Business Owners Have About Their Returns
One of the biggest hurdles you'll face in running your own business is staying on top of your numerous obligations to federal, state, and local tax agencies. Tax codes seem to be in a constant state of flux, making the Internal Revenue Code barely understandable to most people.
The old legal saying that "ignorance of the law is no excuse" is perhaps most often applied in tax settings. It is safe to assume that a tax auditor presenting an assessment of additional taxes, penalties, and interest will not look kindly on an "I didn't know I was required to do that" claim. On the flip side, it is surprising how many small businesses overpay their taxes, neglecting to take deductions they're legally entitled to that can help them lower their tax bill.
Preparing your taxes and strategizing as to how to keep more of your hard-earned dollars in your pocket becomes increasingly difficult with each passing year. Your best course of action to save time, frustration, money, and an auditor knocking on your door, is to have a professional accountant handle your taxes.
Tax professionals have years of experience with tax preparation, religiously attend tax seminars, read scores of journals, magazines, and monthly tax tips, among other things, to correctly interpret the changing tax code.
When it comes to tax planning for small businesses, the complexity of tax law generates a lot of folklore and misinformation that also leads to costly mistakes. With that in mind, here is a look at some of the more common small business tax misperceptions.
1. All Start-up Costs Are Immediately Deductible
Business start-up costs refer to expenses incurred before you begin operating your business. Business start-up costs include both start-up and organizational costs and vary depending on the type of business. Examples of these types of costs include advertising, travel, surveys, and training. These start-up and organizational costs are generally called capital expenditures.
Costs for a particular asset (such as machinery or office equipment) are recovered through depreciation or Section 179 expensing. When you start a business, you can elect to deduct or amortize certain business start-up costs.
You can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs paid or incurred; however, the $5,000 deduction is reduced by the amount your total start-up or organizational costs exceed $50,000, and any remaining costs must be amortized.
2. Overpaying the IRS Makes You "Audit Proof"
The IRS doesn't care if you pay the right amount of taxes or overpay your taxes. They do care if you pay less than you owe and you can't substantiate your deductions. Even if you overpay in one area, the IRS will still hit you with interest and penalties if you underpay in another. It is never a good idea to knowingly or unknowingly overpay the IRS. The best way to "Audit Proof" yourself is to properly document your expenses and make sure you are getting good advice from your tax accountant.
3. You Can Take More Deductions if You Are Incorporated
Self-employed individuals (sole proprietors and S Corps) qualify for many of the same deductions that incorporated businesses do, and for many small businesses, being incorporated is an unnecessary expense and burden. Start-ups can spend thousands of dollars in legal and accounting fees setting up a corporation, only to discover soon thereafter that they need to change their name or move the company in a different direction. In addition, plenty of small business owners who incorporate don't make money for the first few years and find themselves saddled with minimum corporate tax payments and no income.
4. The Home Office Deduction Is a Red Flag for an Audit
While it used to be a red flag, this is no longer true as long as you keep excellent records that satisfy IRS requirements. Because of the proliferation of home offices, tax officials cannot possibly audit all tax returns containing the home office deduction. In other words, there is no need to fear an audit just because you take the home office deduction. A high deduction-to-income ratio, however, may raise a red flag and lead to an audit.
5. Business Expenses Are Not Deductible if You Don't Take the Home Office Deduction
You are still eligible to take deductions for business supplies, business-related phone bills, travel expenses, printing, wages paid to employees or contract workers, depreciation of equipment used for your business, and other expenses related to running a home-based business, whether or not you take the home office deduction.
Tax reform legislation passed in 2017 repealed certain itemized deductions on Schedule A, Itemized Deductions of Form 1040 for tax years 2018 through 2025, including employee business expense deductions related to home office use.
6. Requesting an Extension on Your Taxes Is an Extension To Pay Taxes
Extensions enable you to extend your filing date only. Penalties and interest begin accruing from the date your taxes are due.
7. Part-Time Business Owners Cannot Set Up Self-Employed Pension Plans
If you start up a company while you have a salaried position complete with a 401K plan, you can still set up a SEP-IRA for your business and take the deduction.
Understanding how the tax system works is beneficial to any business owner, whether you run a small to medium-sized business or are a sole proprietor. Whether it is a missed payment or filing deadline, an improperly claimed deduction, or incomplete records, a tax headache is only one mistake away. Furthermore, even if you delegate the tax preparation to someone else, you are still liable for the accuracy of your tax returns.
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