Tax-Saving Tips for Small Businesses

For small business owners, tax-saving strategies are crucial tools for maintaining cash flow, funding growth, and ensuring long-term success. Many business owners may be unaware of the numerous tax deductions, credits, and other strategies available to reduce their tax liability. Proper tax planning lets entrepreneurs keep more of their profits and reinvest more in their companies while avoiding costly mistakes. In this guide, we’ll explore key tax-saving strategies that can help small businesses.

Maximizing Deductions

A business deduction reduces taxable income by subtracting qualified expenses from the company’s gross revenue. Expenses must be “ordinary and necessary” to be deductible. That doesn’t meet they need to be required, however. “Ordinary” means that the expense is commonly incurred by business owners in the industry, and “necessary” means that the expenses are appropriate for management of the business.

Examples of common business expense deductions include the following:

• Office expenses like rent, utilities, software, furniture, and supplies
• Employee wages and benefits, including salaries, retirement plan contributions, and health insurance costs
• Expenses for marketing and advertising, such as costs associated with creating and maintaining a website, placing social media and pay-per-click ads, and production of promotional materials
• Professional services like legal advice and representation, accounting, and consulting
• Insurance premiums, including general liability, workers’ compensation, and professional liability

Home Office Deduction

Business owners who work from home may be eligible to take a home office deduction. To qualify, you must use a specific area of your home exclusively and regularly for business, and it must be your principal place of business. This deduction can be calculated in two different ways:

• Under the simplified method, taxpayers can deducts $5 per square foot of home office space, up to a maximum of 300 square feet.
• Under the actual expense (or “regular”) method, a percentage of total expenses, including rent or mortgage, interest, property taxes, utilities, insurance, and other costs, is deductible. This percentage is based on the proportion of the home’s square footage that is dedicated as office space.

If you plan to use the actual expense method, be sure to keep receipts and detailed records for all costs that you will use to calculate the deduction. It’s also important to be aware that using this method can interfere with a homeowner’s ability to avoid capital gains tax on the sale of the home, and the depreciation it requires would also be subject to capital gains tax at sale. Consult with a knowledgeable tax professional to determine the best calculation method for your home-based business.

Vehicle and Mileage Deductions

As with the home office deduction, you can deduct business use of a vehicle using your choice of two methods:

• The standard mileage rate allows you to deduct a fixed rate per mile driven for business purposes.
• The actual expense method requires you to report expenses such as fuel, licenses, registration, maintenance, insurance, and depreciation.

If the car is used only for business, then these costs are 100% deductible. If, on the other hand, the car is used for both business and personal purposes, then you may deduct only those costs that are “attributable to the portion of the total miles driven that are business miles.” To ensure you can support your deduction in case of an audit, keep detailed records of your business mileage and the proportion of total use of the vehicle it represents.

Immediate Deduction or Capitalization?

Some large expenses that provide benefit for the business for more than one year must be capitalized, so the deduction is spread over multiple years through depreciation and amortization. When an expense is immediately deductible, on the other hand, the entire expense directly reduces the business's current-year taxable income, more significantly reducing the taxes owed for that particular year. Determining which expenses must be depreciated and which can be immediately deducted isn’t always straightforward.

The IRS’s Tangible Property Regulations help businesses determine whether an expense can be deducted immediately or must be capitalized and depreciated over time. Under the rules, certain costs for repairs, maintenance, and improvements to tangible assets such as buildings, machinery, and equipment can be fully deducted in the current year. Many tax professionals, however, are not well versed in these rules, which can lead to missed opportunities. To take full advantage of your available tax deductions while ensuring compliance and avoiding penalties, be sure to work with a tax advisor who knows how to properly interpret these regulations and ensure all expenses are fully documented.

The Tax Cuts and Jobs Act of 2018 (TCJA) made significant changes to accounting rules, which can be beneficial for small business owners. These changes increased the number of small business taxpayers that are eligible to use the cash method of accounting, exempting these businesses from certain accounting rules for inventories, cost capitalization, and long-term contracts. Formerly, only businesses with no more than $5 million in gross receipts were allowed to use the cash method; under the TCJA, this cap was raised to $25 million.

Key Tax Credits for Business Owners

Unlike deductions, which reduce the amount of income that is subject to tax, credits directly reduce the total amount of tax liability, dollar for dollar. Because of this, credits are often much more valuable than deductions. Below are some of the important tax credits that business owners should be aware of:

• The research and development (R&D) tax credit allows businesses that invest in innovation, product development, and process improvements to claim a percentage of qualifying expenses as a credit.
• The Work Opportunity Tax Credit (WOTC): Offers tax credits for hiring employees from specific groups who have faced significant barriers to employment, including veterans, recipients of certain types of government aid, applicants who were formerly incarcerated, those referred after completing a rehabilitation program, and other disadvantaged groups.
• The small business health care tax credit reimburses businesses with fewer than 25 employees for up to half the cost of health insurance premiums they pay on behalf of their employees for two consecutive taxable years.
• The retirement plan startup costs credit offsets the costs of establishing SEP, SIMPLE IRA, 401(k), or other qualified employee retirement plans. The credit provides up to $5,000 for three years toward these expenses.
• The Empowerment Zone tax credit incentivizes businesses to operate and employ workers who live in designated Federal Empowerment Zones. The credit covers 20% of employee wages, up to $3,000 per employee and a maximum total of $15,000 per year.

Additional Tax-Saving Strategies

In addition to making the most of the deductions and credits available to your business this year, you can take steps to minimize your tax burden in the future. If you don’t yet qualify for some of the credits listed above, keep them in mind when you consider investing in your business, hire employees, open new locations, and determine what benefits to offer.

Employee Benefits

Providing employee benefits such as retirement plans, health insurance, and wellness programs will not only help you attract and retain top talent but also provide valuable tax savings. Employer contributions are typically deductible and amount to tax-exempt compensation for employees.

Business Structure

Choosing the right business structure is also essential for tax savings. Most small businesses are organized as either LLCs or S-corporations. Unlike a simple sole proprietorship or partnership, the LLC structure protects business owners’ personal assets from business liabilities. In some situations, forming and S-corporation (which also provides protection for personal assets) results in a lower tax bill than operating as an LLC by reducing self-employment tax. Work with a qualified business advisor to determine the best structure for your small business

State Pass-Through Entity (PTE) Tax Programs

Many states have enacted PTE programs that allow state taxes to be deducted at the entity level, allowing business owners to bypass the federal $10,000 state and local tax (SALT) deduction cap. Owners of pass-through entities, including S-corporations and LLCs, can realize substantial federal tax savings by taking advantage of these programs.

Work With an Expert to Devise Your Tax Strategy

Effective tax planning and ensuring that you’re making the most of the deductions and credits available to your business is essential for maximizing profitability and enabling growth. The right strategies will let you keep more of your hard-earned profits and reinvest more into your company while ensuring you remain in compliance with all tax regulations. Stable Rock’s tax strategy and compliance team can help your business develop your winning strategy.