Tax Saving Strategies for Small Business Owners

  • Operating a small business offers numerous tax-saving opportunities.
  • Small business owners have the advantage of deducting a wider range of expenses than salaried employees.
  • Those who are self-employed can often allocate and deduct costs used for both personal and business purposes.

Operating a small business often means juggling various responsibilities, with tax optimization sometimes slipping through the cracks. Yet, many tax deductions can benefit you as a small business owner. Here’s a list of seven ways to trim your tax bill.

1. Health Insurance Deductions

Purchasing health insurance can undoubtedly be expensive. However, there are tax benefits available for those who are self-employed and bear their own insurance costs. Being self-employed—whether as a freelancer, contractor, gig worker, or any other non-traditional role—might allow you to claim the self-employed health insurance deduction, especially if you don’t have access to a spouse’s plan.

This deduction means you could potentially offset a portion of your premium costs. The amount you can claim as a deduction is usually tied to the net earnings from your business, effectively reducing your taxable income and thus your tax liability.

Furthermore, this benefit isn’t just limited to basic health insurance. If you’re self-employed, you can also consider deducting premiums for dental, vision, and long-term care coverage. Additionally, coverage for your spouse or dependents under the age of 27 by the end of the tax year may also qualify for this deduction.

2. Retirement Savings Deductions

For the forward-thinking small business owner, retirement savings plans offer both long-term potential and immediate tax relief.

Individual or Solo 401(k): If you’re a self-employed individual without other employees, an Individual orSolo 401(k) might be a good option. It allows you to contribute a significant portion of your income. For 2023, the limit is $66,000, with an additional catch-up contribution of $7,500 for those 50 and above.

SEP IRA: Another choice for the self-employed is the SEP IRA, allowing savings of up to 25% of your income. The contribution limits mirror the Solo 401(k) at $66,000, plus the catch-up amount for older individuals.

Traditional and Roth IRAs: Beyond the specialized accounts, traditional and Roth IRAs can further cut your tax liability.

Moreover, you might be eligible for the Saver’s Credit, which rewards you with up to $1,000 (or $2,000 if married and filing jointly) for contributing to various retirement accounts including 401k, 403(b), 457 plan, SIMPLE IRA, SEP IRA, Traditional IRA, and Roth IRA.

Defined Benefits Plans: For business owners with high income, there is also the option to put away big dollars for retirement through a defined benefit plan and save a lot of taxes. There are different types of defined benefit plans including cash balance plans and 412(e)3 plans. In general these plans tend to work best for older owners with younger employees, and for business owners with 10 employees or less.

Cash balance plans may be invested, whereas 412(e)3 plans are fully funded with annuities and/or life insurance and not subjected to market volatility. There are higher administration costs for defined benefit plans but there is also a tax credit for new plans in 2023 and the significant tax deferral can often offset administration costs for the right candidates.

Ensuring that you leverage all available small business tax deductions does require planning and potentially, consultation with a tax professional. A basic understanding of the tax world can significantly enhance your financial management, fortifying your business against unforeseen challenges and facilitating sustainable growth.

3. Leverage the Qualified Business Income Deduction

For those declaring business income on their individual tax returns, the qualified business income deduction, or Section 199A deduction, is a potential bonus. The entities that can tap into this deduction encompass:

  • Sole proprietorships
  • Partnerships
  • LLCs
  • S corporations

This deduction enables eligible entrepreneurs and small businesses to deduct a maximum of 20% of their qualified business income. If your taxable income falls below $182,100 (single) or $364,200 (joint) in 2023, you might qualify. Surpass these limits, and a prorated deduction could be available.

“Qualified business income” generally translates to the net amount of income, gains, losses, and business-related deductions. Exclusions to this definition are:

  • Capital gains/losses
  • Dividends
  • Interest income
  • Overseas income
  • Certain payments to partners and shareholders

Note: For businesses tagged as “specified service trade or business” (like doctors, lawyers, financial planners, and more), the deduction phases out sooner than other professions.

If your business requires you to drive, purchasing a company vehicle can fetch you tax-saving deductions provided by the IRS.

Here are two popular deduction methods:

Standard Mileage Rate: For every business mile driven, the IRS permits a deduction. In 2022, this was set at 62.5 cents per mile, while in 2023, it’s 65.5 cents. To take a deduction under this option, maintain a log distinguishing business miles from personal miles, excluding standard commuting distances.

Actual Expenses: Instead of the per-mile deduction, you might opt to sum up all auto-related business expenses, which encompasses costs like gas, maintenance, tires, licenses, insurance, and more. Calculate the business vs. personal use percentage, and based on this, you can claim the relevant portions of your vehicle expenses. This method might be more advantageous than the standard mileage rate in certain situations.

Staying organized and maintaining accurate records are crucial to ensure that you claim the appropriate deductions and maximize your tax savings.

5. Accounting for Depreciation

Business investments can sometimes be deducted immediately as an expense or over time, which can aid in diminishing your taxable income and consequently your tax liability.

Business equipment usually depreciates over time due to routine use and aging. Recognizing this, the IRS offers ways to match your income deduction to this value drop across the asset’s operational life.

There are different avenues to claim depreciation:

Section 179 Deduction: This lets you deduct a substantial amount when the asset starts its service. For 2023, the cap is $1,060,000.

Bonus Depreciation: Unlike the fixed maximum of Section 179, here you can deduct a sizable percentage from the asset’s purchasing price. The Tax Cuts and Jobs Act of 2017 enhanced this from 50% to a full 100%, enabling deductions for the entire price of new or previously-owned equipment. This deduction will be phased out between 2023 and 2026. For 2023 the deduction dropped from 100% to 80% which is still significant

MACRS Depreciation: Using the Modified Accelerated Cost Recovery System, firms can avail larger tax deductions in the asset’s earlier years and decrease them as years go by, when compared to straight-line depreciation.

A Note on Vehicles: For business-related vehicles, depreciation can be a viable deduction. However, there are IRS rules concerning high-end vehicles. In 2022, first-year depreciation for business-exclusive vehicles is capped at $11,200, plus an extra $8,000 in bonus depreciation. The 2023 values are $12,200 with the same bonus. For SUVs between 6,000 and 14,000 pounds, a majority of cost can be expensed in the acquisition year via bonus depreciation.

6. Tapping into the Home Office Deduction

For entrepreneurs working from home, this deduction is gold. To qualify, two conditions need fulfillment:

Exclusive & Frequent Use: An area in your dwelling (house, condo, mobile home, boat, etc.) should be exclusively and routinely set apart for your business. This can even include detached structures like studios or garages but not spaces used as hotels or similar establishments.

Core Business Spot: This space should be the chief location of your operations or where you consistently engage with customers.

The term ‘exclusive’ implies that the space is primarily for business. While personal interruptions are inevitable, the key is to ensure they’re minimal, mirroring what would happen in a traditional office setup.

For eligibility, it’s vital that the home office area is distinct from personal spaces and is primarily used for business activities.

7. Deducting Business Financing Expenses

The IRS permits the deduction of numerous financing costs related to your business, encompassing interest from loans, credit cards, and other credit sources. However, specific stipulations apply to some finance expenses incurred from loans towards capital assets in your enterprise. Moreover, interest on loans used for non-deductible business expenses will be excluded from deduction. Generally, if there are no particular constraints, the interest often qualifies as a deductible business cost.

A few examples of deductible financing expenses include interest from a mortgage on your business property, charges included in a leasing agreement, or fees related to extended invoice payment periods.

Optimizing Tax Planning for Small Enterprises

For small enterprises, every dime is valuable. Lowering tax obligations can equate to added profits to either keep or plough back into the business. The good news is the IRS offers multiple avenues for small business owners to decrease their tax dues.

Several of these strategies require proactive tax planning, like picking the appropriate business vehicle, making timely retirement contributions, among others. To fully leverage the deductions accessible, it’s advisable to collaborate with a tax expert who can pinpoint and cater to your distinct requirements.

Let McFie Insurance Help You

At McFie Insurance, we help families, individuals, professionals and business owners plan for their finances by offering smart financial solutions and strategies. To learn more about how you can grow wealth and save money, call us today at 702-660-7000

Ben McFieBen T. McFie

There's a lot of confusion around finance; there's so much to know and it's frustrating when you don't know enough to make the best financial decisions. I like to bring clarity to financial matters so people can make good financial decisions that will help them live wealthier more fulfilling lives.