1. Take advantage of tax deductions
First up on the list is one of the easiest ways to reduce taxable income for small businesses — business deductions.
Business deductions allow you to reduce your taxable income, which in turn reduces your overall tax return bill. This is especially beneficial for high-income earners who are looking for ways to manage their earned income efficiently.
Here are some examples of the most common deductions you can take, whether you’re a sole proprietor, LLC, partnership, C-corp, or S-corp:
- If you have a home office, you can deduct a portion of your rent or mortgage interest, utilities, and other home-related expenses as a home office deduction.
- If you have a company car or use your personal vehicle for business purposes, you can deduct your mileage using the IRS standard rate of 65.5 cents per mile (as of 2023) or actual expenses, including gas, oil changes, and repairs.
- If you purchase any equipment or supplies for your business, such as a new computer or office furniture, you can deduct these expenses.
- If you make any charitable contributions or have uncollectible customer debts, you can deduct these, as well.
Remember to consult with a CPA or tax professional to distinguish between deductible and nondeductible expenses, so you don’t accidentally claim expenses you shouldn’t.
2. Make your business investments tax-deductible
Would you rather pay a larger sum in federal income tax or less and use a strategic deduction to invest in your business? If your bottom line is the same, then the strategic deduction gets you more for your money.
Oftentimes taxpayers view tax filing deductions as items that they are already paying for that they can deduct from their taxable income. But you can strategically find helpful deductions and lower your taxable income. (We talk more about tax planning below.)
There are instances where you may be on the fence about investing in your business, but it can have a secondary effect of being tax-deductible. Small business insurance is a great example of a tax-efficient way to support your business. You can utilize the main benefit of protection from unexpected financial loss and the secondary benefit of lowering your taxable income via deductions.
Here are some common forms of business insurance that many industries can deduct from their taxes:
3. Change your business structure
If you’re tired of paying the high cost of taxes as a sole proprietor, changing your business structure can be the key to unlocking significant tax benefits. By transitioning to a limited liability company (LLC) or S-corp, you can benefit from pass-through taxation.
Pass-through taxation is a feature of LLCs and S corporations that allows business income to be taxed at a personal income tax rate. When you have a pass-through LLC and S corporation, you’ll still be able to deduct half of the self-employment tax you pay (for Medicare and Social Security taxes) and can also utilize more deductions in your business and personal life to minimize your entire tax bill.
4. Pay for health insurance
Over the past decade, the cost of family health insurance coverage has surged by 47%, with a 22% increase occurring within the last five years alone, according to a report from the Kaiser Family Foundation.
However, paying for health insurance can provide a double benefit when you’re self-employed. Not only does it ensure you have coverage for medical expenses, but the IRS lets you deduct all or part of your insurance premium, lowering your tax bill and saving you money.
A flexible spending account (FSA) or health savings account (HSA) are two additional ways to reduce what you owe the IRS next year. Both are pre-tax benefits, making the money you put in them tax-exempt. That means you can effectively lower your tax bill while building funds for future healthcare costs.
5. Put tax-deferred money away for retirement
Small business owners can invest in a traditional IRA, up to the contribution limits each year — $7,000 for 2024 and 2025, according to the IRS. But tax-advantaged retirement savings options are also available, including a Solo 401(k) for self-employed individuals without employees.
How can it reduce taxable income? Simple — the contributions you make are tax deductible. Plus, the limits are higher than IRA contribution caps, and the account grows tax-free until retirement.
If you have employees, setting up a small business retirement plan can also help lower your tax bill. For example, let’s say you own a small consulting firm with three employees. You might set up a SIMPLE IRA plan, which is a retirement account that lets you make tax-deductible employer contributions. Plus, you can qualify for a tax credit of up to $500 a year for three years to help offset the startup costs.
6. Hire through the Work Opportunity Tax Credit
Small businesses can claim the Work Opportunity Tax Credit (WOTC) for hiring individuals from certain target groups that have faced barriers to employment. The credit amount varies by tax year but can be as high as $2,400 per employee. However, it’s only available until December 31, 2025, so talk to your tax advisor to see if it makes sense for your business.
For instance, suppose you own a cleaning company and hire a veteran who recently returned from serving overseas. In addition to becoming eligible for the WOTC, you can give someone who has faced employment challenges a chance to succeed.
7. Reimburse business expenses with an accountable plan
If your employee takes a business trip and incurs expenses such as airfare, lodging, and meals, you can reimburse them for these expenses and write them off as a business expense.
However, to qualify for the deduction, you must have an accountable plan that meets IRS requirements and provide detailed documentation and receipts to prove that the expenses are legitimate business expenses.
8. Take depreciation deductions on business equipment
If you own a business, you must understand how financial planning can lower taxable income through strategic spending and depreciation. Depreciation for equipment is like getting a discount on your taxes because it lets you deduct its cost over the course of a few years.
Suppose you own a construction company and want to buy a new excavator for $150,000. The IRS allows you to offset a portion of that amount over several years due to the excavator’s aging and wear and tear. There are various depreciation methods available, so it’s essential to consult with your tax professional to determine the best approach for minimizing your tax bill.
9. Track financial losses for your business
Keeping accurate records of your business losses is a crucial strategy to reduce your tax liability as a small business owner. Compared to commonly used deductions like home mortgage interest and charitable contributions, it can potentially save you thousands of dollars on your tax bill.
10. Plan for year-end tax strategies
Year-end tax planning, such as accelerating or deferring income, making charitable contributions, and maximizing retirement contributions, can lower taxable income. Business owners and independent contractors have deductions and credits available. But planning ahead is critical for avoiding last-minute mistakes and missed opportunities. Here are some tips to help you identify and implement year-end strategies:
- Start early: Begin your year-end tax planning process as early as possible.
- Check your estimated tax payments: Review your estimated tax payments, including local taxes, to ensure that you’re making accurate payments throughout the year and avoid any underpayment penalties.
- Consult with a tax professional: Work with a tax professional to keep up with the changes in tax laws and ensure you’re using all available deductions and credits.
- Evaluate your inventory: Review your inventory to see if any obsolete or unsellable items can be written off.
- Review your business expenses: Review your business expenses to determine which ones might be deductible and which can be accelerated or deferred to maximize your tax savings.
- Consider mutual fund investments: Investing in mutual funds with tax-efficient strategies can help reduce taxable income. Funds that focus on long-term capital gains or tax-exempt municipal bonds can be beneficial for lowering taxes.
- Maximize retirement and charity contributions: Consider maximizing your retirement contributions and donating to charity before the end of the year to reduce your taxable income.
Remember, time is money, and planning ahead can save you both.
