7 Strategies On How to Reduce Income Tax as a Business Owner

Seventy-five percent of small businesses in the U.S. are unincorporated pass-through entities. Their owners report the businesses’ income on their personal taxes. If you pay personal taxes on your business income, you want to reduce income tax paid. There are now over 30 million small businesses in the United States. They employ almost 60 million Americans. Do you own a sole proprietorship, partnership, or another pass-through entity? Paying less tax means growth for your business, a better retirement for you, and improved benefits for your employees. Here are seven strategies to reduce income tax. 1. Restructure Your Business Many businesses and startups don’t change their structure when needed. Small businesses often start as sole proprietorships or partnerships. With this structure, owners are subject to self-employment tax on all business income. LLCs Switching to an LLC allows you a tax choice. You can elect to have an LLC taxed as an S-corp. As an LLC’s owner, “member,” you pay yourself a reasonable salary. The salary is subject to FICA taxes. But the rest of the LLC’s income passes through as a “distribution” of business income not subject to FICA taxes. Paying taxes as an S-corp allows you to reduce income tax paid on a large part of your income. And since 2018, many LLC owners can deduct 20% of business income from individual tax returns. C-corps As your income grows, it makes sense to move to a C-corp once you find yourself in a higher tax bracket. In a C-corp, the first $50k of your income is taxed at 15% vs. the 35% tax rate of the highest tax bracket. Before making this switch, look at your state’s tax laws. Sometimes state taxes for C-corps are much higher. 2. Keep Good Records Keeping good track of income and expenses can save your business a lot when it’s time to pay your income taxes. It’s important to collect and store receipts and other proof of expenses. Detailed documentation lets you take advantage of tax deductions and avoid late penalties. For example, many tax incentives are based on adjusted gross income (AGI). For example, if your AGI exceeds $200k as a single filer, you’ll pay an extra 0.9% in Medicare taxes. Knowing where you are in regards to income can help you keep your AGI below these types of thresholds. 3. Create a Year-End Strategy If you’re having a successful year, you may find yourself with more growth (and income) than you expected. That’s usually a nice problem to have, but this problem can put you in a precarious tax predicament. Fortunately, you can develop a year-end strategy to reduce your tax liability. Tax-Deductible Contributions You can also contribute to a Health Savings Account if you have a high-deductible health plan. HSAs have a triple tax advantage. Your contributions are pre-tax, grow tax-free, and qualified medical expenses are tax-free. Restricted Property Trusts S-corp, C-corp, and LLC income make you eligible for a restricted property trust. The trust owns an insurance policy which allows tax-deferred growth on its value. Your business makes fully-deductible annual contributions to the trust. Then when funding is complete, the policy transfers to the participant. Withdrawal from the policy covers any taxes owed. Learn more about restricted property trusts. 4. Defer Profits to Your Retirement Retirement plans are one of the few ways to claim a deduction without having to spend money for the tax benefit. You do have to meet certain age thresholds to avoid penalties. But profits on the funds are tax-deferred until distributions are finalized. The IRS allows you to put up to $53k into retirement each year. You can contribute to qualified tax savings accounts to avoid paying tax. This is a great option if you won’t need profits until after the age threshold. 5. Offer Benefits to Your Employees Sometimes instead of offering raises, it makes sense to offer benefits. If you increase wages, your employees will have to pay added taxes on those wages. But if you offer more lucrative medical insurance, employees pay less tax. And now you also don’t have to pay your part of the added income, FICA, Medicare, and unemployment tax. Win-win! You can easily set up a 401k or similar tax-deductible plan. Your employees don’t have to pay taxes on the funds they contribute to their retirement. And setting up the plan is good for your business as well. Your business’ contributions to an employee retirement plan are tax deductible. And you may qualify for tax credits for creating the plan. 6. Spend Your Money on Needed Equipment Starting in 2018, you can deduct the cost of machinery and equipment up to $1 million. It may make sense to spread out depreciation over the years instead of taking the tax deduction all at once. You shouldn’t spend capital just to get these deductions. But if you need to procure such items soon, it makes sense to push these purchases into the current tax year. 7. File Your Taxes on Time This may seem like a no brainer, but many companies file extensions each year. If you don’t file on time you could be liable for late filing and late payment penalties. Even if you’re not able to pay the tax, you should still file on time to reduce penalties. C-corps that file late are subject to late filing penalties and late payment penalties on any tax due. Partnerships are subject to late filing penalties multiplied by the number of partners. And S-corps are subject to penalties based on the number of shareholders. It’s easy to see how those fees add up quickly. You Can Reduce Income Tax Owed Paying income tax on your business earnings is inevitable. But you can reduce income tax. Invest in your business, yourself, and your employees. Why not spend your money the best way you see fit? Lower your next income tax bill with these steps.