While new federal tax laws in 2017 eliminated or reduced tax deductions for many individuals, small business owners still have a variety of breaks available to them. If you're a small business owner, here are five simple ways to reduce your taxable income and keep more of your money.
Key Takeaways
- Small business owners are eligible for a variety of tax deductions that individuals without their own businesses are not.
- Business owners can put family members on the payroll as long as they're doing legitimate work.
- Having a small business can also provide deductions for retirement and health care.
- How a small business is structured—sole proprietorship vs. limited liability company, for example—can have an impact on its taxes.
Employ a Family Member
One of the best ways to reduce taxes for your small business is by hiring a family member. The Internal Revenue Service (IRS) allows for a variety of options, all with the potential benefit of sheltering income from taxes. You can even hire your children.
For example, if your business is a sole proprietorship, you can hire your spouse and pay them an income. That income will be subject to federal income tax and Federal Insurance Contributions Act (FICA) taxes for Social Security and Medicare but not to federal unemployment tax (FUTA), as long as they are a legitimate employee and not a partner in the business.
How your children will be taxed depends on their age. All children will be subject to federal income taxes on their wages. Children under 18, however, are not subject to FICA taxes and those under 21 are not subject to FUTA taxes. Part of the benefit to you in hiring a child under 18 is that FICA taxes on employee wages are generally split between employer and employee, with the employer paying half; currently each pay 6.2% for Social Security and 1.45% for Medicare. In this case, neither of you has to pay.
Note that different rules apply if your business is set up as a corporation.
Hiring a child can mean an even bigger benefit for them. Having earned income allows them (or you on their behalf) to put money into an IRA for their retirement. And while their retirement may be many decades in the future, staring early can give them a big jump on building a sizeable fund for when the day finally comes. In particular, you may want to consider a Roth IRA, which will allow them to take their eventual withdrawals tax-free.
Note
As a small business owner, you can also hire your parents.
Fund a Retirement Plan for Yourself and Others
Small business owners have several retirement plan options that aren't available to people who work for someone else and which can result in a significant tax deduction. They include:
- One-participant 401(k) plan. These plans allow you to defer as much as $66,000 (for 2023) in income if you're under 50. If you're 50 or older you're eligible for an additional catch-up contribution ($7,500 in 2023). Although called "one-participant" or "solo" plans, this type of 401(k) can cover both you and a spouse. If you have other employees, you can set up a conventional 401(k) plan as an alternative.
- Simplified Employee Pension plan (SEP). This is a type of IRA that is easy to set up and administer, making it a good choice for busy small business owners. And unlike one-participant 401(k) plans, a SEP can also be used to provide retirement benefits for other employees (in some instances you are required to provide them). Contribution limits (in 2023) are the lesser of 25% of compensation (net earnings from self-employment in the case of self-employed individuals), or $66,000. In addition to being able to contribute to their own account and take a deduction, business owners can also take a deduction for their contributions to their employees' accounts.
- Savings IncentiveMatch Plan for Employees (SIMPLE) IRA plan. Small businesses with 100 or fewer employees are eligible to set up this type of plan. Unlike the two plans described above, SIMPLE IRAs can be funded by both employer and employee. The employer must either match up to 3% of eligible employees' contributions (which can't exceed $15,500 for 2023, or $19,000 including catch-up contributions) or contribute 2% of compensation to every eligible employee's account, regardless of whether the employee contributes. The employer can not only contribute to the plan but match their own contribution in the same way that they match any eligible employees' contributions.
Important
Employers may be eligible for a tax credit of up to $5,000, for three years, for the costs of starting a SEP, SIMPLE IRA, or qualified plan, such as a 401(k).
Save Money for Health Care
Another good way to reduce your small business taxes is by putting money aside for your future health care needs. Medical costs continue to increase, and while you may be healthy now, having some extra money on hand for medical bills could be a lifesaver. You can accomplish this through a Health Savings Account (HSA) if you have an eligible high-deductible health plan.
What's more, if you're self-employed you can often deduct the cost of your health insurance premiums for yourself, your spouse if you have one, and children up to age 27.
In the case of an HSA, you fund the account with pretax dollars (thereby reducing your taxable income), and any withdrawals you make are tax-free as long as you spend the money on what the IRS considers "qualified medical expenses." Plus, in the meantime, the interest or other earnings on the account grow tax-free. For 2023, the contribution limits are $3,850 if your high-deductible plan covers only you, or $7,750 if it covers you and your family.
As an added benefit, the funds in your HSA account roll over from year to year and never expire.
Change Your Business Structure
As a small business owner, you can choose to structure your business in a number of ways and changing that structure may be able to save you some money in taxes. The major options include:
- Sole proprietorship
- Partnership
- LImited liability compan (LLC)
- S corporation
- C corporation
Each can have tax advantages and disadvantages from both a federal and state perspective. Some businesses are taxed on the corporate level, while others pass their income through to their owners, who are then taxed on it as individuals. Pass-through entities generally include sole proprietorships, partnerships, LLCs, and S corporations.
Florida, for example, doesn't have a personal income tax but imposes a 5.5% corporate income tax on certain businesses. Ohio, on the other hand, taxes personal income but allows taxpayers to deduct up to $250,000 in business income from sole proprietorships and other pass-through entities. Texas doesn't tax either personal or business income but does impose a franchise tax on corporations and LLCs.
Deduct Travel Expenses
If you travel as part of your business, you may be able to reduce your taxes. Business travel is fully deductible, though personal travel does not enjoy the same benefit.However, to maximize your business travel deductions, small business owners can combine personal travel with a justifiable business purpose.
Any frequent flier miles you earn on your credit cards from business travel can also be redeemed for personal travel later on. You might as well use them for personal travel since it's not deductible and business travel is.
What's the Difference Between a Business Tax Deduction and a Business Tax Credit?
Deductions lower the amount of income that you're taxed on, while tax credits reduce the tax you owe on a dollar-for-dollar basis.
What Are Employment Taxes?
Employment taxes, which small businesses have to pay all or part of in many cases if they have employees, consist of Social Security and Medicare taxes (FICA) and federal unemployment taxes (FUTA), as well as any required income tax withholding on behalf of the employee.
What Is an Excise Tax for Business?
An excise tax is a tax imposed on businesses that sell certain kinds of goods or services. Both the federal government and some states have excise taxes and what they apply to can differ from one jurisdiction to another.
The Bottom Line
With some advance planning, you can reduce your taxable income as a small business owner and keep more of your money working for you. In some cases, such as deciding on a business structure, consulting a tax professional who's knowledgeable about small businesses can be well worth the cost.
