Small Business Tax Planning

an Open sign in the window of a small business

When starting a new business there are many things that need to be learned to run your business correctly. One thing that you will learn quickly is that filing taxes for a business is much more complex than filing taxes for an individual. As a tax professional, I would always recommend hiring a tax professional to advise you on any tax filing. 

When you have a business, the knowledge of a true tax professional, either an Enrolled Agent or a CPA will save you far more money than you must pay to hire them. Also, there are so many mistakes that can be made when filing taxes for a business it makes sense to have someone who knows what they are doing to prevent an examination or audit. 

Today I will start with going over a lot of the mistakes that can be made on the filings. I will also discuss some of the most valuable tax deductions that can be used for a small business. Hopefully, by this point in the article, you have seen just a small part of the immense value of hiring a tax professional. From here I will lay the things you should be doing throughout the year and in preparation to meet with your tax professional so they can get the most out of your filings and save you money.

 

Common Tax Planning Mistakes That Can Cost a Small Business Owner

After all your hard work throughout the year, it is bad enough that you must fork over large amounts of your income to the IRS in the form of taxes. What is even worse is making some of these common mistakes and seriously overpaying.

One of the biggest and most common mistakes is the misreporting of income. All 1099’s that are sent to you are also sent to the IRS as well. You will not only need to include all income on the tax filing, but you must make sure it is all listed in the correct place. The IRS has a computer system that matches what has been reported to them and what has been reported by you. 

If you fail to report some of your income this system will detect that as well. So, this is not a mistake that you can typically get away with. When this is noticed the IRS will come back and adjust your filing and assess you with penalties and interest for the mistake.

Another common mistake is the overreporting of income. Not all your business income is taxable. With a business, it takes money to make money. When filing your taxes, it is important to utilize allowable deductions to reduce your amount of taxable income. 

People always like to speak about their gross income instead of their actual profit. Utilizing your business expenses and reducing the taxable income down to your companies’ actual profits can save you thousands of dollars in the taxes you have to pay. 

It is especially important not to mix your personal and business finances. Keeping separate records will make it much easier to track deductible expenses. Also, in the case that the IRS decides to do an examination or an audit, having these separate records is a necessity.

Another big mistake that is made is not tax planning. Sitting down with a tax professional and doing tax planning for the future year that you are in not just dealing with the past year in the tax filing. Setting yourself up with good record-keeping for expenses is one thing that can help you save on your overall tax liability. 

Also setting up estimates with the IRS will help you avoid a surprising and scary bill you may not be able to afford once you file. The last thing you want to do with a business is to start being behind with the IRS. They immediately start accruing penalties and interest if late which can set up a business to overpay on taxes drastically. 

Tax planning also helps you to be prepared to file on time or early rather than waiting for the deadline. If you miss the deadline, you are immediately assessed a late filing penalty that is a percentage of what you owe. Check out the IRS website to see all the different penalties that can cause your business to overpay on taxes. 

These are just a few examples of the mistakes that can be made when it comes to taxes that can be prevented with a good tax professional and some good tax planning. Some of these mistakes seem very easily avoidable but remember as your business grows the more complex the filing becomes and the easier it is to make these types of mistakes. 

In the next section, I will go through some of the most valuable deductions that can be utilized so you do not make the mistake of overpaying your taxes.

 

Valuable Tax Deductions Not to Miss

As I have mentioned, a few major benefits in filing your taxes are utilizing deductions to lower your taxable income. Many people call these write-offs. A tax deduction is an expense that you can deduct from your income to reduce your taxes due. 

In this section, we will discuss just a few examples of common and valuable deductions. Consult with your tax professional to see which ones you can qualify for from these examples and the many other deductions available.

One quite common deduction that has become even more common since the coronavirus has forced so many to work from home is the home office deduction. If you are self-employed or a business owner, you may qualify for this. If you use this space exclusively for business purposes and this is your primary place of business, you should be able to use this cost as a deduction.  

If you use your vehicle for business purposes, then you should be able to use the car tax deduction. If you have a car purely for business then you can deduct the vehicle’s entire operating cost. If your vehicle is used for both personal and business, you can only deduct the business usage costs. 

These expenses can be calculated in two different ways. You can use the standard mileage rare. This is where you track the miles driven. The other option for vehicle expenses would be the actual expense method. This would be keeping track of your actual expenses such as gas, oil changes, repairs, tires, insurance registration, or lease payments.  

If you spend money on advertising or any other costs to promote your business these are expenses that can be deducted as well. 

If you are someone who loves to wine and dine your clients, you may be able to deduct up to 50% of qualifying food or beverage costs. To be eligible for this deduction the expenses must be an ordinary part of running your business. 

If you need to hire legal representation throughout the course of the year in many circumstances this expense can be deducted. Telephone and internet costs can even be deducted. 

These are just a few of the many different expenses that can be utilized to reduce your taxable income. For more examples of these expenses see this great article in Forbes magazine. 

To take advantage of these and all the other deductions, organization and keeping records is a must. Keeping good records and having all the proper paperwork ready for when you visit your tax preparer will give them the ability to use everything within tax law to save you money. 

Below is a list of documents that you should gather and bring to your visit with your tax professional.

  • A complete and up to date trial balance
  • Records of current year major asset purchases, disposals, or lease arrangements
  • A copy of their 2019 tax return if you didn’t prepare their tax returns last year
  • Any documentation related to federal or state credits being claimed
  • Mileage logs
  • Documentation of federal and state tax payments made
  • Names, addresses, and FEINs of vendors paid that may need 1099-MISC issued
  • Any payments made from their accounts or credit cards that were not recorded in the company records
  • Details of loans and any advances or repayments between the business and owners
  • Annual payroll records
  • Any distributions from equity owners

Mistakes are still going to be made by any business owner but limiting those mistakes and missed opportunities can save a business owner a lot of money. Consulting with a tax professional and being proactive with your tax planning can keep you off the expensive hamster wheel that a lot of business owners find themselves on. 

Also, tax law is constantly changing so having a true tax professional is a must to keep up with new laws that can benefit your business. 

In conclusion, do not be the business owner who is freaking out come tax time. As you see with a lot of work throughout the year and the correct tax professional filing your taxes can be quite easy. You work hard for your money throughout the year, so it only makes these to keep as much of it in your pocket come tax time.

 

Tax Planning for Self-Employed Individuals

old tax returns and tax debt

Being self-employed gives you a unique opportunity to be your own boss. However, this level of freedom comes with great responsibility. For starters, you are called to take charge of your own retirement plan and, of course, pay your own FICA taxes (Social Security and Medicare). This means that you must understand and comply with your federal tax responsibilities.  This guide will help you get a pretty good idea of what tax planning should look like for you. We will also share valuable insights and tips to help you minimize your tax obligations. 

 

What is the Self-Employment Tax?

In a nutshell, it is the way the federal government funds Medicare and Social Security benefits. The only case you are not obliged to pay this tax is when you have a minimal amount of self-employment income. The way your self-employment income is calculated varies depending on your business structure. For instance, if you are a sole proprietor, statutory employee, or independent contractor and file Schedule C, your self-employed tax is the net profit listed on your Schedule C (or C-EZ). This must be included on your Schedule SE. 

 

Minimizing your Tax Obligations

1. Choose the Best Business Structure

As it has already become apparent, identifying what business structure best suits your needs is important for the self-employed. This decision will not only determine how much you pay in taxes, but also affect (1) the personal liability you face, (2) the amount of paperwork required, and (3) your ability to raise money. Your individual circumstances will pinpoint the structure that makes the most sense, though. You can choose among the following business entities:

  • Partnership – You share the losses and profits of a business with two or more people. This means that you don’t bear the benefit of losses-profits or the tax burden of profits all by yourself. During tax time, each business partner files a Schedule K-1 form that indicates their share of income from the business, tax credits, and deductions. As for the losses, these are passed through to the partners, who report them on their individual tax reruns. On the flip side, each partner is personally liable for the business’ financial obligations. Plus, partnerships require more extensive accounting and legal services than sole proprietorships. Hence, they are costlier to establish. 
  • Sole Proprietorship – The most common business structure. It offers the owner complete managerial control and is very easy to form. Nevertheless, the owner is held responsible for all their business financial obligations. Tax-wise, a sole proprietorship business owner includes income and expenses from the business on form 1040 (their personal income tax return). The losses and profits are recorded on Schedule C (a tax form) that is then filed along with their 1040. Finally, the Schedule C “bottom-line amount” is transferred to their personal tax return. Worth noting is the fact that your business earnings are taxed once. 
  • LLC (Limited Liability Company) –  It is a hybrid form of partnership that enables business owners to benefit from the advantages of both the Partnership and Corporation forms of business (i.e., owners bear no personal liability, losses and profits are passed through to owners without taxation of the business). LLCs are great entities for tax purposes as they enable owners to enjoy liability protection skipping the double taxation of corporations. They also offer more attractions to business owners than S-Corps (i.e., no shareholder limitations. However, they usually dissolve after 30-40 years.
  • C-Corporation (or C-Corp) – It is a legal entity that is separate from the individuals that found the business. A corporation is taxed and held liable for its actions pretty much like a person (liability protection for the owners). This is perhaps the biggest advantage of going for a Corporation business structure – the owner does not have any personal liability. The extensive record-keeping required, alongside the cost to form a corporation, though, are the primary disadvantages. Plus, corporation owners pay a double tax on the earnings of the business. 
  • S-Corporation (or S-Corp) – You may choose the S-Corp (aka Subchapter corporation) structure that enables losses and income to be passed on individual tax returns (single-level federal tax to be paid). Usually, an S-Corp structure is offered to companies with no more than 75 shareholder returns and provides business owners with the liability protection of a corporation. 

The type of business format that best suits your requirements will primarily depend on the following three factors

(1) Record-keeping – How much paperwork is required? Are you up to it? Can you bear the cost of paperwork and record-keeping, along with the costs related to incorporation? Remember that administrative requirements like that can eat up your time, which can, consequently, create costs for the company. But, if you are benefiting from protection from liability and tax implications, a corporation is a good option. In any other case, you would be better off with a sole proprietorship, especially if you own 100% of the business. 

(2) Taxation – There are much fewer tax options available to partnership and proprietorship than to corporations. For example, a self-employed that receives a 1099 pays an additional self-employment tax. Those that do not make much is best to choose a sole proprietor business entity. As for those making at least $50,000 and are 1099’d, it would be better to create a corporation business structure, depending on the number of employees, business owners, and the size of the business. 

(3) Liability – To what extent do you need to be held legally liable for potential losses related to your business? Can you afford the risk of the potential liability? If not, then a partnership or sole proprietorship may best be avoided. 

2. Make Your Estimated Tax Payments on Time

This is a major consideration as it will help you avoid penalties. Ensure you (1) set up estimated tax payments and (2) make the required quarterly estimated tax payments (using Form 1040-ES) to cover both your self-employment tax and income tax liability. Note that you may also need to make estimated tax payments to avoid getting penalties and receiving a big tax bill at the end of the fiscal year. And, don’t forget your periodic tax responsibilities if you have employees (see IRS Publication 15 for more information). The IRS has an automated payment system called EFTPS that you can use for your payments. We strongly advise you to opt for monthly payments as it is easier to stay current than with quarterly payments. This also helps prevent the IRS from penalizing you for not paying your due (quarterly) tax on time. 

Tip: You can save taxes by employing family members (not minors), which allows you to shift income to your relative. That way, the business takes a deduction for employee compensation (ensure it is a reasonable amount), which reduces the business taxable income that flows to you. 

3. Establish an Employer-Sponsored Retirement Plan 

This will not only allow you to take care of your own retirement needs but also provide you with several tax benefits by enabling your business to be eligible for an immediate federal income tax deduction (expenses to fund the plan). Such employer-sponsored retirement plans worth considering are SIMPLE IRA, SEP, SIMPLE 401(K), Keogh plan, and Solo (or one participant or individual) 401(k). Note that until you withdraw earnings and contributed funds, you will not need to pay any federal income tax. IRS Publication 560 has more details about these schemes. You may, however, call us and let us guide you appropriately. 

4. Take Advantage of Business Deductions

Your business is entitled to deductions that reduce your taxable income. Make sure you use every single one of the offered deductions to deduct business expenses, including equipment costs, utilities, office expenses, and rent. Just ensure your business expenses are considered necessary, common, and accepted in your business or trade. Also, using the cash method of accounting allows self-employed taxpayers for greater maneuverability at the end of the year. 

Tip: You may also deduct self-employed healthcare-related expenses (up to 100% of the health insurance cost you provide for yourself, your dependents, and your spouse). Note that your contributions to HSA (health savings account) are also deductible. 

 

Two Effective Ways to Sidestep the 13.25% Self-Employment Tax

1. Become  a Partnership. 

The first would be to become a partner and make K1 distributions (aka guaranteed payments) to yourself.

2. Become an S-Corp.

The second option is to become an S-Corp. Whichever business structure you choose will enable you to sidestep the self-employment tax.

Here’s a savings example to get an idea of what we are proposing here:

Let’s assume that you make $100K and write $50K for business expenses. According to the current federal tax laws, you will be called to pay around 20% tax PLUS the 13.25% self-employment tax. As an S-Corp, though, you will NOT have to pay the 13.25% tax – the profit would be a K1 distribution. 

Important notes:

  • You must file an 1120-S. 
  • Ownership pulls must be consistent (for example, $5K every month).
  • The IRS wants to see one or more W2, which could be yourself. 

 

Make Sure You Do Your Bookkeeping

You may either want to outsource bookkeeping or use platforms like QuickBooks. When it comes to calculating estimated payments and paying the right tax amount on time, bookkeeping with the help of a software or by trusting a reliable and experienced tax accountant makes things far easier. 

As you can see, there are legitimate (aka legal) ways to save money on your taxes while being self-employed.  It’s simply a matter of planning well, staying on top of things and taking advantage of all possible tax savings strategies.