Tax season is daunting for all, but it is even harder for small business owners. Fortunately, the IRS has a number of tax deductions that could dramatically lower your tax bill. Here are a few strategies that small businesses owners can use to save on taxes in the future while reducing their taxable income.
Don’t forget to deduct startup costs as a tax deduction. Your legal fees when consulting with intellectual property experts or a lawyer for drawing up the articles of incorporation are legitimate deductible business expenses. You can deduct the costs for marketing, web design and several thousand other dollars per the IRS guidelines. You can deduct many expenses like equipment purchases and office supplies up front in your first year. This deduction reduces your taxable income for both the income tax and self-employment taxes like Social Security. The only caveat is the $5,000 limit as of 2016. If you buy $50,000 in manufacturing equipment or servers, that needs to be depreciated over a fifteen-year time frame.
Pay Yourself Properly
Take care to pay yourself, instead of working for free on the business. And then do the analysis so that you don’t get double taxed. Too many businesses pay taxes on company profits, and then the owner takes a cut of the profits. If you aren’t sure as to whether or not your business income is taxed before you take out a share or is used for pass-through income instead, consult with an accountant or financial planner.
Another way to reduce your small business taxes is to contribute to a retirement plan. Small business owners can reduce their personal taxes by contributing to a tax-deductible IRA, and working with a financial adviser, your business can reduce its taxable income by contributing to the retirement plans of all employees, including your own. You can set up a SEP or Simplified Employee Pension Plan. You can reduce your own taxes by contributing to it personally, and then reduce business taxes by having the company contribute to it, too. This doubles how much you can contribute tax free. You will owe income taxes on the retirement income when you start making withdrawals.
You may or may not be able to have employer sponsored health insurance through your small business, but you may be able to deduct your personal health insurance premiums as a sole proprietor.
Special Depreciation Rules
We already talked about how large purchases need to be deducted over a long time frame. Anything you expect to use over several years can’t be deducted up front unless it falls under the startup tax deduction. What many don’t realize is that your depreciation schedule has some flexibility. You can use a special depreciation allowance to take 50% of the cost as a deduction in the year of purchase. Note that this only applies to tangible property, not intangibles like software licenses and intellectual property rights. In a few cases, a 100% deduction using section 179 of the IRS code is possible. Consult with a small business tax expert to find out what qualifies for this tax deduction, since it can apply to up to half a million dollars in purchases. The only universal exception is residential rental property.
Home Office Deductions
If you work from home part time or full time, you can deduct part of your home expenses. You have to use the space entirely for work, so you can’t write off 20% of your mortgage, homeowners insurance, utilities and property taxes because you have a desk in the corner of the living room. Convert a spare bedroom into an office, though, and you could deduct these expenses legitimately.
Contribute to a retirement account as an individual and have it matched with contributions by your employer, your small business, and you could save on your taxes and literally save for the future. Talk to a tax expert on your options for seeing significant tax savings by depreciating large expenses, though startup expenses along with operating costs are already deductible. Don’t forget to pay yourself for your efforts so that you have money to live on and reduce the taxable income of the business. You may need to consult with a financial expert on how to ensure that your business income isn’t double taxed, once as business income and secondarily as personal income. If you work from home, you could deduct a portion of what would otherwise be living expenses.