Tax Planning Strategies

It’s important small businesses know how to navigate the tax system.

By Alexandra Walsh

According to the National Small Business Association, 59% of small business owners say federal taxes are one of the most significant burdens on their business. And another study found about the same number, 60%, of small businesses miss out on significant tax deductions and credits.

Tax season isn’t just a few months out of a small business owner’s year. You should be focused on how to manage your business taxes throughout the year. It’s important to note these tax planning strategies are meant to be guidance, not advice.

You should consult a tax advisor and conduct your own research before making decisions.

Business Structure

Your business structure dictates your company’s tax needs and guidelines. It’s important for you to consider what your company’s goals are and which structure will best serve those goals.

For example, although a C-corporation is considered a double taxation entity—meaning after you pay the 21% flat rate, you may also end up paying again in your personal filing if you’ve taken a distribution from the company.

Another consideration is that each structure has its own distinct tax reporting requirements. In an S-corporation, you would have to be on payroll as the owner and pay taxes on that income. On the other hand, you do not have to be on payroll for your LLC; you would file taxes for your LLC with your personal tax return with profits or losses listed on a Schedule C form.

Financial Organization

Everything that happens in your business, from a financial and even operational perspective, impacts your profits or loss, and impacts your taxes as well. It’s critical to maintain complete and accurate financials records to get a clear view of how your business is doing.

Consider buying some accounting software that makes it easy to generate a balance sheet. Income statements keep up with revenue and expenses, but balance sheets will be able to tell you how much cash you have available, how much of that is loans, and track what financial contributions you’ve personally made to the business.

No matter how you choose to keep track of your finances, consistency is the key, and all bank accounts should be reconciled on a monthly basis.

Separate Finances

You should set up separate bank accounts for your personal and business finances from day one. If you are audited, having personal expenses mixed in with your business expenses could result in rejected deductions and penalty payments for any past deductions you were not entitled to.

If you need to pad your business account with personal funds, always do so with an official bank transfer and record it as a contribution or a loan in your balance sheet.

Deductions and Credits

The Internal Revenue Service defines business expenses that can be deducted from your tax filing as those that are ordinary and necessary for the course of business.

Common deductions include rent for office space, marketing expenses, insurance, payroll, and subscriptions. Your business might qualify for R&D credit for research and development expenses while creating a new process or while enhancing a business entity that already exists. You’ll have to hire an external tax agency to assess whether you qualify for the credit and assign an appropriate dollar amount.

Here are some less common, but still equally important, business deductions.

Pension Plan Startup Costs: If you set up a pension plan for your employees, pension plan startup costs are eligible for deduction over the first few years of that plan.

Tax season isn’t just a few months out of a small business owner’s year. You should be focused on how to manage your business taxes throughout the year.

Bad Debt: A bad debt deduction is available, but it’s important to understand whether your debts qualify.

If your business is on a cash basis—you only report cash received when it’s deposited in your bank account and you record expenses when you pay them—you don’t qualify for bad debt because the revenue related to a defaulted payment by a customer wasn’t included in your income.

But if your business is on an accrual basis, the revenue would have been recorded in prior months and you’re eligible for this deduction.

Charitable Contributions: In most cases, charitable contributions will be addressed in your personal tax return. But if you’re making them through your business, make sure they are included in your profit and loss statement.

Flag this for your tax advisor as they prepare your return, and they’ll determine how they should be reported.

Electric Vehicle Tax Credit: If your business requires that you purchase a vehicle, you might be eligible for an electric vehicle tax credit. There are income limitations, so make sure you do your research before making a purchase.

Documentation and compliance are crucial for all deductions and credits that you claim. You don’t have to keep a record of every little transaction, but you should know and defer to whatever the IRS threshold is for your business structure. It’s also a good idea to keep notes of the business needs for expenses to reference later.

Stay Updated on Tax Laws

It’s a good practice to regularly consult a tax professional and conduct your own research to stay up to date on any temporary and long-term changes to tax laws. For instance, businesses were allowed to deduct 100% of meal expenses during the COVID-19 pandemic to support local restaurants, but that credit expired after two years.

If you aren’t keeping up with changes in legislation, you could miss deductions or set yourself up for penalty fees.

Maximize Retirement Contributions

Any contribution you can make toward your retirement is a great idea. The more you can contribute, the better. But as a business owner, it’s important to think about which retirement savings plan will best serve your tax strategy, your goals, and the goals of your employees.

With a Simplified Employee Pension, or SEP, the employer makes 100% of the retirement contribution. Some exclusions or parameters on the amount could be implemented based on factors such as employee tenure, but business leaders should make those decisions with a financial advisor.

A 401(k) plan requires a retirement contribution from the employee through payroll withholdings, but the employer matches that contribution. If you are your only employee, you may be able to contribute to your 401(k) in both capacities.

The IRS says that a Savings Incentive Match Plan for Employees (SIMPLE) IRA may be best for small businesses because it doesn’t require the usual start-up and operating costs of a conventional retirement plan.

Each option has its respective contribution requirements, but a business can seek a deduction for contributions it makes to its employees’ retirement plans and reduce its net income.

Compensation Strategies

Although this does not pertain to many small businesses, incentives such as stock options for employees or investors, depending on your entity structure, would be considered deferred compensation and could be an eligible tax deduction for your business.

As mentioned earlier, as the owner of an S-corporation, you would be required to pay yourself a reasonable salary based on the IRS guidelines. You can optimize tax efficiency by adjusting that salary based on your business’ financial makeup as it changes and future investment goals.

Impact of Business on Personal Taxes

Knowing how the net income of your business flows through your personal return will provide insight into your personal taxable income and which tax bracket you fall into.

By accelerating reinvestments into your business, you can lower both your business and personal net incomes.

By way of example, let’s say your company’s expected net income for the year is $250,000, but you want to lower that to $200,000. You reinvest $50,000 in business expenses that otherwise could have waited until the following year. However, this is another situation where consulting a tax professional is crucial. In lowering one year’s net income, you could increase the next. Careful budgeting and analysis is key.

Also, if you’re registered as an S-corporation, estimating your personal tax liability will require you to consider your own salary along with income from the business.

Plan for Estimated Tax Payments

If you don’t pay your estimated taxes throughout the year, you will incur penalties for underpayment. It’s important to budget for what you estimate your quarterly tax payments will be.

You also need to be aware of how taxes are expected to be paid, based on the requirements of your business entity. In some cases, a business’ taxes are paid directly to the IRS. In other cases, the business’ taxes are routed through the owner’s personal tax return. And there may be state taxes that need to be paid directly, regardless of the business’ federal classification.

Defer Income and Accelerate Expense

Businesses that operate on a cash basis have the option to delay collecting income from their customers during the last month of the year, which lowers that year’s net income and raises the income of the following year.

Always consult a financial professional to make sure any changes that you make to your business’ income, within the tax laws, are aligned with personal and professional financial goals.

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While it’s helpful for small business owners to be familiar with these strategies and abreast of changing tax laws, having experts integrated into your team is a worthy investment.

Consider seeking out a tax advisor or tax planner as well as an accounting firm. If cost is a concern, consider hiring a freelancer who can maintain your bookkeeping under the guidance of your tax advisor. A fractional or part-time chief financial officer (CFO) can also be beneficial as your business grows.

As parting advice: Always consult a tax advisor to confirm which credits apply to your business.

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Alexandra Walsh is the vice president of Association Vision, a Washington, D.C.–area communications company. She has extensive experience in management positions with a range of organizations.