13 Essential Tax Saving Tips for Small Business Owners
There are many steps small businesses can take to minimize their income taxes, including making estimated tax payments, claiming deductions, and deducting mileage expenses. If you’re looking for ways to reduce your tax liability, follow our tax saving tips for small business owners below.
1. Keep Organized
The most important step to minimizing your small business tax is to ensure you deduct every dollar you spend on business expenses—and that means being organized. Tax returns should never be compiled based on a box full of receipts. You’ll never know if you lost a receipt and therefore missed the deduction.
Here are some tips to stay organized:
- Have a separate bank account only for business activity
- Use bookkeeping software to track your bank account activity; by tying your expenses to your banking activity, you’ll be sure to capture all expenses
- Prepare your return based on the financial statements generated by your bookkeeping software
- Save receipts by either placing them in a file or attaching electronic copies to the transactions in your bookkeeping software
For more on staying organized, read our bookkeeping tips for small businesses. You may also be interested in our guide to the IRS Deductible Business Expense Categories, which includes a free downloadable worksheet.
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2. Hire a CPA or an Enrolled Agent
Almost anyone can sign a tax return as a paid preparer—there are no licensing requirements. Be wary of bookkeepers wanting to prepare your taxes. Bookkeeping and taxes are two completely different fields within accounting. While bookkeepers may know where to put your income and expense numbers on the tax forms, being a tax professional is so much more.
You will want to find a CPA, who is licensed by individual states, or find an enrolled agent, who is licensed directly by the IRS. Both are required to meet education requirements, pass an exam, and complete education classes on a continuing basis.
It’s not realistic for you to both manage your business and know everything you should about taxes. Best of all, a tax professional will very likely pay for themselves with tax savings. Maybe not every year, or even the majority of years but, at some point over the life of your business, you’ll be very happy to be in the hands of a tax pro.
3. Make Estimated Tax Payments
Small business owners are required to make estimated tax payments on their business income. S corporation (S-corp) owners must estimate the amount of income tax on their business income and submit the payments in four quarterly installments. Sole proprietors and partners must estimate the amount of both self-employment tax and income tax on their business income.
Self-employment tax is 15.3% and is in addition to income tax, which could be as high as 37% in 2023. Needless to say, sole proprietors need to stay on top of their estimated payments or they could fall far behind very quickly.
Generally, estimated tax payments are only necessary when you have income that isn’t subject to withholding, such as business income. However, the amount of the estimated payments is determined by estimating the total tax on your tax return and subtracting any projected withholding. There is great information on paying estimated taxes on IRS’s website.
4. Claim the 199A Qualified Business Income Deduction
For tax years 2018 through 2025, taxpayers can reduce their taxable income through the qualified business income (QBI) deduction, which is equal to 20% of income flowing through to their personal returns from a sole proprietorship, partnership, or S-corp.
There are several limitations to the income deduction, but the limitations don’t apply to joint taxpayers with a total taxable income of less than $340,100 for 2022 and single taxpayers with a total taxable income of less than $170,050 for 2022. Even if your taxable income exceeds these thresholds, you likely qualify for some deduction, but the calculations become more complicated.
5. Pay Wages to Your Children
It’s likely that your children have a much lower marginal tax rate than you do. Therefore, shifting business income to them will save taxes. Assign them chores and duties around your business and pay your children a reasonable amount.
The wages paid to your child save tax on your personal return at your high marginal tax rate, while your child pays tax at their low (often zero) marginal tax rate. This strategy will work for any low-tax-rate individuals to whom you wish to provide money, including retired parents. Instead of gifting money, assign them business duties and run the payments through payroll.
Sole proprietors and partnerships, where the only partners are the parents of the child, don’t have to pay Social Security and Medicare taxes on wages paid to their child under 18 years old. However, you do need to withhold federal and state income tax, just as you would for other employees.
S-corps must treat the wages of children the same as for any other employee and withhold Social Security and Medicare. While paying children younger than 18 years old is usually a great idea for sole proprietors and partnerships, S-corps need to compare the income tax savings to the additional payroll tax liability.
6. Claim the Self-employed Health Insurance Deduction
You may be able to deduct 100% of the premiums paid during the year for qualifying health insurance for yourself, your spouse, and any dependent child under age 27 at the end of the year. Qualifying health insurance includes medical insurance, qualifying long-term care coverage, and all Medicare premiums.
7. Contribute to a Retirement Plan
As a self-employed individual, you’re eligible to contribute to a Keogh, or H.R. 10, plan. How much you can put into your plan depends in part on the type of plan you have. While this is so, there is a limit to how much of your yearly salary you can count toward your retirement plan contributions. This amount changes every year.
- 2023: $330,000
- 2022: $305,000
- 2021: $290,000
- 2020: $285,000
- 2019: $280,000
You can subtract your plan contributions on Form 1040 if you make any contributions during the year.
8. Invest in a Business Building
If you’re currently renting your business property from a third party, consider buying a building to house your business. Business buildings are a great tax shelter because you can deduct the expense of the building while the value of the building increases. I call this a “phantom expense”—you’re deducting depreciation related to the building that doesn’t exist, thus lowering taxable income. The value of the building is most likely increasing.
If your business is an S-corp, it’s best to buy the building personally and then lease it to your business.
When you purchase a warehouse, an office building, or a residential rental property, you may consider performing a cost segregation analysis. Cost segregation analyses are detailed studies into how much building parts and fixtures cost. They are usually done by a trained professional, like an engineer, appraiser, or contractor.
During the study, the parts of the building that make it up will be looked at and given a depreciable life of five, seven, or fifteen years. This can be a great way to save money on taxes, take advantage of the extra depreciation deduction, and get more cash.
By separating the cost of MACRS property with a shorter life span than the cost of the building, you can claim extra depreciation on the individual parts of property. So, any equipment, furniture, or fixtures on the property, like a heating, ventilation, and air conditioning (HVAC) system, will be qualified for bonus depreciation.
9. Deduct Fixed Assets Using Bonus Depreciation or Section 179
Bonus depreciation and section 179 expense are both rules that allow you to currently deduct the entire cost of fixed asset purchases, instead of depreciating them over a period of years. Prior to 2023, bonus depreciation was allowed on 100% of the cost of qualifying purchases, making section 179 mostly unnecessary.
For 2023, bonus depreciation is limited to 80% of the cost of qualifying assets. So, you can maximize your deduction by first claiming the maximum section 179 and then claiming bonus depreciation on the remaining costs.
Qualifying assets for section 179 and bonus depreciation include most equipment, but there are some important differences between the two. You can learn about these through our comparison of Bonus Depreciation vs Section 179.
10. Screen Job Candidates for the Work Opportunity Tax Credit
The Work Opportunity Credit (WOTC) is a tax credit available to business owners who hire and pay workers with certification from a state workforce agency as members of one of the 10 identified targeted groups listed below:
- IV-A recipients
- Designated community residents
- Vocational rehabilitation referrals
- Summer youth employees
- Supplemental Nutrition Assistance Program (SNAP) benefits recipients
- Supplemental security income (SSI) recipients
- Long-term family assistance recipients
- Long-term unemployment recipient
The credit is worth 40% of the qualified first-year pay of workers who worked at least 400 hours. For employees who worked at least 120 hours but less than 400 hours in their first year, the credit is lowered to 25% of their qualified first-year wages. Most businesses can get about $2,400 in WOTC.
To take advantage of this money-saving tax credit, you’ll need to complete IRS Form 8850 before you make an offer to your potential employee. To learn more about this powerful tax savings tool, read our article on the work opportunity tax credit.
11. Claim the Deduction on Home Office Expenses
Many small business owners can deduct the cost of operating a qualified home office. With the home office deduction, you can write off some of the costs of running your home when you do your taxes.
The business part of real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs are all business costs that can be deducted. You can use either the simple or the regular method.
Our article on what the home office tax deduction is provides more insight. We also go over how to calculate the deduction using both methods, complete with samples, and what expenses qualify for the deduction.
12. Deduct Your Mileage Expenses
Deducting mileage is an easy decision if you regularly drive your personal vehicle for business purposes. At 65. 5 cents per mile driven in 2023, the standard mileage rate can very quickly add up to a big tax deduction. Note that commuting to and from your business location isn’t deductible as a business trip.
In the old days, taxpayers tried to keep manual mileage logs and it was a pretty big hassle. But now, there are many great mileage tracking apps that will run in the background of your phone and automatically record the start and stop of each trip. At the end of the day, you just swipe left or right to separate business from personal trips.
13. Convert Your Sole Proprietorship to an S-corp
The primary tax advantage of converting your sole proprietorship to an S-corp is payroll tax savings. In a sole proprietorship, all of the business income is subject to both self-employment tax, which is the equivalent of payroll taxes paid by employees, and income taxes.
With an S-corp, only W-2 wages and salary paid to the owner are subject to payroll taxes. The business income remaining after owner compensation is subject to income taxes but not payroll taxes.
A common question is when to make the conversion to an S-corp. A good rule of thumb is to make the conversion when you hire employees. Prior to having employees, it’s hard to argue that income from the business is attributable to anything other than the owner’s labor. Therefore, the IRS will argue that all the income of the S-corp should be paid in wages, and you won’t save any payroll taxes. We’ll discuss reasonable compensation more in my next tip.
Most business payments between S-corps and their owner have no income tax effect. The S-corp deducts the payment as an expense, which reduces the net income flowing to the shareholder. The payment is taxable to the shareholder, which offsets the reduction in net income. Therefore the overall effect on taxable income is a wash.
However, not all payments are treated the same for payroll tax purposes. Wages paid are taxable for payroll tax purposes, but other business payments—such as interest, rent, and shareholder distributions—aren’t. Therefore, you can save payroll taxes by withdrawing money as rent, interest, and shareholder distributions instead of wages.
1. Minimize Your Compensation
As a shareholder/employee, your compensation must be paid through the payroll system and have payroll taxes withheld from it. The way to save payroll taxes is to minimize your compensation while finding other ways to withdraw the cash you need.
However—and this is extremely important—you must pay yourself reasonable compensation for the services you perform for the business. You can’t intentionally underpay yourself. Determining a reasonable salary is a huge gray area where the IRS and taxpayers are fighting constantly. Be sure you can justify the low salary you pay yourself.
2. Loan Your S-corp Money
If your business needs an infusion of cash, consider loaning the corporation money instead of investing it as equity capital. The corporation will then repay the loan to you plus interest at a reasonable rate. The interest is tax-deductible by the corporation and taxable to you, so you don’t save income tax, but you do withdraw the interest without paying payroll taxes. Ensure your loan is documented with a promissory note that has a reasonable interest rate.
3. Lease Real Property to Your S-corp
A good general rule to follow is to not own real estate inside a corporation. Instead, own the real estate personally, or in a single-member limited liability company (LLC) if you’re concerned about liability protection. Then rent the real estate to your S-corp at a profit. Then, you’re able to withdraw the rent from your corporation without paying payroll taxes. As with all these strategies, see to it that the dollar amounts of any contracts are reasonable.
4. Take a Shareholder Distribution From Your S-corp
The simplest way to take money out of your S-corp without paying payroll tax is to take a shareholder distribution. It’s neither deductible by the S-corp nor taxable to you, so it has no income tax consequences. However, excessive shareholder distributions could cause the IRS to question whether your compensation is high enough given the success of the company.
Another problem with taking a shareholder distribution—and the reason you need tips 2 and 3—is that if the company is struggling, a shareholder distribution may not be reasonable. However, if the company has a signed promissory note (tip 2) or lease (tip 3) with you, then they’re justified in making payments to you regardless of how they’re performing. This ensures your payments from the S-corp will continue to be reasonable and can be counted on to pay your living expenses.
We hope that our tax tips for small business owners have helped you. Good tax planning and saving on your taxes starts with being organized and having a solid bookkeeping system to produce accurate financial statements. That way, you aren’t depending on a box of receipts to determine your deductions.
Once you’re organized, hire a tax pro to help you sort through the myriad of tax deductions that might be available to your business. Finally, as your business grows and you hire employees, you should consider converting to an S-corp for considerable payroll tax savings.