There are many strategies that can help small business owner save money on taxes, especially if they plan well beforehand. The objective is to use strategies that will turn personal expenses, which would normally be spent with after tax dollars, to expenses spent with pre-tax dollars. These strategies implemented to the letter of the IRS Code, legally morally and ethically can save thousands of dollars for the business owner.
Most business owners feel that tax planning should be left in the hands of their CPA, but that doesn’t always work. A CPA records what you have already done filing forms and filling in boxes. He/she figures the taxes due in the most efficient way that he/she knows how, after the fact. Many CPA’s have ideas on future plans after they come up, but they rarely will make a recommendation on a strategy before they come up. Although there are plenty of strategies depending on the individual circumstances of each business, here are five that stand out and that can be easily implemented.
- Setting up the business as the proper tax filing entity. Many small businesses are set up as Limited Liability Companies in order to provide the corporate veil which protects the owners’ assets in the event of a lawsuit. As an LLC they usually start out filing a schedule “C” on their tax return which is tax classified as a sole proprietorship. My experience has found that as the business grows it should be changing its tax filing status to a Sub S corporation because there are more tax saving opportunities. A lot of people don’t know the difference between these two business structures and it is always a good idea to check the differences between LLC and S-Corp business types and how taxation is affected by that. One of the most obvious advantages is that the owner can classify half of the income of the corporation as wages where he/she pays FICA and the other half is classified as income which is classified like a dividend saving the 15.3 percent tax on the income side. Another big advantage, although not mentioned much, is that an LLC filing as a sole proprietor has seven times the chance of audit by the IRS.
- Setting up a proper retirement plan. There are many types of retirement plans available ranging from a personal IRA to a Sep IRA to a Simple IRA to a 401K to a defined benefit plan. Often a company will set up a retirement and keep that plan in place. If they re-evaluate the tax consequence they should see the benefit of changing the retirement plan as they increase their profits. With a little innovation, advanced strategies could be implemented to allow for greater deductions and the ability to defer taxation where tax brackets are lower or use insurance products to fund life insurance, which can be used to throw off tax free income at a later date.
- Employ family members. By employing a family member, you can transfer up to $6300.00 tax free and have the next $9225.00 taxed at 10%. That is over $15,000 in tax advantaged funds that could be used for purposes such as funding a tuition or some other benefit that you would normally fund with post tax dollars. There are specific rules for hiring your children that must be adhered to by the employer. They are as follows:
- The child must be at least age seven
- The child must be paid a reasonable wage for the work performed
- There must be a written job description
- Custodial accounts must be in the child’s name
- Leasing a home office to the business. Although many folks think that this is a red flag for the IRS, the exact opposite is true. Even if you have an office that you visit full time, you can lease back up to two weeks per year for a home office as a business expense as long as you occasionally use it and it is properly documented.
- Hire a tax coach. Hiring someone who can set up a strategic tax plan for your personal and business life with a focus on saving taxes in all areas is essential to your overall success as a small business owner.
Setting up your business to take advantage of standard IRS rulings allows the business owner to legally deduct personal expenses from income from the business. The five strategies mentioned above are only the “tip of the iceberg” what is below the iceberg are over 40 strategies for high earners from small business. Some of these strategies include setting up a closely held insurance company where you can defer up to 1.2 million dollars per year or a comprehensive medical reimbursement plan (MERP) claimed as a business expense. The holistic approach to taxes is necessary because with the taxation and regulation that is in place for small business owners they have to use as many tactics as legally possible to succeed.
Roy Innella is President and CEO of The Wealth Advocate based in King of Prussia, PA.