How to Save Tax on Business Income

#1. Choose the Right Business Structure

The legal structure of your business plays a significant role in determining your tax liabilities. Different structures are taxed differently:

• Sole Proprietorship: Profits are taxed as personal income, meaning you’re taxed at your individual tax rate.
• Partnership: Profits are passed through to the partners and taxed at individual tax rates.
• Limited Liability Company (LLC): LLCs can choose their tax treatment. They can be taxed as a sole proprietorship, partnership, or corporation (C-corp or S-corp).
• S-Corporation: This structure allows profits to pass through to the owners, but avoids the double taxation that occurs with C-corporations.
• C-Corporation: Profits are taxed at the corporate level, and dividends are taxed again at the individual level (double taxation). However, C-corps can take advantage of more tax deductions than other structures.

Tip: Consult with a tax advisor to determine the optimal structure for your business to minimize tax exposure.

#2. Claim All Business Deductions

You can reduce your taxable business income by claiming all legitimate business deductions. The IRS allows business owners to deduct necessary and ordinary business expenses. Some common deductions include:

• Operating expenses: Rent, utilities, office supplies, and wages paid to employees.
• Business vehicle expenses: If you use your vehicle for business, you can deduct the business portion of vehicle expenses like fuel, insurance, and maintenance. You can choose between the standard mileage rate or actual expenses.
• Home office deduction: If you run your business from home, you can deduct a portion of your home expenses such as mortgage interest, utilities, and maintenance (based on the percentage of your home used for business).
• Equipment and depreciation: If you purchase assets like machinery, computers, or furniture for your business, you can either deduct the full cost (if eligible for Section 179) or depreciate it over several years.
• Employee wages and benefits: Salaries, bonuses, and employee benefit plans like retirement contributions (401(k)), health insurance premiums, and life insurance are deductible.
• Travel expenses: If you travel for business, expenses such as airfare, lodging, and meals are deductible.
• Marketing and advertising: Costs for running ads, promotions, or marketing campaigns to grow your business are tax-deductible.

#3. Utilize Tax Credits

Tax credits are even more valuable than deductions, as they directly reduce your tax bill. Some common tax credits available to businesses include:

• Research & Development (R&D) Tax Credit: If your business engages in innovation or develops new products or technologies, you may be eligible for this credit.
• Work Opportunity Tax Credit (WOTC): If you hire employees from certain groups, such as veterans or long-term unemployed individuals, you may qualify for this credit.
• Energy Efficiency Credits: If you invest in energy-efficient equipment or adopt green technologies, you may be eligible for credits to reduce your tax liability.

#4. Claim All Business Deductions

You can defer income to a later year, particularly if your business income fluctuates or you expect a lower tax rate in the future. Deferring income is a way to lower your taxable income in the current year, thus reducing your tax burden. Some ways to defer income include:

• Delaying invoice payments: If you’re on a cash basis, you can delay sending invoices or receiving payments until the next tax year, deferring income.
• Deferring bonuses: If possible, delay paying bonuses or commissions to employees or contractors until the following year.
• Contributing to retirement plans: Contributing to retirement accounts like a 401(k) or SEP IRA can defer your taxable income because contributions are made pre-tax.

#5. Contribute to Retirement Plans

Setting up a retirement plan for yourself and your employees not only helps ensure financial security but also offers significant tax savings. Contributions to retirement accounts are tax-deductible, which reduces your taxable income. Some popular options include:

Solo 401(k): This is a 401(k) designed for self-employed individuals, allowing them to contribute both as an employee and an employer, maximizing contribution limits.

401(k) Plan: A 401(k) allows you to contribute a significant portion of your income (up to $20,500 for 2022, or $27,000 if you’re over 50) on a tax-deferred basis.

SEP IRA: The Simplified Employee Pension (SEP) allows business owners to contribute up to 25% of their income (or $58,000 for 2022) to their retirement account.

#6. Take Advantage of Section 179 Deduction

Under Section 179 of the IRS Tax Code, businesses can deduct the entire cost of qualifying equipment, machinery, or software in the year it’s purchased and placed in service, rather than depreciating it over several years. For example:

• Equipment and machinery used in the business.
• Computer software purchased for business use.
• Vehicles that meet specific weight requirements.

In 2022, businesses can deduct up to $1,080,000 under Section 179, with a total equipment purchase limit of $2.7 million.

#7. Contribute to Retirement Plans

Provide tax-free benefits to your employees to reduce your tax liability. Certain fringe benefits are tax-deductible and not taxable to the employees:

Transportation and parking: Employer-provided parking and transit passes are tax-free up to certain limits.

Health insurance: You can deduct the premiums you pay for your employees’ health insurance, and employees don’t have to pay taxes on it.

Life insurance: You can provide life insurance for your employees as a tax-free benefit.

Education assistance: You can provide up to $5,250 per year in educational assistance to employees, which is tax-free for both the employee and the employer.

Transportation and parking: Employer-provided parking and transit passes are tax-free up to certain limits.

#8. Take Advantage of Section 179 Deduction

If you have family members working in your business, consider income splitting to lower the overall family tax burden. For example:

• Hire your spouse or children and pay them a reasonable salary for their work. This may shift income from your higher tax bracket to their lower tax brackets.
• Paying your children: If your children are under 18 and work in the business, you may be able to avoid payroll taxes, depending on the state laws and IRS rules.

Note: Ensure that the salaries you pay are reasonable for the work done. The IRS may challenge excessive salaries paid to family members, so always keep records of the work performed.

#9. Track Losses for Carry-Forward

If your business experiences a loss, you can carry that loss forward to future years and offset future income. This process is known as a Net Operating Loss (NOL) Carryforward.

• If your business’s expenses exceed its income, the losses can offset taxable income in future years, reducing future tax obligations.
• Recent tax reforms have allowed more flexibility in how you carry forward these losses.

#10. Consider Tax-Advantaged Investments

Investing in tax-advantaged assets, such as:

• Municipal bonds (which are often exempt from federal taxes),
• Qualified opportunity zone investments (which may offer tax incentives like capital gains tax deferral and exclusion), can also reduce your tax liability.