10 Strategies for Small Business Taxes | Tory Burch Foundation

According to the National Small Business Association, 59% of small business owners say that federal taxes are one of the most significant burdens on their business. And a study by SCORE, the Service Corps of Retired Executives, found that 60% of small businesses miss out on significant tax deductions and credits. 

Tax season isn’t just a few months out of a CEO’s year; You should be focused on how to manage your business taxes along every step of your journey as an entrepreneur, explains CPA Ramona Cedeño, founder and CEO of small business accounting firm FiBrick. She returned to our webinar series to share 10 tax strategies to reduce small business taxes by taking advantage of all the credits and deductions that are available. 

It’s important to note that 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.

1. OPTIMIZE ENTITY SETUP.

The business structure you choose will dictate your company’s tax needs and guidelines. “It’s important that you consider the long term vision for the business and for you in conjunction with what is the best structure from a tax perspective,” Cedeño said. What are your goals, 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 — that entity might be preferable if you plan to scale your business with fundraising from investors in exchange for equity.

Another consideration is that each structure has 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. 

2. MASTER FINANCIAL ORGANIZATION

“Everything that happens in your business, from a financial and even operational perspective, at the end of the day, impacts your profits or your loss, and it impacts your taxes,” Cedeño said. It’s critical to maintain complete and accurate financials records to get a clear view into how your business is doing. 

Consider getting accounting software, such as QuickBooks and Xero, which 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. If you’re hesitant to purchase bookkeeping software, Cedeño advised that while she doesn’t prefer tracking expenses in Microsoft Excel, she believes it can be an effective tool for businesses with a low volume of transactions. 

No matter how you choose to keep track of your finances, consistency is key. She recommended reconciling all bank accounts on a monthly basis. 

3. SEPARATE PERSONAL AND BUSINESS FINANCES

Do yourself a favor and set up separate bank accounts for your personal and business finances from day one. You don’t want any confusion or gray areas. If audited, having personal expenses mixed in with your business expenses could result in rejected deductions and penalty payments for any past deductions you weren’t entitled to. If you do 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. 

4. UNDERSTAND 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. Cedeño also spoke to the fact that while a Research and Development tax credit, or R&D, is popular with businesses in the tech space, it is not exclusive to that industry. Your business might qualify for an R&D credit for research and development expenses while creating a new process, manufacturing your product, or 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.

Lesser-known Deductions and Credits

Cedeño also walked through a series of less common, but equally important business deductions:

Startup Costs: When you haven’t launched your business yet, but you’re spending a lot of money getting all of your ducks in a row, startup costs can be deducted. Consult an accountant or other tax advisor to ensure your expenses meet requirements and follow IRS guidelines. 

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

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 or client 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. Learn more about how the IRS defines bad debt deductions.

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 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 car, 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 is 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. 

5. STAY UPDATED ON CHANGES TO TAX LAWS

It’s good practice to regularly consult tax professionals and conduct your own research to stay up-to-date on temporary and long term changes to tax laws. Cedeño used the example of businesses being allowed to deduct 100% of meal expenses during the COVID-19 pandemic to support local restaurants, but that credit expired after 2 years. If you aren’t keeping up with changes in legislation, you could miss deductions or set yourself up for penalty fees. 

6. MAXIMIZE RETIREMENT CONTRIBUTIONS

Any contribution you can make toward your retirement is great (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 employees’ retirement plans and reduce its net income. 

7. IMPLEMENT TAX-EFFICIENT COMPENSATION STRATEGIES

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-Ccrp, you would be required to pay yourself a “reasonable” salary based on the IRS guidelines. You can optimize the tax efficiency by adjusting that salary based on your business’ financial makeup as it changes and future investment goals. 

8. UNDERSTAND IMPACT OF BUSINESS ON PERSONAL TAXES

Knowing how the net income of your business flows through your personal return will give you insight into your personal taxable income and which tax bracket you fall into. But you have more control here than you might think. By accelerating reinvestments into your business, you can lower both your business and personal net incomes. For example, let’s say your company’s expected net income for the year is $100,000, but you want to lower that to $75,000. You reinvest $25,000 in business expenses that otherwise could have waited until the following year. However, Cedeño warned that 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-corp, estimating your personal tax liability will require you to take into account for your own salary along with income from the business. 

9. 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. 

10. 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. 

While it’s helpful for entrepreneurs to be familiar with these strategies and abreast of changing tax laws, having experts integrated into your team is a worthy investment. Cedeño recommended 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, CFO can also be beneficial as your business grows.