Tax season is inevitable. It's one of the most daunting times of the year for any small business owner. Whether you hire a professional tax preparer or do it yourself, you'll need to be prepared in advance. You can reduce your taxes by preparing early. Here, we'll share nine ways you can reduce your business taxes legally.
1. Health insurance tax deduction
Did you know that the IRS offers multiple deductions on taxes? One of them happens to be the premiums paid on health insurance. If you earn an income through your business and pay for your own insurance, you are eligible for tax deductions on the premiums paid. To qualify for the health insurance tax deduction, you must be ineligible to acquire other health insurance benefits from your employer or spouse.
2. Deduct assets acquired within the year
Did you know about the special provision within the federal tax that allows business owners to deduct the cost of assets acquired in the year purchased? With this provision, in Section 179, you can deduct the total cost of an asset from your EBT (earnings before tax) and drastically reduce the tax obligation.
For example, if you purchased a business vehicle in 2022 for $200,000, you're allowed to deduct the $200,000 from your earnings coupled with the interest and other expenses. This can drastically reduce the amount of money due. Remember, you can only do this in the year you purchased the asset. If you didn't apply this tax deduction in the year of purchase, read the next point.
3. Depreciation of assets
If you didn't deduct the total cost of assets in the year of purchase, worry not. There's a solution for you. The IRS allows business owners to deduct the depreciation of assets annually until the asset is categorized as obsolete.
So, what exactly do we mean? These are different categories of assets: depreciation ones and appreciative ones. The depreciation ones are the assets that reduce in value. It simply means you can't sell the asset for the value you purchased it.
For example, a vehicle purchased at $200,000 with a 15% annual depreciation rate means the value at the end of the year of purchase will be $170,000. The difference of $30,000 is what will be deducted to reduce tax.
4. Home office deductions
Do you use any part of your home for business purposes? If so, you're eligible to have some tax advantages on it. Tax deductions on home offices are applicable if the space is solely devoted to only your official business duties. The space doesn't need to be a whole room, just a significant dedicated area. The deductions are based on the square footage of the space used for this sole purpose.
The tax deductions on home office are done in two ways; under direct and indirect expenses.
Renovations and appraisals on the dedicated space are recorded as direct expenses. The rent, utilities, and other bills based on the square footage are deducted as indirect expenses. To get the direct cost percentage, you divide the total square footage of the home by the square footage of the office space.
According to the IRS, there are two exclusive cases you're not subjected to the sole use rule. These include the usage of the home for inventory storage and the use of the home as a daycare center.
5. Reductions from bad debts
Bad debt occurs when a customer makes a purchase but doesn't pay or when you give loans as a business, and they are not paid back. Bad debts are deducted from taxable income. However, there's a but! This form of deductible is only applicable if you use the accrual method of accounting. The accrual method accounts for revenue when the client makes a purchase. In the accrual method, income is recorded immediately after a purchase is made with or without actual payment.
For example, Car Company A sells a car with a promissory note to another company B within the current quarter. If Company B makes the payment within the next quarter, the sale will be recorded within the current quarter despite having received the proceeds yet under the accrual method.
If company B goes under receivership and cannot fulfill its payment obligations, Company A will be forced to record the sale as a bad debt. This bad debt is deductible from their taxable income. When loans or accounts payable become uncollectible, you are legally obligated to deduct this as a business expense.
6. Employ contractors
Did you know that when you hire freelancers and independent contractors, you are not obligated to pay their employment taxes or other healthcare benefits? Freelancers and independent contractors can be great for your business. Having one allows you to get plenty of work done without having an employee on your payroll. You can still get high-quality work from subcontractors at a lesser cost.
7. Hire family members
Some incredible benefits arise from hiring family members. One of them is the reduction in payable taxes. If you hire your partner, you are obliged not to pay the unemployment (FUTA) taxes, and if you hire your kids, you are not obligated to pay the employment (FICA) taxes.
8. Maximize your retirement fund
It is common sense to have a retirement fund but what is not so common is how the fund can help in reducing taxable income. Small business owners can save up to $57,000 annually before taxes in retirement contributions, as stated in the Fisher401k. The contributions, according to the IRS, are tax-free.
9. Incorporate your business
While operating as a sole proprietorship may have some advantages, sole proprietors miss out on multiple tax benefits. It's beneficial to operate as an LLC as owners can remove the employer portion of FICA taxes reducing the taxable income. Also, if the company is structured as a C-corp, the first $50,000 taxable income is taxed at a lower rate. According to UpCounsel, by incorporating your business, you can adopt a remuneration system where you're compensated through nontaxable dividends; therefore, your income won't be subjected to self-employment tax.
That's all for today and if you're looking for a tax professional, make sure you ask these 12 questions before making the hiring decision. We hope our tips will help you save some money in the next tax season.