“The hardest thing to understand in the world is the income tax.”
- Albert Einstein
Taxes have never been enjoyable; in fact, they are one of the most stressful and demanding aspects of running a small business. Whether you've started a small business or already have one, it's critical to explore tax saving tips. Tax savings contribute to the expansion of profit margins.
It can sometimes be gruelling for a business owner to give away a large part of their hard-earned money to the government in the form of tax. However, there are some significant tax-saving methods that small business owners should consider to reduce their taxable income. Listed below are a few tax loopholes that can be advantageous for small businesses.
Tax Loopholes for Small Business Owners
Defer Income to Reduce Tax
Tax rates are dynamic. Therefore, as a small business owner, you ought to be knowledgeable about accounting and taxes in general. Deferring revenue at the start of the year or at the end of the year is one of the several loopholes that small businesses can exploit to minimize their annual taxable income. This helps in reducing the amount of tax payable. However, it is contingent upon a variety of conditions.
However, when can income be deferred? Consider the following scenario: you completed work for a customer in December 2021 but have not yet paid the client for your services. If you wait until January 2022 to charge your customer for services completed in December, you can postpone income to the next year and reduce your tax burden in 2021. Therefore, it is critical to keep track of your income to determine how much you may postpone for tax purposes.
Consider Saving Major Business Purchases for Year-End
Every operating and growing small business
requires equipment and operational upgrades. You may take advantage of another tax break that results in significant savings on end-of-year company expenditures. By the end of the year, consider purchasing new office equipment, a new computer, or upgrading your present set of office furniture or other large expenditures. This allows you to claim the depreciation of an entire year. However, track these expenses to take advantage of eligible tax deductions.
Home Office Deductions
Home office deductions is another tax loophole that can form a large part of your overall eligible small business tax deductions each year. Rent, mortgage, property taxes, utilities, telephone, and house insurance, all included in the expense of operating a home office. However, you may be unaware that you may use them to offset some of your tax liability. While you cannot claim all of these expenses, claiming a portion of them year after year might save a significant amount of money.
You can claim the deduction whether you own or rent a property, and you can use it for a single-family home, an apartment, a condo, or a houseboat. No hotel or other temporary housing allowed. This restriction also applies to freestanding buildings. A studio, garage, or barn can be used as a home office if it fits the “exclusive and regular use” conditions.
However, Internal Revenue Code (IRC) Section 179 permits you to deduct in a single year the majority of tangible personal property you acquire and use for your business for more than 51% of the time. The Tax Cuts and Jobs Act limits this deduction to $1 million per year. This provision prohibits you from deducting more than your net taxable business income for the year.
Taxable Income vs. Non-taxable Income
In general, there is a misconception that all the money included in your income is taxable. Interestingly, not all incomes are taxable. Some parts of the income are taxable, and some are not. Taxable income is the amount of money that must be declared on your return and is taxed. Often, company owners confuse taxable and non-taxable income.
If you are a member of a religious congregation that has made a vow of poverty, work for an organization operated by that order, and give the order your profits, your income is not taxed.
While earnings from businesses are taxable, dividends, government grants, state subsidies, and interest on savings are all taxable income. Corporation tax, value-added tax (VAT), business rate, dividend tax, income tax, national insurance, and capital gains tax are just a few of the taxes that apply to small businesses.
Best Tips to Reduce Taxable Income
Deduct Traveling and Accommodation Expenses
As a business owner, there may be times when you may have to travel frequently for work. To save money on taxes, the best thing to do is to book your business travel and accommodations through the company account, instead of your personal account. These charges are considered business expenses and may be deducted from the company's taxable income. This is one of the most commonly practiced tax saving methods worldwide.
Change Your Business Structure
When you formally start a business, you must choose a business entity. The type of entity you choose will have its own tax regulations and deductions. Your business's legal framework is not a one-and-done proposition. As businesses expand, adapt, and change, it may make sense to modify your business's legal structure
. In general, it is a good idea to look over your business structure every few years and make any changes that might be needed to take advantage of some of the more sophisticated forms of tax advantage.
Contribute To a Retirement Plan
As a small company owner, you forfeit an employer-sponsored 401(k) match. These classic 401(k) plans are pre-tax, which means they are deducted from your taxable income and thereby lower the amount of tax you will pay. There are various retirement plan alternatives available, including IRAs and 403(b) plans, that can help you optimize your retirement investments while also reaping substantial tax benefits. Donations to a typical IRA account allow you to take annual tax deductions.
Employ Family Members
Employing a family member is one of the best tax-saving methods for small businesses. The Internal Revenue Service (IRS) provides a variety of tax-saving solutions. Additionally, you can hire your children using the alternatives presented.
Scott Goble, a certified public accountant (CPA) and founder of Sound Accounting, says that by employing family members, "small business owners might pay a reduced marginal tax rate or even avoid paying taxes on income paid to their children."
Family members hired may be paid a salary in the same manner as other employees. However, a hired family member with no other source of income may be paid a fixed annual salary. Because the salaries given to workers are a cost to the business, they can be deducted from the business's taxable revenue. As a result, the company's overall taxable income is reduced.
Small businesses must find strategies to minimize their taxable income to increase their earnings. Tax savings ideas will undoubtedly increase your business's tax efficiency. With prudent preparation, you may lower your taxable income and retain a greater portion of your funds for business operations. However, consult a specialist
or financial advisor to see that you qualify for any possible savings.
How can I reduce my taxable income?
A few ways to reduce taxable income are:
Donate to charity
Maximize your retirement
Accelerate deductions and defer income
Buy high, sell low
Does a Roth IRA reduce taxable income?
Roth IRAs are distinguished by the fact that they are funded using after-tax money, which means they have no effect on your taxes and you will not be taxed on the amount distributed.
What is taxable income?
Taxable income is the part of an individual's or business's income that is used to determine how much tax the individual or business owes the government in a given tax year. Wages, salaries, bonuses, and tips are all considered taxable income, as are investment income and different sorts of unearned income.