As a small business owner or entrepreneur, following the right tax strategy is essential for maximizing your profitability, reducing your tax liability, and ensuring legal compliance. By implementing an effective tax strategy, your small businesses can significantly improve cash flow, reinvest in growth, and optimize long-term performance.
In this small business tax planning guide, we’ll break down some of the most common tax strategies for small business owners, such as claiming deductions and credits you qualify for. We’ll also discuss common tax mistakes to avoid, ways to reduce your taxable income with a retirement plan, and tools that can help your small business maintain accurate financial records.
Understanding Small Business Tax Obligations
There are various types of tax obligations that small businesses in the U.S. may be subject to. These include:
- Federal income tax obligations
- State and local tax obligations, depending on the physical location and legal structure of the business
- Employment or self-employment tax obligations, such as payroll, Social Security, and Medicare taxes
- Other types of taxes, such as excise, property, or sales tax
The Internal Revenue Service (IRS) website is the best and most accurate online resource for small businesses to learn about their federal tax obligations. It features links to important tax forms and detailed articles on assorted topics, including an overview of business taxes, a small business tax center, and a tax guide for corporations.
6 Key Tax Strategies for Small Businesses
Here are six savvy tax strategies that small businesses should follow:
- Maximize the tax deductions you claim
- Take advantage of tax credits you qualify for
- Choose a business structure that offers tax advantages
- Reduce your taxable income through a retirement plan
- Leverage depreciation and the Section 179 deduction
- Follow best practices for recordkeeping and tax planning
Maximize Tax Deductions
Tax deductions lower your total taxable income, which reduces your overall tax liability. As the IRS explains, “A deduction is an amount you subtract from your income when you file so you don’t pay tax on it. By lowering your income, deductions lower your tax.”
There are four main types of expenses that business owners can deduct:
- Energy-efficient commercial buildings
- Home offices
- Work vehicle expenses
- Business interest
Small business owners can maximize their deductions (and hang onto more of their profits) by carefully tracking all work-related expenses, such as office supplies, client meals, company vehicles, and employee compensation and benefits. Some popular examples of tools for tracking business expenses include Expensify, SAP Concur Expense, Zoho Expense, and Intuit QuickBooks Online.
Common Deductions
- Home Office Deduction: The home office deduction is available to sole proprietors and general partners who use part of their home exclusively for business purposes.
- Vehicle Expenses: Businesses that use vehicles for work purposes can deduct related expenses, including mileage and maintenance. There are two methods to calculate your deduction — the standard mileage rate vs. actual expenses.
- Office Supplies and Equipment: Various expenses for office supplies, technology, and furniture can be deducted from your taxable income, including laptops and desktop computers.
Take Advantage of Tax Credits
As the IRS explains on its website, “A credit is an amount you subtract from the tax you owe. This can lower your tax payment or increase your refund.”
Since they directly reduce the total amount you owe, tax credits are highly valuable for small businesses, which need to be as cost-efficient as possible. Let’s look at three examples of common tax credits that small businesses like yours may qualify for.
Common Tax Credits
- Work Opportunity Tax Credit (WOTC): The WOTC is available for businesses that hire individuals from specific groups, such as veterans or long-term unemployed individuals.
- Research and Development (R&D) Tax Credit: Your business may qualify for this tax credit if it has invested in developing new products, processes, or technology. Eligible businesses can claim this tax credit by filing IRS Form 6765 (Credit for Increasing Research Activities).
- Energy Efficiency Credits: These types of tax credits are available to businesses that implement energy-saving improvements, such as upgrading to energy-efficient LED lighting systems or installing solar panels. Your business may also qualify for an energy-efficient commercial buildings deduction.
Consider Business Structure for Tax Benefits
Every U.S. business needs to choose a legal structure, such as sole proprietorship, limited liability company (LLC), C corporation, S corporation, or partnership. The structure you select significantly impacts your tax obligations and filing requirements, which you can read more about in our guide to choosing a business structure.
For now, let’s focus on two business structures that offer notable tax advantages: the S corporation and the LLC.
S Corporation
There are two main types of corporations in the United States: C corporations, which are the most complex structure, and S corporations. One of the biggest differences between C and S corporations is that C corporations are subject to double taxation, while S corporations are what’s known as “pass-through” or “flow-through” business entities. That means income is only taxed at the personal level, rather than being taxed at the business level — a major financial advantage over the C corp structure.
Limited Liability Company (LLC)
The limited liability company (LLC) structure offers financial flexibility by allowing owners, who are referred to as “members,” to choose whether they wish to be taxed as a partnership, corporation, or on the member’s personal income tax return, which is known as a “disregarded entity.” Learn more about tax treatment of the LLC structure.
Retirement Contributions for Tax Savings
There are two main types of retirement plans under the Employee Retirement Income Security Act (ERISA): defined benefit plans and defined contribution plans. As a small business owner, you can leverage your retirement plan to simultaneously save for retirement while also reducing your taxable income.
Let’s look at two common types of retirement plans that can help boost your tax savings: SEP-IRA and solo 401(k) plans.
SEP-IRA
SEP stands for Simplified Employee Pension, and IRA stands for Individual Retirement Arrangement. As the Department of Labor (DOL) explains on its website, “A SEP allows employees to make contributions on a tax-favored basis to individual retirement accounts (IRAs) owned by the employees. SEPs are subject to minimal reporting and disclosure requirements.” A SEP-IRA plan allows contributions of up to 25 percent of an employee’s compensation, subject to caps that change each year (such as $69,000 for 2024, $66,000 for 2023, and $61,000 for 2022).
Solo 401(k)
A solo 401(k) (also known as a “solo-k” or “uni-k”) is a type of defined contribution plan meant for self-employed individuals, such as sole proprietors. A solo 401(k) allows high contribution limits, which the IRS breaks down in detail.
Utilize Depreciation and Section 179 Deduction
Depreciation refers to the loss of financial value over time, like a vehicle or piece of industrial equipment losing value each year after being purchased. Depreciation allows businesses to deduct the cost of property and equipment over time, while Section 179 of the Internal Revenue Code (IRC) allows for an immediate deduction of the full cost of qualifying property. Some examples of qualifying property include:
- Office or warehouse equipment, such as printers, computers, and conveyors
- Construction, mining, and manufacturing equipment
- Vehicles that are used at least 50% for business purposes
For comprehensive instructions, refer to IRS Publication 946, where the IRS provides an extremely detailed explanation of how to depreciate property for businesses, including vehicles, farm property, and office space within residential homes.
Planning and Recordkeeping Strategies
A successful tax strategy is about more than just filing the right forms or claiming all the credits and deductions you qualify for. It’s equally important to maintain accurate records and plan for upcoming tax payments so that your business doesn’t find itself faced with unplanned expenses.
Keep Detailed Records
It can be difficult (or outright impossible) to file timely, accurate tax forms if you don’t have detailed records to reference. To substantiate deductions and tax credits, it’s imperative for small businesses to maintain accurate financial records, receipts, and invoices.
By automating numerous processes, accounting software makes it significantly faster and easier to accurately track your finances and prepare business tax forms. Some examples of popular accounting tools and platforms for small businesses to explore include:
- FreshBooks
- Intuit QuickBooks Online
- Sage 50 Accounting
- Wave
- Xero
- Zoho Books
Plan for Quarterly Estimated Taxes
Small business owners may be required to pay estimated taxes on a quarterly basis to avoid underpayment penalties. To prepare for these expenses, it’s essential for businesses to set aside funds throughout the year, which can be allocated toward paying quarterly taxes as needed. The general rule of thumb is to set aside approximately 30% to 35% of your net business income, or about one-third, to help your business cover quarterly taxes as they come due.
3 Common Mistakes to Avoid
The tax code is highly complex, especially when it comes to entity types like C corporations. Unfortunately, this complexity can lead small business owners to make preventable and costly tax errors.
Let’s look at three common tax mistakes for businesses to watch out for, and more importantly, what steps you can take to avoid them.
- Missing Important Deadlines
If your small business misses a filing deadline or is late to file a tax form, financial penalties and interest can begin to accrue and rapidly accumulate until they’re paid in full. Therefore, it’s essential to manage your tax calendar carefully and start preparing for upcoming deadlines well before they arrive.
Even if you’re unable to make a full payment by the due date, it’s still important to file in a timely manner. From there, your business can explore payment options like installment agreements.
- Misclassifying Employees
A study by the National Employment Law Project revealed that between 10% and 30% of U.S. employers misclassify workers, like misclassifying employees as independent contractors. Misclassification is typically an intentional act that occurs to evade employment taxes, avoid paying workers for overtime, or avoid paying benefits related to workers’ compensation.
Despite being widespread, employee misclassification is a serious compliance error that can lead to IRS audits and potentially significant financial penalties. To avoid penalties and maintain legal compliance, it’s vital for employers to appropriately classify workers under the Fair Labor Standards Act (FLSA), which the IRS provides guidance on here. Potential classifications include full-time employee, part-time employee, temp worker, seasonal worker, independent contractor, or intern.
- Not Consulting a Tax Professional
The tax code is complex, but compliance doesn’t have to be. The best way to ensure that your business correctly follows state and federal tax regulations is to consult with a tax professional, such as a Certified Public Accountant (CPA) or Enrolled Agent (EA). In addition to giving you peace of mind about compliance, another benefit of working with a tax professional is that they can help you identify opportunities for maximizing deductions, claiming tax credits, and reducing your tax liability.
Learn Tax and Accounting Skills with a Business Degree from National University
By following a tax strategy that aligns with your company’s goals and needs, you can lower your tax liability while boosting your profitability. For example, you can avoid double taxation by choosing a pass-through business structure. It’s also important to explore tax credits and deductions, leverage retirement plans, and maintain detailed records.
As a small business owner, it’s in your best financial interests to stay up-to-date on the latest tax law developments, which will empower you to make informed strategic decisions that support your business goals. In addition to keeping yourself informed, it’s strongly recommended to consult a CPA or other tax professional who can provide personalized expert guidance on tax compliance and planning. You may also be interested in exploring small business tax calculators, of which there are countless versions to choose from online.
Whether this is your first time starting a business or you’re an experienced entrepreneur, you can strengthen your skills, deepen your knowledge, and broaden your network with a business degree from National University. Whether you’re searching for undergraduate, graduate, or doctoral programs, you’ll find accredited online and on-campus options at National University, including our online MBA. Contact admissions for more information about enrollment, or apply to NU online today.
