5 Tax Planning Strategies for Small Business

As tax filing season approaches, small business owners inevitably start thinking about how to reduce their business taxes. From taking advantage of available credits and deductions to timing revenues and expenses, there are many year-end tax planning strategies that can help reduce your overall tax burden. Here are five strategies every small business owner should consider in order to lower their tax burden and keep more money in their pockets.

1. Consider a tax status change

As a small business owner, you have several options for structuring your business. You can operate as a sole proprietor, partnership, limited liability company (LLC), S corporation or C corporation. Your business structure will impact how you file your small business taxes.

If you’ve outgrown your current business structure in the past year, you may be able to change to one that’s a better fit. For example, LLCs can elect to be taxed like a C corporation by filing Form 8832 with the IRS.

Making such an election used to be rare, as the top corporate tax rate was 35%, but the Tax Cuts and Jobs Act of 2017 (TCJA) dropped the top corporate income tax rate from 35% to 21%.

Corporations vs. pass-through businesses

Pass-through businesses, such as sole proprietorships, partnerships, LLCs and S corporations, don’t pay a corporate income tax. Instead, the company’s net income “passes through” to the owner’s individual tax return, where the highest tax bracket is 37%. For LLC members in the top tax bracket, a tax status change can result in significant tax savings.

While the Inflation Reduction Act of 2022 brought back the corporate alternative minimum tax (AMT), small businesses won’t be impacted. The new 15% corporate AMT applies only to C corporations with average annual income of over $1 billion.

Of course, tax savings aren’t the only factor that goes into selecting a structure for your small business. Before changing your tax status, consult with a tax professional who can help you crunch the numbers and run a cost-benefit analysis.

2. Take advantage of tax deductions

The qualified business income (QBI) deduction provides pass-through business owners a deduction worth up to 20% of their share of the business’s income — though it does come with many rules and limitations.

Owners of specified service trades or businesses (SSTBs) lose out on the deduction if their income is too high. SSTBs generally include any service-based business — other than engineering and architecture firms — where the business depends on its employees’ or owners’ reputation or skill.

Examples of these types of SSTBs include:

• Law firms
• Medical practices
• Consulting firms
• Professional athletes
• Performing artists
• Accountants
• Financial advisers
• Investment managers

If your business is an SSTB, your QBI deduction starts to phase out once your total taxable income exceeds a certain amount. For the 2023 tax year, those thresholds are $182,100 if single or $364,200 if married filing a joint return. You’ll need to use Part II of Form 8995-A to calculate your deduction; however, once your income is over $232,100 for single filers ($464,200 for married filing jointly), you can’t take the deduction.

If your business isn’t an SSTB, but your total taxable income is above those upper limits, you can claim the deduction, but it’s limited to:

• 50% of your share of W-2 wages paid by the business; or
• 25% of those wages, plus 2.5% of your share of qualified property

Confused? You’re not alone. The QBI deduction can provide a generous deduction for small business owner taxes but figuring out who can claim it and then calculating the deduction is no easy task. Talk to your accountant if you think you might qualify.

Are you eligible for the home office deduction?

The home office deduction can be a valuable tax planning strategy for small business owners who work from home because it allows them to deduct expenses related to using a portion of their home for business.

In order to qualify, the space must be used regularly and exclusively for business purposes.

There are two ways to calculate your deduction. The simplified method allows a deduction of $5 per square footage of your home used exclusively for business (up to a maximum of 300 square feet).

If you use the actual expenses method, you calculate the percentage of your home’s square footage used for business, then deduct that percentage of your qualified expenses, such as mortgage interest or rent, real estate taxes, utilities, and repairs and maintenance.

3. Leverage tax credits

Tax credits are another way for businesses to reduce their tax burden, unlike tax deductions, which reduce an individual’s or business’s taxable income, tax credits directly reduce the amount of tax owed. Here are a few to consider.

Work opportunity tax credit

The Work Opportunity Tax Credit (WOTC) is designed to help employers hire and retain individuals from certain target groups that have consistently faced significant barriers to employment. This includes members of families receiving benefits under the Temporary Assistance for Needy Families (TANF) program, felons, veterans and those from other target groups.

The credit is worth up to $2,400 per eligible new hire.

To be eligible for the WOTC, small businesses must hire individuals who are a member of one of these target groups, complete Form 8850, and submit that form to a designated local state agency within 28 days from the new employee’s start date.

Once the state agency confirms that the employee is eligible for the credit, the business can claim the credit on their next regularly filed return.

Disabled access credit

The Disabled Access Credit (DAC) is designed to help small business owners offset some of the costs associated with providing access for people with disabilities. The credit is worth 50% of up to $10,000 in eligible expenses, but you can’t claim the credit on the first $250 of qualifying expenses.

To claim the credit, your business must have revenue of $1 million or less and no more than 30 full-time employees.

Some examples of expenses eligible for the DAC include modifying existing facilities to make them accessible for disabled individuals, offering Braille, large print, and audio versions of materials, providing a sign language interpreter or reader for customers or employees, or purchasing adaptive equipment.

Credit for small employer health insurance premiums

Small businesses that provide health insurance benefits for their employees may be able to claim a tax credit to help offset some of those costs.

To qualify, you must:

• Have fewer than 25 full-time equivalent employees
• Pay average wages of less than $62,000 per year per full-time equivalent in 2023 (That amount is indexed for inflation so it changes annually)
• Purchase group health insurance through the Small Business Health Options Program Marketplace
• Pay at least 50% of the cost of employee-only coverage for each employee

If you qualify for the credit, it’s worth up to 50% of the premiums you paid during the year. You can claim the credit for two consecutive tax years.

4. Defer — or accelerate — income

Many small businesses use the cash method of accounting on their books and tax returns. Under the cash method, a company recognizes income when it’s received and expenses when paid — in other words, when cash actually changes hands. That creates some interesting tax planning strategies.

If you expect to be in a lower tax bracket next year, you might want to defer income to next year, when you’ll pay taxes at a lower rate.

When to defer income

For example, say you did some work for a client in December 2023, but you haven’t yet billed the client for your services. If you wait until January 2024 to invoice your client for the work you did in December, you could defer income to the next year and lower your 2023 tax bill.

When to accelerate income

On the other hand, it might make more sense to accelerate income into this year — especially if you think tax rates will increase in the near future. In that case, you might want to send your invoice and try to collect payment from your client in 2023, so more income will be taxed at your current tax rate.

The same concept works with expenses. If you’re in a high tax bracket this year, you might want to accelerate expenses in 2023 to reduce your taxable income. Here’s a handy guide for when to accelerate or defer income and expenses.

5. Set up — or contribute to — a retirement account

Setting up or contributing to a retirement account can reduce your taxable income. Business owners have several options for retirement savings, both for themselves and their employees.

• If you set up a 401(k) plan before the end of the tax year, you can deduct any contributions made to the plan when you file your tax return. The plan’s terms dictate how much an employer can contribute. For 2023, total employee and employer contributions are limited to the lesser of an employee’s compensation or $66,000.
• If you miss the cutoff to set up a 401(k) plan in 2023, you might still be able to set up a simplified employee pension plan, also known as a SEP. You have until the due date of your return (including extensions) to set up a SEP. The employer’s contribution to a SEP is limited to 25% of the employee’s compensation, capped at $66,000 for 2023.

If you start up a 401(k) or SEP, not only can you deduct contributions to the plan, but you may qualify for the retirement plans startup costs tax credit, available to employers that:

• Had 100 or fewer employees who received at least $5,000 in compensation during the year
• Had at least one plan participant who was a non-highly compensated employee
• Have not had another employer-sponsored retirement plan in the past three years

The credit is worth 50% of the plan’s startup costs, up to a maximum of $5,000.

Important 2024 tax filing deadlines

Tax day typically falls on April 15 for most people, but if that date falls on a weekend or holiday, the IRS pushes the deadline to the following business day. But tax day isn’t the only important date for small business owners. Here are a few other important dates to mark on your tax filing calendar in 2024:

Every business’s tax situation is unique, so it’s important to discuss these small business tax planning strategies with your tax professional before making any significant moves. Still, these strategies should help you to prepare for your year-end tax planning meeting and understand more about how your small business can minimize taxes.