As tax rates continue to increase, it has become exceedingly more important for business owners to devise tax planning strategies to help reduce the burden of business taxes. In this article, we will highlight proven methods for lowering business taxes.
• Set up a retirement plan for yourself. You are not taxed on the income you contribute to your retirement plan. Earnings grow tax-free until withdrawal from the retirement plan.
Some popular retirement plans for the self employed include:
• SEP (2010 Contribution Limit- Cannot exceed the lesser of 25% of an employee’s compensation, or $49,000).
• Profit-sharing Keogh plan (2010 Contribution Limit- Cannot exceed the lesser of 25% of an employee’s compensation, or $49,000).
• Solo 401(K) plan (2010 Contribution Limit – Cannot exceed $16,500 of your pre-tax income. If you are over the age of 50, you can do the catch up contribution of $5,500, for a total of $22,000. In addition to the $16,500, as the employer you can also make a profit sharing contribution up to 25% of your pay not to exceed $49,000 for 2010.)
• For married business owners, if you have high health insurance, dental insurance premiums and out-of-pocket medical expenses, establish a Section 105 HRA plan, and then hire your spouse as an employee of your business.
• Have your spouse list you and any children you might have as beneficiaries. This then allows you to deduct your hospital insurance and medical bills as business expenses, not as itemized deductions.
• When hiring your spouse, make sure he/she is doing a bona fide job that adds value to your business and make sure he/she is receiving reasonable wages. Keep good records of time and description of duties performed.
• For business owners with children under the age of 18, hiring your children produces great tax savings. Firstly, your child’s compensation is deductible as a business expense. Secondly, the wages of a Child under 18 years old are not subject to Social security or Medicare withholdings. Finally you shift income from your higher tax bracket to your child(ren)’s lower tax bracket. When hiring your child(ren), make sure he/she is doing a bona fide job that adds value to your business and make sure he/she is receiving reasonable wages. Accurate recordkeeping of logged time is essential.
• Rather than writing off purchased equipment over its life, through depreciation, elect to use Section 179 Deduction. Section 179 allows businesses to deduct the full purchase price of qualifying equipment purchased or financed in the year it is purchased.
• For those business owners who anticipate tax rates in the coming year are going to be lower, try deferring income into next year while accelerating deductibles. This will reduce current taxes and defer tax liabilities into the following year.
• Electing to use Section 179 rather than depreciating recently purchased equipment, stocking up on office supplies, purchasing equipment needed in the business are all good year end strategies for accelerating deductibles. You can also elect to apply any unused Net Operating Loss (NOL), or make an extra charitable donation to further reduce your taxable income.
• If your business uses cash based accounting, one way to defer income into the next year, is to invoice your customers at the end of the year, let’s say December 31st by doing this your postponing recognition of revenue into the next year.
• If you anticipate being in a higher tax bracket next year, you do the exact opposite. You accelerate income into the current year to take advantage of the lower tax rates and defer deductibles.
• Write off obsolete, damaged, or worthless inventory or equipment as an expense.
• If you use a portion of your home for business purposes you may be able to take a home office deduction. You must satisfy the requirements (see Form 8829 at IRS.GOV) and the deduction amount cannot exceed income from your business.
Avoid penalties from late payments of taxes, by using the Electronic Federal Tax Payment System (EFTPS). This is a convenient tax payment system provided free by the U.S. Department of Treasury.
• Once your business starts to become more profitable, it will be more beneficial for you to incorporate the business. There are two types of corporations to choose from, these are S-corporation and C-corporation.
You would want to pick an S-corporation if the following apply:
• you still anticipate losses in the future,
• you don’t really have a need for public financing,
• you are not in the highest individual tax bracket ,
• You have substantial capital gains and qualified dividend.
You would want to pick a C-corporation if the following apply:
• You have a need for public financing
• You are in the highest individual tax bracket
For more information on tax planning, please visit www.pick-an-entity.com
The foregoing is intended for educational purposes only and does not constitute legal or professional advice. Nothing contained herein is intended to be used, or can be used, by any person to avoid penalties that may be assessed under federal or any state law.
© Copyright 2010, Ugonna Chukwu, CPA