by Susan Paige
According to statistics, the average tax rate a corporation in the United States pays stands at 25.7%. That includes the average of state corporate income taxes as well.
For many businesses, losing a quarter of your earnings to taxes can strain your bottom line. Moreover, if you are a small business, sole proprietor, or a partnership that’s already living on razor-thin margins, any additional taxes you pay can potentially mean life or death for your business.
Thus, many entrepreneurs invest in learning how they can reduce their business tax burden to improve their lot. Here is a compact guide to help you discover how to lower your taxable income.
1. Don’t Ignore Carryovers
At times, you may have credits or deductions that you don’t fully utilize in a tax year. Many of these allow for a carryover into future years. You can use these carryovers in the coming years as a way to reduce your firm’s tax bill.
Some examples of deductions and credits that can qualify for carryover include:
- Capital losses
- Net operating losses (which are capped at 80% of taxable income)
- Charitable contribution deductions
- Home office deduction
- General business credits
Ensure that you track these deductions and credits so that you don’t forget to take advantage of them in future years. A tax preparation program can help you automatically keep track as can your tax preparer.
2. Invest in Research and Development
For many entrepreneurs, it may come as a misnomer to hear that you can manage your tax bill by spending on research and development (R&D).
The federal government extends an R&D tax credit to stimulate innovation. The credit applies to any business but is specially tailored to empower small businesses and startups to adopt R&D.
An R&D credit can help you lower the tax your business pays for the current year as well as in future years. The credit also lowers your firm’s effective tax rate allowing you to claw back more profits. The ability to retain more profit will, in turn, grow your company’s market value while also increasing its cash flow.
Section 41 of the Internal Revenue Code (IRC) and its related regulations lay out the rules governing the Research & Experimentation Tax Credit, including what qualifies a firm to claim this credit.
As your R&D expenses grow, you can apply to increase the credit as long as the costs you point to meet the qualification guidelines.
Additionally, if your business is eligible and has no income tax liability, you can use the R&D credit to settle the Federal Insurance Contributions Act (FICA) portion of your payroll taxes up to $250,000.
3. Rethink Your Business Structure
For entrepreneurs operating as sole proprietors and partnerships, it may be time to rethink your firm’s structure for more significant tax benefits.
Many small business founders end up selecting the Limited Liability Company (LLC) structure for tax purposes. The main reason for this is that an LLC is seen as a ‘pass-through entity.’
What does that mean?
An LLC can choose to pay tax as an S corporation. In such a scenario, the owner can pay themselves a reasonable salary, which will be subject to FICA taxes similar to an employee’s salary.
The remaining business income then gets to ‘pass through’ as business income distribution, which won’t be subject to FICA taxes. The result is that you can avoid an outstanding self-employment tax bill on a significant portion of your income.
Furthermore, as of 2018, choosing to structure your firm as a pass-through entity affords you another significant tax benefit. As an owner of the LLC, you can deduct 20% of the business income on your individual tax returns.
There are, however, several caveats to this deduction you should know about.
You won’t be able to take out the deduction if you own a service business that has a taxable income of $315,000 and above if you are married and filing jointly. The same restriction will apply if you are unmarried and hit a taxable income of $157,500.
Since claiming the R&D credit is a technical affair, it is wise to consult an experienced professional (visit this page for more) to ensure you maximize the benefits.
4. Hire Your Family Members
Do you have a family member who keeps asking you for a job? As it turns out, that can move from being irritating to beneficial from a tax perspective.
If there’s a family member you can bring on board to help with running critical tasks for your firm, you get tax benefits from that.
When you hire a family member, it affords you the ability to take a business deduction for reasonable remuneration paid to them. That immediately reduces your taxable income.
On top of that, it may potentially help you sidestep applicable taxes by FICA and the Federal Unemployment Tax (FUTA).
5. Avoid Selling Old Assets
If your business owns property, equipment, and other physical assets that no longer contribute to its profitability, you should think of abandoning it.
When you abandon it, it will be treated as an ordinary loss. On the other hand, should you decide to sell it, it ends up being a capital loss.
You can deduct an ordinary loss in full while a capital loss which is subject to limitations. Section 1231 will be useful in helping you determine how the property is classified to determine the best way to get rid of it.
Consult your accountant to find out whether abandoning your old assets can be more beneficial from a tax standpoint as compared to selling it, before making a decision.
Learn How to Lower Your Taxable Income
In a competitive business environment, the amount of tax you pay can drag your growth or help you move faster. As an entrepreneur, learning how to lower your taxable income is a critical component of your cost management. Invest in hiring the right expertise to show you the various ways you can cut down on your taxable income for you to grow sustainably.
Are you looking to learn how to optimize your business? Check out more of our posts for actionable insights that can help you streamline your business.