What You Need to Know
- Your small-business clients may not know or understand the range of tax strategies and deductions available to them.
- For clients unsure what they're doing, pass along these five tips.
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 mimnimize their overall tax bill.
Here are five strategies to discuss with your small business-owning clients that may help them lower their tax burden and keep more money in their pockets.
1. Consider a Tax Status Change
Small business owners have several options for structuring their business. They can operate as a sole proprietor, partnership, limited liability company (LLC), S corporation or C corporation. The business structure will impact how taxes are filed for the business.
A company that has outgrown its current business structure in the past year 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
- 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 2022 tax year, those thresholds are $170,050 if single or $340,100 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 $220,050 for single filers ($440,100 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.
Home Office Deduction Eligibility
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.