As the tax filing season approaches, small business owners consider minimizing their business taxes. There are various year-end tax planning strategies, including leveraging available credits and deductions and strategically timing revenues and expenses, all aimed at reducing the overall tax burden. Streamline your tax processes and embark on a well-thought-out tax planning journey that caters to your specific tax needs.

Small business owners have several choices in structuring their businesses, such as operating as a sole proprietor, partnership, limited liability company (LLC), S corporation, or C corporation. The chosen business structure significantly influences the approach to filing small business taxes. Planning strategically leads to profound tax benefits, while not correctly planning leads to seriously poor implications for the IRS. Look at these three tax planning strategies all small businesses need to remember.

1. Know About and Use Applicable Deductions

The tax planning strategy of the home office deduction proves beneficial for small business owners who operate from their residences, as it allows them to deduct expenses related to using a part of their home for business purposes. To qualify, the designated space must be utilized regularly and exclusively for business activities. Two methods exist for calculating this deduction. The simplified approach permits a deduction of $5 per square foot of home space used solely for business, capped at 300 square feet. Alternatively, the actual expenses method involves calculating the percentage of your home’s square footage used for business and then deducting that percentage from qualified expenses, including mortgage interest or rent, real estate taxes, utilities, and repairs and maintenance.

Another vital deduction is the qualified business income (QBI) deduction, which offers pass-through business owners a deduction of up to 20% of their share of the business’s income. However, this deduction comes with various rules and limitations. Specifically, owners of specified service trades or businesses (SSTBs) may lose out on the deduction if their income exceeds certain thresholds. SSTBs generally encompass service-oriented businesses, excluding engineering and architecture firms, whose success relies on their employees’ or owners’ reputations or skills.

Awareness of these and other deductions for comprehensive tax planning is crucial.

2. Know About and Use Applicable Tax Credits

Businesses have an alternative route to alleviate their tax burden through tax credits, distinct from tax deductions that reduce taxable income. Tax credits directly decrease the actual amount of tax owed. More exist, but three noteworthy credits include:

• Work Opportunity Tax Credit (WOTC) – This credit, valued at up to $2,400 per eligible new hire, requires small businesses to hire individuals from specified target groups. To qualify for WOTC, companies must employ individuals from these groups, complete Form 8850, and submit it to a designated local state agency within 28 days of the new employee’s start date. Once eligibility is confirmed, the business can claim the credit on their subsequent tax return.
• Disabled Access Credit (DAC) – DAC aids small businesses in offsetting expenses related to providing access for individuals with disabilities. The credit is 50% of eligible costs up to $10,000, excluding the first $250 of qualifying expenses. To claim the credit, businesses must have revenue of $1 million or less and, at most, 30 full-time employees.
• Credit for Small Employer Health Insurance Premiums – Small businesses offering health insurance benefits may qualify for a tax credit to mitigate some of the associated costs. This credit, worth up to 50% of the premiums paid during the year, is available for two consecutive tax years if eligibility criteria get met.

3. Contribute to Retirement Accounts

Establishing or contributing to a retirement account can reduce taxable income, offering numerous options for business owners and their employees. A 401(k) plan, if set up before the tax year concludes, allows for the deduction of contributions when filing a tax return. The plan’s terms determine the maximum employer contribution, with total contributions (employee and employer) limited to the lesser of an employee’s compensation or $66,000 for 2023. If the 401(k) set-up deadline passes, an alternative is the simplified employee pension plan (SEP), which lasts until the return’s due date, including extensions. Contributions to an SEP caps at 25% of the employee’s compensation, with a maximum of $66,000 for the year.

Embarking on a 401(k) or SEP allows the deduction of contributions and qualifies for the retirement plan startup costs tax credit. This credit applies to employers meeting specific criteria, such as having 100 or fewer employees receiving at least $5,000 in compensation, having a non-highly compensated employee as a plan participant, and not having another employer-sponsored retirement plan in the past three years. The credit is valued at 50% of the plan’s startup costs, up to a maximum of $5,000.

Taxes By Design is a tax partner that ensures small businesses and their owners aren’t just surviving tax season, but mastering it. Leveraging a tax professional allows small business owners to further thrive by focusing on their lives and work.