5 Ways for Small Business Owners to Reduce Their Taxable Income

Taxes can be stressful for a small business owner. You likely wear many hats, and the last thing you want to do is give more of your hard-earned business income to the government. Thankfully, there are many tax savings strategies to reduce your taxable liability as a business owner. If you need ways to reduce your taxable income this year, consider some of the following methods below.

Employ a Family Member

One of the best ways to reduce taxes for your small business is by hiring a family member. The Internal Revenue Service (IRS) allows for a variety of options, all with the potential benefit of sheltering income from taxes. You can even hire your children.

According to Scott Goble, a certified public accountant (CPA) and founder of Sound Accounting, by hiring family members, “small business owners are able to pay a lower marginal rate, or eliminate the tax on the income paid to their children.”

For example, sole proprietorships do not need to pay social security and Medicare taxes on the wages of a child, nor the Federal Unemployment Tax Act (FUTA) tax. It is important to point out that earnings need to come from justifiable business purposes. The IRS also allows small business owners the benefit of reducing their taxes by hiring a spouse, who would not be subject to the FUTA tax. Depending on the benefits they may have through another job, you may also be able to put aside retirement savings for them.

Start a Retirement Plan

As a small business owner, you give up a 401(k) match matched by an employer. However, there are several retirement account options that maximize retirement savings and reap valuable tax benefits. For example, with the one-participant 401(k) plan, the IRS allows you to put away up to $57,000 in total contributions for retirement. Some of those retirement planning vehicles include:

  • Simplified Employee Pension Plan (SEP)
  • IRA or a Roth IRA
  • 403(b) plans

There are a variety of different retirement plan options for business owners on the IRS website as a tax savings strategy.

Save Money for Healthcare Needs

One of the best ways to reduce small business taxes is by putting aside money for healthcare needs. Medical costs continue to increase, and while you may be healthy now, saving money for unexpected or future healthcare needs is essential. You can accomplish this through a Health Savings Account (HSA) if you have an eligible high-deductible health plan.

“I also encourage every business owner to explore utilizing an HSA. As medical costs rise, many businesses look to lower the costs of health insurance," says Sean Moore, CFP, ChFC of Smart Wealth Advisory. "By utilizing HSAs, the business and the employees can reduce taxes and potentially associated medical costs.”

Moore explains that the savings come in three key ways, otherwise known as the triple tax advantage: your contributions are pre-tax, they grow tax-free, and withdrawals for qualified medical expenses are tax-free.

Change Your Business Structure

As a small business owner, you don't have the benefit of an employer paying a portion of your taxes. You're on the hook for the entire amount of Social Security and Medicare taxes. If your business is taxed as a limited liability company (LLC), you still have to pay those taxes, though in certain circumstances you may be able to eliminate the employer-half of those two tax responsibilities This might be a wise switch for some small businesses. While there are many things to consider in this switch, such as paying yourself a reasonable salary and other associated risks, it can be a good way to reduce your taxable responsibility.

Deduct Travel Expenses

If you travel a lot, you may be able to reduce your business taxes. Business travel is fully deductible, though personal travel does not enjoy the same benefit. However, to maximize your business travel, small business owners can combine personal travel with a justifiable business purpose. Any frequent flier miles earned from business travel can also be redeemed for personal travel later on.

The Bottom Line

With wise planning, you can reduce your taxable income as a small business owner and keep more of your money working for you. Just remember to consult a tax professional to make sure you qualify for the potential savings discussed here.

Article Sources
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  1. Internal Revenue Service. "Family Help."

  2. Internal Revenue Service. "One-Participant 401(k) Plans."

  3. Internal Revenue Service. "Publication 969 (2020), Health Savings Accounts and Other Tax-Favored Health Plans."

  4. Internal Revenue Service. "Topic No. 554 Self-Employment Tax."

  5. Internal Revenue Service. "Limited Liability Company (LLC)."

  6. Internal Revenue Service. "Topic No. 511 Business Travel Expenses."