You should consult with a tax professional for personalized advice. This article is not intended as recommendations or advice, and is for informational purposes only.
As a small business owner, you have certain opportunities to get the most out of your tax planning. Here are a few ways to help maximize deductions for your small business.
Leverage the CARES act
The Coronavirus Aid, Relief and Economic Security (CARES) Act included several new tax planning for small business opportunities.The CARES Act relaxed some of the restrictions on Net Operating Losses (NOL) that the Tax Cuts and Jobs Act of 2017 (TCJA) put into place.
NOLs occur when a company’s tax deductions are higher than its taxable income. Before the TCJA, an NOL could be carried back up to two prior tax years to offset a previous year’s tax bill or carried forward for up to 20 years. The TCJA ended the option to carry NOLs back two years. It also added a rule that allows taxpayers to offset only 80% of their taxable income with NOLs.
The CARES Act partially eased these limitations by removing the 80% limit on carryovers from 2017 and earlier. It also allows taxpayers to carry NOLs from 2018, 2019 and 2020 back up to five years.
If your business lost money due to the pandemic, talk to your accountant about carrying the loss back to a prior year. You may be able to recover some of the taxes paid when revenues were higher.
Consider a tax status change
As a small business owner, you have several options for structuring your company. You can operate as a sole proprietor, partnership, limited liability company (LLC), S corporation or C corporation. Each of these business structures has its own tax implications.
If your current structure no longer suits your business, you might be able to switch to a different one. 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 TCJA lowered the top corporate income tax rate from 35% to 21%.
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.
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.
Contribute to a retirement account
You can reduce your taxable income by setting up or contributing to a retirement account. Business owners have several options for retirement savings, both for you and your employees.
- If you set up a 401(k) plan before the end of the tax year, you can deduct any contributions made to the plan when you file your tax return. The terms of the plan determine how much an employer can contribute.
- If you miss the cutoff to set up a 401(k) plan, you might still be able to set up a simplified employee pension plan (SEP). You have until the due date of your return (including extensions) to set up a SEP. The employer’s contribution to a SEP is limited to 25% of the employee’s compensation.
If you set up a 401(k) or SEP, not only can you deduct contributions to the plan, but you may qualify for the retirement plans startup costs tax credit, which is available to employers that:
- Had 100 or fewer employees who received at least $5,000 in compensation during the year
- Had at least one plan participant who was a non-highly compensated employee
- Have not had another employer-sponsored retirement plan in the past three years
The credit is worth 50% of the plan’s startup costs, up to a maximum of $500. If you’d like to review your retirement plan investment options and help determine which is the best for you, contact us to discuss.