How Small Business Owners Can Prevent Having a Tax Debt

First-time business owners come across many obstacles. While many are not aware of the fact, handling taxes is one of the biggest roadblocks a business owner faces in the first year of working.

It’s no wonder that small businesses in America collectively spend over 2.5 billion hours preparing for and answering tax return questions every year.

That means that a lot of time and money goes into making sure everything is done correctly come tax time.

Unfortunately, even with the best intentions, many small business owners still end up owing the government money come April.

How Are Small Businesses Taxed?

The first step to preventing a tax debt is understanding how your business is taxed.

In the United States, there are two ways that businesses can be taxed: as sole proprietorships or partnerships, and as corporations.

Sole proprietorships and partnerships are taxed according to individual income tax laws. Meaning that the business income and losses are reported on the owner’s personal tax return.

Corporations, on the other hand, are taxed separately from their owners. This type of business is more complex and difficult to set up, so most small businesses in America are not corporations.

What Types of Taxes do Small Businesses Pay?

Small businesses in America can face a variety of taxes, but the most common are income tax, self-employment tax, and payroll tax.

  • Income Tax is the amount of money a business owes to the federal government on its profits.
  • Self-Employment Tax is the Social Security and Medicare taxes that small business owners have to pay on their net income. These taxes are usually about 15.3% of income.
  • Payroll Tax is the money employers pay to cover their employees’ Social Security and Medicare taxes. This tax is usually 6.2% of an employee’s wages.

Knowing what taxes you need to pay each year is crucial to your success. Another important thing is to stay up-to-date on tax law changes, on a state and federal level.

A surprising number of small business owners fail to stay updated on tax laws. As CNBC writes, roughly 1 in 5 business owners don’t even know their effective tax rate.

If you don’t have a bookkeeper or an accountant, you’ll probably have to look up law changes manually, by comparing new and old laws.

A document comparison tool like Draftable can make the job a lot easier for you. Draftable can take two documents, automatically spot changes, and highlight them for you. To keep your taxes in order, you need all of the help you can get.

That’s why you need to make use of every tool available. All of that brings us to…

5 Ways to Reduce Small Business Taxes

There are many ways for small businesses to reduce their tax burden, but we will discuss five of the most popular methods.

1. Employ one of your family members

One way to reduce your taxable income is to hire a family member. You can pay them a salary, and they can work for your business full-time or part-time. By doing this, you can enable your business to pay a lower marginal rate or even eliminate the tax on the income paid to their children.

For instance, a sole proprietorship doesn’t need to pay medical taxes or social security on child wages or the FUTA tax. The one thing you need to know is that these earnings need to come from justifiable business purposes.

You can also hire a spouse and enjoy some of the benefits, the IRS offers.

2. Change the structure of your business

If you’ve been operating your small business as a sole proprietorship or partnership, you may be able to save money by changing its structure to a corporation.

When you operate as a corporation, you are considered a separate entity from the company. This means that the company can own assets and incur liabilities independently from you. Additionally, corporations can offer their employees certain benefits, like 401(k) plans, which sole proprietorships and partnerships cannot.

3. Deduct your travel expenses

If you’re traveling for business, you can deduct your travel expenses from your taxable income. This includes airfare, hotel costs, car rental fees, and even meals eaten while traveling for business.

Keep in mind that you can only deduct expenses that are “ordinary and necessary.” This means that the expense must be helpful and appropriate for your business. You also can’t deduct any expenses that were paid with company funds.

4. Save some money for your healthcare needs

If you’re self-employed, you’re responsible for paying both your own Social Security and Medicare taxes. This amounts to about 15.3% of your income.

One way to reduce this tax burden is to save some of your income specifically for healthcare costs. You can do this by setting up a health savings account (HSA). An HSA is a tax-exempt account that allows you to save money specifically for medical expenses.

To be eligible for an HSA, you must be enrolled in a high-deductible health insurance plan.

5. Start your retirement plan early

Another way to reduce your taxable income is to start contributing to a retirement plan early. The sooner you start saving for retirement, the more time your money has to grow.

There are many different types of retirement plans available, but some of the most popular options for small businesses include SEP IRAs and SIMPLE IRAs.

SEP IRAs are employer-sponsored retirement plans that allow business owners to make tax-deductible contributions to their employees’ accounts. SIMPLE IRAs are also employer-sponsored, but they are less expensive to set up and administer than SEP IRAs.

Closing Thoughts

If you want your business to succeed, you need to do your homework and stay on top of your taxes. This can be a daunting task, but it’s one that’s well worth your time and effort.

There are many ways for small businesses to reduce their tax burden. By employing one of the methods discussed in this article, you can help your business stay profitable while keeping more of your hard-earned money.

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