How to Reduce Taxes Without Reducing Net Profits
Everyone likes being profitable, yet no one likes paying taxes. So, how can we reduce taxes without reducing net profit?
Retirement Contributions
Making contributions to your qualified retirement plan (SEP/SIMPLE IRA; Solo 401-K; etc) through your business can reduce your federal income tax, but does not reduce your taxable net profit. The cool and unique thing about this deduction is that the IRS allows you to make retirement contributions beyond December 31, up to the filing deadline of your main tax return, in order to maximize your deduction for the previous year.
Health Insurance Premiums
The health insurance premiums paid on behalf of the owner(s) work very similar to retirement plan contributions: They reduce your federal income tax, but not your business’s net profit. Health savings accounts can be used to achieve the same objective. First, make sure you’re eligible for the deduction. For example, if your spouse has health insurance through their employer and they have the option to cover the entire family, you may not be able to claim the deduction through your business.
S Corporation Conversion
If your small business is profitable (especially beyond $50K/yr) and you file taxes on Schedule C, you may benefit from electing to be taxed as an S-Corporation. This strategy will help you to legally reduce self-employment tax. But be careful when adopting this strategy. Electing to be taxed as an S-Corp comes with increased compliance issues, which means more fees. You’ll have a separate tax return to prepare, and you’ll have to run a payroll for yourself (which will require payroll tax returns). You’ll want to do this with the help of a tax pro. Make sure all of the extra fees associated with becoming and maintaining an S Corp do not eat up what would have been your tax savings.
Non-Business-Related Deductions and Credits
All business owners will eventually end up filing a Form 1040 (the main tax form), and it includes all of the credits and deductions that aren’t business-related. Make sure you are maximizing all credits and deductions outside of the business. They will not reduce your net profit at all but the tax savings can be great.
The main thing to remember about the 1040 tax return is that it includes ALL sources of income, and well as all of the available credits and deductions; not just the business stuff. The popular ones are the student interest deduction, charitable contributions, the Child Tax Credit, Earned Income Credit, etc. Reach out to your tax pro to see which credits and deductions you may qualify for.
How to Talk to Your Clients About Raising Your Prices
You’ve determined that it’s time to raise your prices. How do you communicate this to your clients and customers?
First of all, don’t make it sound like you’re breaking bad news. Raising prices is a natural and recurring step in the life of a service-based business. Know your worth. Get confident and comfortable in your own head of the value that your business provides. If you can’t convince yourself that a price increase is warranted, then you won’t be able to sell it to anyone else.
Obviously, you don’t want to alienate your clients. You want to keep them happy. And believe it not, your clients don’t just want you to survive—they actually want you to be profitable. So this can absolutely be a win-win situation if you play it right.
You especially want to get your long-term clients on board with a price increase. If they’re unhappy, they have the potential to spread their discontent throughout your culture and community of members. This is the kind of water fountain talk you want to avoid happening at your place of business or on social media.
In this post, we offer some suggestions and thoughts on informing your clients about pricing changes. At the end of this post, you can find a link to our pricing increase template letter to help make this task easier for you.
- For starters, always give 30 days notice when raising rates. You don’t want clients to feel like they’ve been rushed or ambushed into a new commitment.
- Put it in writing—at the very least, you should send them an email.
Keep in mind, your clients will view a rate increase relative to the price they’re currently paying. A $6 per month bump might seem like no big deal, but if their membership fee is already $80 per month, that’s a 7.5% increase in price, which may not go unnoticed—especially if they’re currently paying a higher-than-market price for your service.
- Transparency in general can go a long way toward sweetening the news. Explain exactly what you’re doing, why you need to do it, and make it relevant to them. If you made a guarantee to provide a certain level of service as part of their membership agreement and now you need to increase pricing in order to maintain that level? Explain that.
People get attached to their service providers especially in fitness and wellness. They care that they are compensated fairly and have good working conditions and opportunities. So your clients will usually get behind an argument for increasing rates that involves paying their service providers more, or investing in your team in some way. It’s more than fine to get a little personal about this in your email.
As I’ve said recently, I’m in favor of increasing prices regularly by small amounts rather than by large amounts less frequently. Clients are more accepting because they’re likely to see that you’re just keeping up with the rising cost of doing business. But there are times when a large price increase is justified—to you, at least.
- If you’re implementing a small increase for the cost of doing business, say 2 to 3%, amounting to a few dollars more per month, it’s okay to simply inform your clients of this and invite them to contact you with any questions or concerns.
- If it’s a bigger increase, however, it might be a good idea to sit down with your clients one-on-one, or give them a call, in addition to sending an email.
The important thing here is to demonstrate how they’ll benefit from the improved services you’ll be providing with more funds in hand. Even better if you can tie it in directly to how this will help them reach their goals or soothe their pain point.
Maybe you’re going to improve the temperature control in your building so they won’t be chilly anymore while getting a massage. Or maybe you’re adding new equipment so they won’t have to wait in line to use the weight machines, and they can get home faster to their kids on gym night.
- If you’ve been seriously underpriced in the past and now need to get in line with the market, you probably need to be adding more services to justify a very steep increase. I’ve seen a gym membership cost jump from $59 to $100, but they changed their business model to do that by adding new equipment and more programming at the same time, like additional access to coaches and classes.
In general, if you’re not comfortable asking your clients to ride the increase with you, ask yourself if there’s something you need to add in to your services so that you ARE comfortable charging an increase.
And because we know it’s hard to ask for money, sign up below to get a free pricing increase template letter you can use.
Raising Prices Doesn’t Guarantee Increased Profitability
If you’re trying to increase your business profits (and who isn’t?), you might think the sure-fire way to do that is simply to raise your prices. If your customers pay more, you’ll make more. Right? Not necessarily.
Well, if you’re using the Profit First method, raising prices will indeed equate to increased Profit. Because you take in revenue, you immediately pay yourself a profit. So if you take in more revenue (by raising your prices), you’ll pay yourself more profit. But increased revenue does not necessarily mean increased profitability.
Profitability vs. More Profits
And what is profitability exactly? It’s a measure of your profit relative to your expenses. It’s an assessment that helps you determine if your business can sustain itself and grow. Ultimately you want to be able to project the profitability of your business well into the future.
Here’s why raising your prices does not automatically equate to increased profitability.
You do have to raise your prices from time to time no matter what because of inflation. The cost of doing business is always gradually increasing because the costs of goods and services in our economy are generally rising over time.
So if you raise prices just enough to keep up with the cost of doing business, you might not increase your profitability at all. So how do you increase profitability?
There are endless tactics and factors of influence. (Here are just a few ideas specifically for gym owners.)
But at the most basic level when we’re talking about profitability, raising prices alone won’t cut it. You have to raise your prices and you also have to monitor your expenses.
How to Plan a Pricing Increase
Price increase strategy incorporates many factors. Ideally, you have a system in place for reviewing your client pricing structure on a regular basis. This involves running reports and examining numbers that are very specific to your business and its service offerings. Read about one fitness studio owner’s successful formula for profitable pricing here.
But let’s say you’re leaving your pricing structure in place for now because it’s working well. How much should you raise your prices, even if just to stay even with current expenses?
I’m always a proponent for increasing your prices regularly by small amounts rather than implementing larger increases less often. It’s easier for clients to stomach.
At minimum, we suggest increasing your prices by 1 to 2% annually to account for an inevitable increase in the cost of something or other. But a 3 to 5% increase is very standard.
Your landlord might raise the rent, or the cost of your CRM software monthly subscription might go up—or both. You might be able to predict how much your vendors will raise their prices this year by reviewing the history of previous years.
And then consider whether you need to upgrade to a higher tier of an existing expense, or purchase something new altogether this year. You’ll need to factor that into your spending plan, and possibly your pricing increase, if you haven’t saved ahead to pay for it.
You should examine your full roster of expenses at least quarterly, and definitely whenever you’re thinking about implementing a pricing increase. We talked about analyzing your recurring business expenses and how to reduce them in this earlier post. Trim whatever you can. This is a step toward increased profitability.
Along with that, you should look at any other areas where you may have inefficiencies in your business. Are you running a tight ship with your team members for maximum productivity? Trim here too, if necessary. Labor inefficiency is an enemy of profitability.
Raise Prices to Achieve Broader Goals
Now you’re aware that you need to increase prices incrementally on a regular basis just to keep up with rising costs. Of course, it’d be great if you also could strategically raise prices to help you achieve your broader business goals.
For example, do you have a goal to pay yourself more every month? You can use a pricing increase to take an incremental step toward that. Work backwards with the numbers. Do you know what your revenue needs to be in order to increase your Owner’s Pay by as much as you want to? Figure out how much you need to increase incoming revenue per client in order to make that incremental step.
Final Thoughts
Overall, determine an increase that you are comfortable selling to your clients. Are you confident that a $10 increase in their monthly membership fee is worth it for them?
Part of raising rates and your journey toward increased profitability might also involve changing your business model to add more value to their membership. If your goal is to have a higher market share (more clients), then you’ll naturally need to scale your business over time to accommodate them.
Having a higher market share also makes you a more competitive business, and this alone can improve profitability.
And stay tuned for next week’s post, where we’ll offer some best practices for how to tell your clients that prices are going up!