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?
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.