In both retail and construction, 95% of revenue goes to expenses and taxes, leaving just 5% profit.
All businesses need to pay taxes, and while it’s unavoidable, there are several things you can do to minimize your business tax liability. Each year individuals need to prepare and pay their taxes by April 15th, but businesses need to do this year-round. The amount you have to pay will depend on how much your business makes that year, as well as several decisions that you’ve made.
For a rundown of what tax liability is, and how to keep it to a minimum, keep reading.
What Is Business Tax Liability?
The money that you owe to the IRS (Internal Revenue Service), state, or local government is your tax liability. It’s made up of several forms of tax:
- Income tax
- Capital gains tax
- Employment tax
- Past unpaid taxes
Your tax liability is essentially a sum of all the taxes your business owes.
Minimizing Your Business Tax Liability
There are several things you can do to minimize your tax liability, and having an understanding of these will help you develop the most cost-effective tax strategy. This includes deductions, tax credits, and certain investments that you can make.
1. Know What Deductions You Can Make
One of the best ways to reduce your tax liability is through deductions. Most people are aware that this is possible, but they often don’t know what deductions they can make. As such, businesses often don’t claim certain deductions and end up paying more in taxes than they need to.
Vehicles are one of the most common. Personal vehicle mileage and expenses can be deducted if they’re used for business purposes. The same goes for certain costs when running a business from home, such as utilities, rent, and mortgages.
If a cell phone is primarily used for business, the bill may be deductible. If you go for meals (or other entertainment) with potential/existing clients, contractors, employees or partners, then you can deduct up to 50% of the costs of these.
You can deduct any purchases of equipment for your business. This often includes things like:
- Office furniture
It’s also possible to claim deductions when setting up and making contributions to retirement plans.
2. Make Smart Purchases and Investments
Depending on the nature of your business, this can be one of the largest elements that affects your tax liability. One factor here that many people don’t consider is the timing of such purchases. Depending on when you buy equipment, it could apply to this tax year or the next.
Managing finances is crucial for any business, and that applies here too. At the start of the year, you should work out everything you intend to buy that year so you can develop a good tax plan.
Sometimes there can be unexpected purchases that come up. If it’s close to the end of the year and there is something you’ll need to buy within a few months, it might be ideal to purchase it sooner rather than later. This will mean you can claim it as a deduction this year, which might be ideal.
The same thing can apply to a marketing campaign. The costs of this will likely be spread over several months, and if you pay for some of it before the end of the year you’ll be able to add that amount to that year’s deductions.
Something else that many people believe is that all income that a business receives is taxable, and all outgoings are deductible. In reality, this can vary depending on the nature of the inflow and outflow.
Income from goods or services, for example, is taxable. Some forms of income that aren’t taxable include lines of credit, bank loans, and loans from the business owner. Such loans are also only deductible once the business actually spends the money.
3. Invest in Your Employees
Another effective way of reducing your tax liability is by investing profits back into your employees. Not only does this lower your tax liability, but it can also help improve your team.
In most cases, the salaries you pay your employees, as well as bonuses and other compensation, are deductible. For this, they need to be:
- A reasonable amount
- For the services that were provided
- In the current year
You can also claim employee retirement contributions in your deductibles. This includes any 401(k) contributions, provided they’re within the limitations set out in section 404 of the IRC (Internal Revenue Code).
It can be beneficial from a tax perspective to offer employees profit sharing, employee matching, or safe harbour contributions. This is also desirable to employees, so it will increase their job satisfaction and help you attract more skilled workers.
4. Employ a Family Member
This may not be practical for all businesses, but hiring a family member can lower the taxes you need to pay each year. There are various options available for this, including hiring your children.
Small businesses don’t have to pay as high a marginal rate, or may even not have to pay any tax on income to family members they employ. This can include avoiding having to pay social security, Medicare taxes, and FUTA (Federal Unemployment Tax Act) taxes.
Before doing this, however, you need to be aware that the earnings need to be justifiable, as to prevent people from doing this simply to avoid taxes. You can also hire a spouse without having to pay the FUTA tax, and you can make retirement contributions for them.
Help With Your Business Tax Liability
All of these strategies can help reduce your business tax liability, but you must do things right. Making mistakes can result in issues and fines, so if you’re not 100% sure what you’re doing, it’s best to hire a professional service.
At Bennett Financials, we offer a range of services such as tax planning, tax resolution, and bookkeeping. To find out more about how we can help your business, click here to contact us today.