Running a small business has its ups and downs, in those early days where it’s just you and your spouse, you don’t have to worry about the dramas that can occur between employees. Although often as a small business you will not have the knowledge or experience with things like tax deductibles, meaning you end up paying more in taxes than necessary. With the limited profit margin that comes in the early days of running your own business, every dollar counts, so minimizing tax is a must.
There are a number of ways you can start minimizing your taxes now, such as seeking a financial advisor or accountant who is experienced in doing so. Although you may not have the financial freedom to start there, finding the best way to reduce taxes on your own can lead to those services becoming affordable.
Here is an overview of how you can start minimizing your taxes as a small business owner.
Keep it in the Family
One of the best-known ways to reduce tax in your small business is by hiring family members, this is because the Internal Revenue Services allow for a variety of options to shelter income from taxes.
For Spouses
There are many benefits to employing your spouse, such as it not affecting your Solo 401k benefits, but also, they’re only subject to certain taxes. The income of a spouse working for your business is subject to income tax withholding as well as Medicare tax, but not the Federal Unemployment Tax Act (FUTA).
As of 2021, the FUTA tax rate is 6% of the first $7,000 paid to each employee annually.
For Children
While it may be difficult to convince them to come to work, children of the owner of a business are not subject to the FUTA, nor Social Security or Medicare tax.
As of 2021, Social Security tax is 6.2% of all wage income, and Medicare tax is 1.45% of all wage income.
Setting Up for Retirement
Not only is organizing a workplace retirement plan for yourself a good way to ensure your survival during those golden years, but it also has tax benefits. There are several types of retirement plans which are relevant to small businesses, they are the Solo 401k, SEP IRA, and Simple IRA.
Solo 401k
The Solo 401k benefits revolve around the business being run by one person, and can include the spouse of that one person. This makes it an ideal plan for those super small-scale businesses which aren’t planning on upscaling. Although another of the Solo 401k benefits is that it can be transferred to a standard 401k account if more employees are required.
There are two kinds of Solo 401k which can offer different tax benefits: traditional and Roth. The traditional Solo 401k tax advantage reduces income in the year they are made, and distributions during retirement are taxed as ordinary income. Whereas a Roth 401k offers no initial tax break but allows distributions to be taken tax-free during retirement. Either of these may be more or less suitable for you and your small business.
Simple IRA and SEP IRA
These offer similar tax advantages to the Solo 401k, and are often considered much easier to set up and manage. On top of this, these retirement plans allow for more staff members and may be a better place to start if you are planning on hiring employees other than your spouse. Read here to see the differences between the Solo 401k and these kinds of IRA benefit plans.
Tax Advantages, Tax Credits, and Tax Deductions
These are the most common terms people think of when considering how to reduce taxable income. Tax advantages are more related to the workplace retirement plan that you’re using, but can also include education savings accounts, medical savings accounts, and government bonds. Working alongside your accountant when looking at which workplace retirement plan is most beneficial to you may be the best place to start.
Tax Credits
These are the federal government’s way of encouraging both businesses and individuals to do, or not to do, certain things which affect society as a whole. One can gain tax credits for reducing the environmental impact of their business, hiring employees, providing access to disabled employees and the public, and providing health coverage for employees.
Tax Deductions
These are reductions on the taxable income of you and your business through purchasing goods or services which are either beneficial or necessary to the running of your business. Prime examples include business insurance, travel for business reasons, equipment for your business, and office rent.
Work alongside an accountant to determine whether you can utilize tax advantages, tax credits, or tax deductions in your business.