7 tax tips for small business owners
Quick insights
- Selecting the appropriate business structure can affect your tax obligations.
- Planning ahead for taxes may allow you to maximize deductions and steer clear of unexpected bills.
- Separating business and personal finances can make recordkeeping and claiming deductions easier.
As a small business owner, managing your tax liability can be just as important as driving revenue. Everything from tracking daily spending to determining your legal entity influences your finances year-round—not only at tax time.
In this article, we explain how business structure affects taxes and provide seven practical tax strategies for small business owners to help maintain financial health. Note that you may want to consult a tax professional about your specific situation.
1. Understand how company structure affects taxes
The legal form of your business determines how your income is taxed and how to pay yourself as a business owner. Each type of business structure comes with its own tax responsibilities and financial advantages.
Sole proprietorships, partnerships, limited liability companies (LLCs), S corporations and C corporations are the most widely used structures.
- With sole proprietors and single-member LLCs, business earnings are by default reported on your personal federal tax return and taxed at your individual rate.
- With partnerships and multi-member LLCs, your portion of business earnings is by default reported on your federal tax return and taxed at your individual rate.
- Note that sole proprietors, LLC members and partners are required to pay tax on business earnings whether or not they have received distributions from the business.
S corporations and C corporations have different tax rules. With an S corporation, profits and losses pass through to your personal return.
- S corps allow you to pay yourself, as an employee, a reasonable salary and take remaining profits as distributions, which may reduce self-employment taxes.
- C corporations are taxed as separate entities, paying corporate tax on profits. Shareholders pay tax again when they receive dividends.
2. Separate business and personal expenses
Combining personal and business transactions might result in confusion and complicate your tax preparation. Maintaining a clear separation between these expenses can make it easier to identify deductions and maintain solid business records should you face an audit.
Setting up a dedicated business checking account and using a business credit card are some effective ways to track expenses. Whether you are paying for software subscriptions or taking a client to lunch, diligently recording each expense on a dedicated business debit or credit card is one way to keep personal and business expenses separate.
3. Maximize your deductible expenses
There are several common business expenses that are deductible and may help lower your taxable income. Common deductible expenses may include office supplies, business travel, software, marketing and certain home office costs, to name a few.
Internal Revenue Service (IRS) rules frequently change regarding which deductions are allowed or their limits, so reviewing IRS guidelinesOpens overlay annually helps you stay up to date. A tax professional or accountant also can help confirm that you are claiming any eligible deductions.
4. Fund a tax-advantaged retirement plan
Contributing to a retirement plan may be an effective way to lower your taxable income as a small business owner while also contributing to your future. Contributions to vehicles like SEP IRAs, SIMPLE IRAs or solo 401(k)s can be tax deductible, depending on the plan and your business structure.
These retirement accounts not only support long-term growth, but also may exclude a portion of your income from taxes each year. Because rules and contribution limits vary, consulting a financial professional can help you to choose the best wealth management plan for your situation.
5. Reevaluate your business entity structure
As your business grows and changes, your original business structure might not remain the best fit. Regularly reassessing your business structure helps you respond to revenue spikes, staffing fluctuations or operational changes.
Switching your business structure, such as moving from a standard limited partnership to an S corporation, may result in tax savings and added liability protection, depending on your situation. Since every structure comes with unique tax consequences, you should speak with a tax advisor before making changes.
6. Prepare for estimated quarterly taxes
Because taxes are not automatically withheld from business income, many small business owners must make estimated quarterly tax payments. Failing to make these payments on time can result in costly penalties and interest. If you expect to owe $1,000 or more in taxes for the year (after accounting for withholding and credits), you generally need to pay quarterly estimated taxes.
Setting up calendar reminders, calculating cash flow and allocating funds throughout the year can help you prepare for quarterly tax payments. It may be useful to automatically transfer a set percentage of your income into a separate business savings account. This can help ensure you have funds ready when quarterly tax deadlines arrive.
7. Leverage Section 179 depreciation
Utilizing Section 179 may help decrease your taxable income. Section 179 of the IRS tax code can allow businesses to deduct up to the entire cost of qualifying equipment or software the year it is placed in use. The alternative is spreading the deduction over multiple years.
If using this tax strategy, you should consider the following:
- Annual limits: There are yearly deduction maximums, so reviewing guidance on the IRS website or consulting a tax expert can help you stay up to date.
- Eligible property: Not all assets are eligible. Qualifying assets typically include machinery, computers, certain vehicles and office furniture.
- Bonus depreciation: You may also be eligible for bonus depreciation on certain purchases that go beyond Section 179 limits.
Frequently asked questions about small business tax strategies
What are some common tax deductions for small business owners?
Frequent deductions may include office expenses, travel, marketing, software, home office costs and retirement plan contributions.
Can I change my business structure after starting my business?
Yes, you can change your business entity as your revenue or business goals shift. Changing the tax classification of your business is subject to limitations. Consulting a tax professional can help you understand the possible financial and tax impacts of changing your business structure.
How does a home office deduction work?
If you use a portion of your home exclusively and regularly for business purposes, you may be eligible to deduct a portion of your rent, utilities and related expenses on your taxes.
What records should I keep for tax purposes?
It is helpful to maintain good recordkeeping, such as keeping receipts, invoices, bank statements, mileage logs and tax documents for a minimum of three years in case you face an IRS audit.
