7 Sneaky Tax Loopholes for Small Business
Chances are, you could be paying less in taxes. Small business owners wear many hats and juggle a myriad of responsibilities, which means that you have little time to dig deeper into your business taxes, understand how they work, and what to do to start saving on business tax deductions and other tax loopholes for small business.
But fear not! In this article, we'll walk you through the best small business tax loopholes so you can reduce your tax liability and keep more of your hard-earned money in your pocket.
What Are Tax Loopholes for Small Business Owners?
First things first, what are tax loopholes for small business owners and are they legal?
Tax loopholes allow people or businesses to legally reduce their tax liability. They are often the result of specific incentives or exemptions that the government created to promote certain behaviors, such as becoming a small business owner!
Small businesses are the driving force of the US economy. In fact, businesses with 500 employees or fewer account for 99.9% of all US businesses. It makes sense that the government would create opportunities for small businesses to save money every tax year so they can grow more and continue to contribute to the economy.
So, while the term “loophole” might sound dubious, these are legitimate ways to reduce your taxable income, and many savvy business owners use them!
1. Self-Employment Tax
What Is Self-Employment Tax?
Self-employment taxes cover Social Security and Medicare taxes for people who work for themselves (AKA, entrepreneurs and small business owners). As of 2024, the self-employment tax rate is 15.3% (12.4% for Social Security and 2.9% for Medicare).
This can be a big expense for small business owners. Thankfully, there's a way to lower your taxable income and pay less in self-employment taxes!
Choosing the Right Business Structure
One of the most important decisions you can make as a small business owner is not about your branding or creating a strong marketing plan. It's about choosing the right business structure for your business. Why? Because this choice impacts your personal liability, business operations, and, perhaps most importantly, your tax obligations.
The most common business structures for small businesses are sole proprietorship, partnership, limited liability company (LLC), and corporation (C-Corp or S-Corp). Each structure has its own set of pros and cons for tax purposes, but choosing the S Corporation tax status can result in significant tax savings when it comes to self-employment tax.
Self-Employment Taxes and S-Corporate Tax Election
When a business owner elects S-Corp status, they must pay themselves a reasonable salary. This salary is subject to self-employment taxes. However, any additional profits can be distributed as dividends, which are not subject to self-employment taxes.
For example, let’s say your business earns $100,000 in profit. As an S-Corp, you might pay yourself a reasonable salary of $50,000. This salary is subject to payroll taxes. The remaining $50,000 can be distributed as a dividend, avoiding the 15.3% self-employment tax.
Let's crunch some numbers:
Salary Portion: $50,000 (salary) x 15.3% (self-employment tax rate) = $7,650
Dividend Portion: $50,000 (dividend) x 0% (self-employment tax rate) = $0
In other words, reducing your business's taxable income would save you $7,650 every tax year!
If your business is not currently registered as an S Corporation and you're considering making the switch, get in touch with us to discuss your options.
2. Home Office Deduction
If you use part of your home exclusively for business purposes, you may qualify for the home office deduction. For entrepreneurs who work from home, this is a great way to write off some of your business expenses, including rent, mortgage interest, utilities, and maintenance costs.
The IRS has two methods to calculate this deduction:
Simplified Method: With this method, you can deduct $5 per square foot of your home used for business, with a maximum limit of 300 square feet. The maximum deduction under this method is $1,500 per year. The simplified method is straightforward and reduces record-keeping requirements, making it an easy option for many small business owners!
Regular Method: This method requires you to calculate the actual expenses of your home office based on the percentage of your home used for business. For example, if your home office occupies 10% of your home’s total square footage, you can deduct 10% of your rent or mortgage interest, utilities, homeowners insurance, and maintenance costs. This method involves more detailed record-keeping, but it can result in a larger deduction if your home office expenses are above average.
Looking for more ways to save on tax deductible business expenses? Here are 10 creative tax deductions for small businesses to save big!
3. Section 179 Deduction
The Section 179 deduction allows you to deduct the full price of qualifying items purchased or financed during the tax year as long as it stays below a specified limit. Machinery, computers, software, office furniture, and vehicles used for business purposes can all potentially qualify for this tax deduction.
The limits for the Section 179 deduction change every tax year. In 2024, the Section 179 deduction limit was set at $1,220,000. In 2023, it was $1,160,000.
4. Health Insurance Deduction
When you're self-employed, you can deduct health insurance premiums you pay for yourself, your spouse, and your dependents. This deduction is available even if you do not itemize deductions on your tax return. If you provide health insurance coverage for your employees, you may also qualify for the Small Business Health Care Tax Credit, which can further reduce your tax liability.
With the rising costs of healthcare, the ability to deduct medical expenses can come in very handy for small business owners! Use this small business tax deductions checklist to find more ways to reduce your tax burden.
5. Retirement Plans
Small business owners can reduce their taxable income by contributing to retirement plans. Several options are available, each with its own set of rules and benefits:
SEP IRA (Simplified Employee Pension Individual Retirement Account): This plan allows you to contribute up to 25% of your net earnings from self-employment. Contributions are tax-deductible, and the plan is easy to set up and maintain!
SIMPLE IRA (Savings Incentive Match Plan for Employees): This plan allows both employer and employee contributions. Employees can defer a portion of their salary to the plan, and employers are required to make either matching contributions up to 3% of an employee’s salary or non-elective contributions of 2% of each eligible employee’s salary. If your small business has employees, this plan gives you a straightforward way to provide retirement benefits.
Solo 401(k): If you don't have any employees, Solo 401(k) plans have higher contribution limits than other retirement plans. As of 2024, you can contribute up to $23,000 as an employee, with an additional $7,500 catch-up contribution if you’re over 50. As a self-employed individual, see this instruction by the Internal Revenue Service (IRS).
6. Travel Expenses
Going somewhere for business reasons? You can deduct travel expenses such as airfare, hotel stays, business meals, and even mileage if you drive. If you travel often for business purposes, deducting vehicle expenses and other travel-related expenses can come with significant tax benefits!
Make sure to keep detailed records and receipts to back up these deductions. Always make a note of the purpose of your trip, dates, and expenses incurred. The IRS requires all travel to be ordinary, necessary, and directly related to your business in order to be deductible. Consider using a dedicated business credit card and maintaining a travel log to streamline record-keeping!
7. Qualified Business Income (QBI) Deduction
With the QBI deduction, self-employed individuals and small business owners can deduct up to 20% of their qualified business income from their taxable income. If your business is a pass-through entity, such as a sole proprietorship, a partnership, or an S-Corp, you may be eligible for this tax loophole.
The Qualified Business Income deduction can be highly valuable to small business owners, but it has complex rules that may be hard for you to navigate on your own. Consider getting in touch with a tax professional!
FAQs
Are There Tax Breaks for Small Business Owners?
Absolutely! There are many tax write-offs for small business owners that can significantly reduce your tax liabilities. If you work from home, you can take advantage of the home office expenses tax deductions. If you use your car for business purposes, you can use business vehicle deductions. Electing the S-Corporation tax status can also help you save money on self-employment taxes. Overall, small business taxes come with many deductions and loopholes that entrepreneurs can use to owe less money to the government!
How Much Income Can a Small Business Make Without Paying Taxes?
The IRS requires self-employed individuals and small business owners to file an income tax return if your net earnings were $400 or more. If your net earnings were less than $400, check out this form to see if you meet any of the requirements to still have to fill out an income tax return.
Will I Get a Tax Refund If My Business Loses Money?
If your business makes negative profit, you could be eligible for a tax refund. The exact details depend on your business structure and the nature of your business, so make sure to consult with a tax professional to figure out how to make the most of it when your business expenses exceed your revenue.
How Much Can a Small Business Write Off?
Each small business tax deduction typically comes with its own set of regulations and limits. For example, the simplified method for the home office deduction allows entrepreneurs to write off a maximum of $1,500 per year. In the case of less clear-cut regulations, such as when lowering your self-employment taxes by using the S-Corporation tax status, you need to convince the IRS that your salary to yourself is reasonable for your position and industry.
Can I Deduct My Cell Phone as a Business Expense?
Yes, you can deduct your cell phone as a business expense if it is used for business purposes. The IRS allows you to write off the portion of your cell phone expenses that directly relate to business use. If you use your cell phone exclusively for business, you can deduct the entire cost, including the purchase price, monthly service charges, and any related expenses like accessories or repairs. If you use the cell phone for both personal and business purposes, you can only deduct the percentage of the expenses that apply to business use.
Can I Claim My Internet Bill as a Business Expense?
Yes, if you use the internet for business purposes! You can claim this deduction if you work from home or if you have a dedicated business office. If you use the internet for both personal and business purposes, you can only deduct the percentage of the expense that pertains to business use.
Can I Claim My Mortgage as a Business Expense?
Yes, but only if you use a part of your home exclusively and regularly for business. This tax deduction can include a portion of your mortgage interest and other home-related expenses, such as maintenance. You can't claim your entire mortgage as a business expense.
What Are the Tax Disadvantages of an LLC?
This is a hefty topic that you can learn more about in this article on LLCs vs S-Corps. That said, from a tax standpoint, one of the disadvantages of an LLC is that you typically have to pay self-employment taxes on all of your business income. With an S-Corp, you can split your business profits into a salary and dividends. While you still have to pay self-employment taxes on your salary, you don't have to pay them on the dividends. This can potentially save you thousands of dollars in taxes every year!
Find Clarity in Tax Season with Desi Tax
Small business taxes is a complicated topic, but it doesn't have to give you a headache. Desi Tax Services® helps business owners stay on top of their numbers, take advantage of the small business tax loopholes available to them, and start saving money you didn't know they had!
Learn more about our tax services and start feeling ready for tax season!
