How to Reduce Your Company Tax Liability
We added a few new liability-mitigating tips to this article in addition to updating information from the previous version.
Because of governmental reactions to COVID-19, there's expected to be a lot of changes to small-business taxation. Proposed legislation could bring tax breaks for incorporated businesses.
Nothing stings the wallet like tax season. The tips and advice in this article can help you mitigate that sting by lowering your overall tax burden. Paying less in taxes is a surefire way to increase your cash flow, enabling you to keep and invest more of your profits.
Incorporate your business
Incorporating your business is a mostly painless process that allows you to take advantage of tax breaks only available to incorporated companies. Before you incorporate, however, you should know a thing or two about the different types of business entities.
A sole proprietorship is the most common business entity, and as the name implies, it involves only one business owner. For example, if you own and operate any type of business on your own, you're considered a sole proprietor, and there’s no legal separation between you and your business
The problem with being a sole proprietor is that you are personally taxed on all gains made by your business in a given year. You are also personally liable for any claims made against your business. But if you incorporate your business, you can take a salary that is taxed based on employee tax rates. So you can essentially pay lower taxes on money you take as a salary. That’s why it’s smart to incorporate instead of staying as a sole proprietor.
C Corporation or S Corporation: Which Is the Best One?
Corporations typically come in two different forms, either a C corporation or an S corporation. According to SBA.gov, the IRS defines an S corporation as "a unique entity, separate and apart from those who own it." In order to create an S corporation, you need to register the business in the state where the business is headquartered.
The main advantage of an S corporation is that you don't have to pay taxes on the profits or losses of your business. Instead, your company's shareholders pay income taxes on any of the shares they receive from the business. As the business owner, you can reduce your individual tax liability because the shareholders are required to pay all the taxes. Many business owners like this type of entity because they aren't subject to double taxation.
Incorporating as a C corporation enables your business to carry its losses forward. This means that if you lose $100,000 in your first year, you can apply those losses over consecutive years. So if you made $60,000 the next year, you could deduct any amount from your losses to decrease your tax liability.
Much like an S corporation, C corporations are considered separate entities from their owners. In a C corporation, the IRS taxes you at the corporate level and then taxes you again when the profits are distributed to the owners.
Hire a tax professional
Once you’ve started a business, you have one of two choices: become a tax expert yourself, or hire someone to maximize your deductions. Unless you love tax law, our recommendation is to hire professional tax help.
Business taxes are complicated, but there are a ton of expenses you can deduct—office supplies, driving miles, travel expenses, the list goes on. Rather than try to keep track of all of this yourself, let the experts squeeze every penny back from the tax man for you.
Make charitable donations
A quarter of your taxable income can be deducted via charitable contributions. In addition to reducing your tax liability, charity work can be a great opportunity to build trust in your community and increase your business reputation.
Hire contracted employees
Employees that do contract work allow you to get the job done while not having to pay employee taxes and healthcare costs. Plus, if you love the contractor you’ve worked with, you might decide to bring the person on full-time in the long run.
We’ve listed a few of our favorite ways to decrease your tax liability and tried to pick options that were both effective and easy to implement. But we do recommend that any tax advice we’ve given be talked over with your attorney or tax specialist, as every business has different needs and structures.
At Business.org, our research is meant to offer general product and service recommendations. We don't guarantee that our suggestions will work best for each individual or business, so consider your unique needs when choosing products and services.