As a proprietor of a small enterprise, it is common to assume various roles and responsibilities. Your primary focus is likely on efficiently managing the operations of your business rather than prioritizing tax optimization. Nevertheless, there exist several viable avenues for reducing your tax liability through widely recognized tax deductions specifically designed for small businesses. By availing these deductions, you can subsequently reinvest the resulting savings back into your business, fostering its growth and development.
Learn the essential strategies for minimizing your business tax liability with these 7 valuable tips.
Purchasing health insurance can undoubtedly be a significant financial burden. However, self-employed individuals who bear the cost of their own insurance can take advantage of certain benefits provided by the IRS. By doing so, they may be able to reduce their tax liability.
Typically, employees who receive health insurance coverage from their employers share the expense of the premiums. If you work for yourself, whether as a freelancer, independent contractor, gig worker, or in any other capacity where you are in charge of your own health insurance and cannot get coverage through your partner, you might qualify for the self-employed health insurance deduction.
Should you meet the necessary criteria for claiming this deduction, you may be able to deduct either all or a portion of your insurance premium. The cap on the amount that can be requested from the insurance policy is typically based on the net profits generated by the business or venture that the policy is built upon. This deduction has the potential to reduce your tax liability, resulting in annual savings whenever you qualify for its application.
The deductibility provision extends to self-employed individuals for various types of insurance premiums, including medical, dental, vision, and long-term care coverage. Additionally, you have the option to claim the deduction for your spouse or any qualifying dependents who are 26 years old or younger after the tax year.
As a proprietor of a small business, you have a range of retirement savings options that offer tax advantages and enable you to maximize your retirement savings. Consider setting up a Solo 401(k) plan, also known as a single-participant 401(k), if you are self-employed and have no employees. This plan allows you to contribute up to 100% of your income as an employee contribution, up to the annual limit. Additionally, you may be eligible for an employer contribution based on your net income from self-employment.
Another option to consider is the Self-Employed Person Individual Retirement Account, or SEP IRA. This retirement account allows you to save up to 25% of your income in the account and has similar contribution limits as a solo 401(k) ($61,000 and an additional $6,500 for those age 50 or older).
You also have the option to contribute to Traditional and Roth IRAs, which may further reduce your tax bill.
Furthermore, you may be eligible to claim the Saver’s Credit, which is worth up to $1,000 ($2,000 for married couples filing jointly) for contributing to your retirement account. You may be eligible to receive the Saver’s Credit if you have made contributions to a 401(k), 403(b), 457 plan, Simple IRA, or SEP IRA. Contributions made to a traditional IRA or a Roth IRA are also eligible for the Saver’s Credit.
Qualified business income deduction
Individuals who report business income on their personal tax return may be eligible to claim the qualified business income deduction, also known as the Section 199A deduction. This deduction is available to sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations. It allows eligible self-employed individuals and small business owners to deduct up to 20% of their qualified business income on their taxes. To qualify, taxable income must be under $164,900 for single filers or $329,800 for joint filers in 2021, or $170,050 and $340,100 in 2022, respectively. In the event that the taxable income surpasses the designated income threshold, it is possible to receive a deduction that is proportionate to the excess amount.
To determine qualified business income, the IRS defines it as “the net amount of qualified items of income, gain, deduction, and loss with respect to any trade or business.” This includes income, gains, losses, and expenses incurred as part of the business. However, it does not include capital gains or losses, dividends, interest income, income earned outside the U.S., or certain wage and guaranteed payments made to partners and shareholders.
For businesses considered a specified service trade or business, the Section 199A deduction does not apply when taxable income is above $440,100 for joint filers and $220,050 for other filers in 2022. Taxpayers who engage in a specified service trade or business may be eligible to claim a partial deduction, provided that their taxable income falls within the specified thresholds. For joint filers, this range is between $340,100 and $440,100, while for other filers, it is between $170,050 and $220,050. Examples of specified service trade or business include doctors, lawyers, financial planners, consultants, and other professional services.
Depending on the nature of your business, you may need to drive as part of your work. If you choose to buy a company vehicle, it could result in lower taxes through deductions the IRS makes available to small businesses.
You can generally figure the amount of your deductible car expense by using one of two methods:
- Standard mileage rate. The IRS allows you to deduct expenses related to operating and maintaining your business vehicle per mile driven. In 2021, the standard mileage rate id 56 cents per mile. In 2022, the standard mileage rate is 58.5 cents per mile from January 1 through June 30 and 62.5 cents per mile from July 1 through December 31. To determine the number of miles driven for business, you’ll need two numbers for your business vehicle (or vehicles): the total number of miles driven during the year and total number of miles driven just for business. You’ll need to log your business miles to make sure you only deduct for those miles driven and not for personal use. Additionally, this will require driving extra miles beyond your regular daily commute from your residence to your office.
- Actual expenses. The IRS allows you to tally all of your auto-related business expenses and use this method for calculating the allowable deduction on your car as an alternative to the standard mileage rate. Deductible expenses include costs like gas and oil, maintenance and repairs, tires, registration fees and taxes (also deductible under the standard mileage deduction), licenses, rental or lease payments, insurance and more. Again, you’ll need to keep track of how much you used your vehicle for business versus personal use. Based on the percentage used for business, you can deduct the applicable amounts of your actual vehicle expenses if it saves you more money on your taxes than the standard mileage rate.
Home office deduction
The home office deduction is a valuable tool that small business owners can utilize to effectively reduce their annual tax liability. Meeting two specific conditions is essential to qualify for this deduction:
1. Exclusive and regular use: You must utilize a specific portion of your residence, such as a house, apartment, condominium, mobile home, boat, or similar structure, exclusively for business purposes consistently. This also encompasses any additional structures on your property, such as a detached studio, barn, greenhouse, or garage. However, it is important to note that areas of your property exclusively used for hotel, motel, inn, or similar business purposes are not eligible for this deduction.
- Principal place of business: Your home office must either serve as the primary location for your business operations or be a place where you consistently meet with clients or customers. It is important to be aware that certain exceptions apply to this rule, such as daycare facilities or storage facilities.
The term “exclusive use” pertains to the idea that the office space is exclusively intended for business-related tasks. Nevertheless, this does not imply that you must immediately leave the office whenever you receive a personal phone call unrelated to your business, nor does it imply that your family members are forbidden from entering the office. The Internal Revenue Service (IRS) assesses whether the necessary requirements for exclusive use are fulfilled, ensuring that personal activities do not excessively disrupt the operations of the home office, similar to how they would not be allowed in a conventional office building.
To qualify for the deduction, the office area must be clearly separated from other areas of your home that are used for personal purposes. Additionally, the home office must be regularly utilized as the primary location for conducting your business operations.
The Internal Revenue Service (IRS) permits the deduction of most financing costs incurred for business purposes, including fees and interest on loans, credit cards, and other forms of credit. However, specific requirements must be met for finance charges related to loans taken for capital assets used in the business. Additionally, interest on loans with non-deductible interest may not be eligible for deduction. Interest payments are typically viewed as deductible business expenses for tax purposes, unless they are subject to specific restrictions.
Examples of financing costs that may be deductible for your business include mortgage interest on an office building, financing charges included in a lease agreement, or fees associated with invoices that offer extended payment terms.
Making charitable contributions is an effective strategy to minimize your tax liability. By donating cash, toys, household items, appreciated stocks, and dedicating your time as a volunteer to eligible charitable organizations, you can achieve significant tax savings.
Although the time dedicated to volunteering is not tax-deductible, there are certain expenses related to volunteer work that may qualify for deduction. These expenses include the cost of ingredients for a dish donated or specific travel expenses incurred while attending a charitable event, which can be eligible for deduction at a rate of 14 cents per mile in 2022.
It is important to note that your donations are only tax deductible if the organization you contribute to is a qualified nonprofit organization. Additionally, in order for charitable contributions to effectively reduce your tax bill, you must itemize your tax deductions.
However, there is an exception for the year 2020. If you choose to take the standard deduction, you can still deduct up to $300 per tax return for qualified cash contributions. For the year 2021, this amount increases to $600 per tax return for those filing jointly as married, and $300 for other filing statuses.
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