As any owner can attest, growing and maintaining small business profits is a constant battle. However, by understanding and utilizing some business-friendly tax loopholes, savvy small business owners can find ways to keep a lot more of their hard-earned capital.
Here’s a look at five legal tax loopholes and tricks that can be a big help for small business owners.
The Benefits of S Corporation Status
S Corporation status can be a major money saver for small business owners who are already operating successful and lucrative businesses. An owner of an S Corporation can split total business profit into wages and “dividends.” Business owners can set wages for themselves and their employees at Fair Market Value and pay the remainder of profits in the form of a dividend, which is not subject to the 15% payroll tax.
For example, if an S Corporation makes $100,000 per year in profits, but pays out only $40,000 of that profit in wages, the Corporation saves $9,000 annually by not paying the 15% tax on the remaining $60,000 paid out in dividends.
Manipulating State Tax Nexus
Some states have a much more business-friendly tax code than others, and understanding which actions establish tax nexus (sufficient physical presence to necessitate tax payment) and which don’t in a given state can allow businesses to avoid paying higher state taxes.
State tax laws vary from state-to-state, but by avoiding owning property in a particular state, having employees in a particular state and/or booking sales in a particular state can all help to avoid establishing unfavorable tax nexus in that state.
Deduct Medical Expenses via a Medical Reimbursement Plan
Out-of-pocket medical expenses are typically not tax-deductible. However, business owners can implement a Medical Reimbursement Plan and have the business reimburse all medical expenses. By utilizing this loophole, non-deductible medical expenses become legally legitimate business expenses.
Family Income Splitting
Family income splitting is another legally legitimate way for small business owners to avoid paying higher tax rates on high-margin income. Here’s an example of how hiring a son or daughter can help reduce taxes.
If a small business owner makes $70,000 per year in income, all of the income above $37,450 will be taxed in the 25% income bracket. However, by paying $35,000 of that income to a son or daughter employee of the business (who can then use it for living expenses and college tuition, for example), all of the $70,000 income will be taxed at a 15% rate or lower.
Deduct Vacation Cost as a Business Expense
By planning vacations in coordination with business travel or vice versa, the travel expense associated with a vacation can become tax deductible. For certain businesses, this technique works like a charm.
For example, if a small business owner would like a tax-deductible flight to Las Vegas, he or she could make a lowball offer on a piece of commercial real estate in the Las Vegas area on behalf of the business.
In the best-case scenario, the business could acquire a nice piece of real estate from a desperate seller at a below-market price. But in the likely event that the offer is rejected, the trip to Vegas is still legally a business trip, and the cost of the flight and hotel room can be deducted as a business expense.
Bonus Tip: Take Advantage of Small Business Tax Credits
One effective way to maximize your tax refund as a small business owner is to apply for every tax credit you qualify for. Tax credits are offered by the IRS to incentivize businesses for completing certain objectives, such as hiring a veteran, setting up a retirement plan, providing child care services to your employees, or installing an energy-friendly system.
Tax credits directly reduce your tax burden, as opposed to tax deductions, which reduce the amount of your taxable income. Visit the Business Tax Credits page on IRS.gov for a list of credits that may be available to your business.
These examples are just a few of the ways that small business owners can take advantage of opportunities hidden in the tax code.
However, this last point is crucial: Proper planning and strict adherence to regulations required to benefit from these loopholes is a major legal undertaking that no small business owner should attempt without the counsel of a tax professional.
Wayne Duggan contributed to this article.