6 Self Employed Tax Deductions Small Business Owners Should Know

 In tax tips

There’s also not much you can do to stop interest rates from climbing or stocks from falling, either. Still, you may have more control than you realize when it comes to another financial pain point that can significantly impact your budget — your taxes. Taxes are your largest expense in life. 

You can reduce your tax obligations as a small business owner through several potential money-saving opportunities. Some of these strategies may seem obvious while others may not.  

1  S Corporations  

An S Corp is a tax designation, usually elected by LLCs. Many sole proprietors form an LLC when they want personal liability protection or to keep their personal assets and credit profiles separated from the actions of their business. Then, they can choose to be taxed as an S Corp for the tax benefits. It’s also a popular designation for a business with several owners or partners who want to avoid the “double taxation” that happens with a C Corp tax designation. 

S Corporation structure allows you to pay yourself a reasonable salary, thus reducing the 15.3% self-employment tax, as payroll tax is only collected on the salary and not the remaining business profits.  The S Corp advantage is that you only pay FICA payroll tax on your employment wages. The remaining profits from your S Corp are not subject to self-employment tax or FICA payroll taxes. Those profits are only subject to income tax. 

2  Solo 401(k) Plan 

Solo 401(k) plans offer self-employed and owner-only businesses high saving limits and tax advantages. Solo 401(k)s allow you to contribute to the plan as both the employer and employee, providing you the ability to maximize your personal retirement contributions and business deductions while lowering your personal taxes.  The contribution limits are nearly 10x a traditional IRA. 

Self-employed individuals and business owners with no common-law employees and their spouses who are employed by the business can still set up a Solo 401k plan and even contribute pre-tax income up to $61,000 as both your own employer & the employee. Employers can contribute up to 25% of compensation* not to exceed $58,000 for the 2021 tax year and $61,000 for the 2022 tax year.

These also allow for maximum flexibility and can even be used to invest in private equity & cryptocurrencies. 

3 Primary Residence Exclusion To Minimize Capital Gain Tax

Of course, you want to make a nice profit on your home when you sell it. But beware a bite on your earnings: the capital gains tax. If your home has substantially increased in value, you could be liable for a substantial sum when you pay your annual income tax.  You can sell your primary residence and avoid paying capital gains taxes on the first $250,000 of your profits if your tax-filing status is single, and up to $500,000 if married and filing jointly. The exemption is only available once every two years. But it can in effect render the capital gains tax moot.

To qualify the property as your primary residence, the IRS requires that you prove that it was your main home where you lived most of the time. You’ll need to show that:

  • You owned the home for at least two years
  • You lived in the property as the primary residence for at least two out of the five years immediately preceding the sale

A Bankrate article mentions that there is a workout around how this rule is interpreted.   You don’t have to show you lived in the home the entire time you owned it or even consecutively for two years. You could, for example, purchase the house, live in it for 12 months, rent it out for a few years and then move in to establish primary residence for another 12 months. As long as you lived in the property as your primary residence for a total of 24 months within the five years before the home’s sale, you can qualify for the capital gains tax exemption.

This can lead to massive savings.   

4 1031 Exchange

This allows you to reinvest real estate sale proceeds that would otherwise be subject to capital gains taxes.

If you hold a property for business or investment and want to do a “like-kind exchange”, this lets you defer capital gains tax.  A 1031 exchange is a tax break. You can sell a property held for business or investment purposes and swap it for a new one that you purchase for the same purpose, allowing you to defer capital gains tax on the sale.

Proceeds from the sale must be held in escrow by a third party, then used to buy the new property; you cannot receive them, even temporarily.

5 IRS Section 179 Tax Deduction  

Depending on vehicle weight, this deduction allows business owners to potentially write off the entire cost of a vehicle used for work. Costing more than $160,000, Mercedes G-Wagons is hardly what most people would think of as a bargain — but for higher income earners, these luxury SUVs are rolling tax loopholes.

The so-called “Hummer Deduction,” Section 179, allows a car that weighs at least 6,000 pounds to count as a tax benefit in some circumstances. Snap it up via your company, use it for business at least 50% half the time, and that Mercedes G-class — or Cadillac Escalade (starting at $76K) or Infinity QX80 (from $70,000) — could earn a $25,000 deduction the first year of ownership. It must also have a gross vehicle weight of between 6,000 pounds and 14,000 pounds. If you’re purchasing a vehicle for your business and you plan to claim Section 179 tax breaks, make sure that the vehicle title has the name of the business instead of your personal name.

That real estate agent with the G-wagon? Likely took advantage of a large write-off.

6 Charitable Remainder Trust

Since 1969, countless families have used charitable remainder trusts (CRTs) to increase their income, save taxes, and benefit charities. This allows you to put tax-deductible money into a trust that donates to a qualified charity of your choosing at the end of the term (20 years, typically).

In the meantime, the trust pays you an annuity (a percentage of the assets) over that same time.  A CRT lets you convert a highly appreciated asset like stock or real estate into lifetime income. It reduces your income taxes now and estate taxes when you die. You pay no capital gains tax when the asset is sold. It also lets you help one or more charities that have special meaning to you.  

Conclusion 

In small businesses, every penny counts. If you can lower your tax liability, it may result in extra profit you get to keep—or reinvest in your business. Fortunately, the IRS has provided several opportunities to lower your tax bill as a small business owner.

Some of these require tax planning in advance, such as choosing the right vehicle for your business, suitable retirement account contributions, and more. To make the most of the deductions available to you, consider working with a tax professional who can identify your unique needs. If you are a small business and have any questions feel free to reach out for a free consultation. 

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