30% of small businesses believe they are overpaying in annual taxes. This means your company is probably paying more taxes than it should. But don’t worry, you don’t have to overpay.
Did you know that you can greatly reduce your tax liability by increasing tax efficiency? You can invest in your business and employees to reduce tax liability. Don’t pay more business taxes than you need to!
Do you want to learn more about how to increase tax efficiency? Keep reading for 8 tips on how to help your business save on taxes.
What Is Tax Efficiency?
Tax efficiency is what businesses call an effective tax plan. When businesses put a tax system into place across their organization, they increase tax efficiency. This means the company pays the least amount of legal taxes required while complying with the tax code.
A tax system is designed to lower tax liability through business investments and improvements. Tax efficiency also refers to the timing of purchases. Tax systems provide strategic planning and alignment.
This allows companies to increase revenue, decrease tax liability, and enhance business operations.
1. Use the Most Tax-Efficient Business Structure
The type of business structure you choose for your organization is an important piece of effective tax efficiency. The structure you choose for your business determines the type and amount of taxes you pay. There are three main types:
- Personal taxes (your income taxes paid on salary)
- Self-employment taxes (for small businesses or sole proprietorships)
- Corporate taxes
The rates of each of these vary and can greatly impact your tax liability.
A sole proprietorship is for someone who works alone. This business structure pays personal and business taxes. They are responsible for all business liabilities because this business structure doesn’t have personal protections in place.
Sole proprietors do not form a separate entity. This means personal and business liabilities blend together and you pay both taxes together. Unless you register your business as another structure, you are automatically placed as a sole proprietor.
Limited Liability Corporation (LLC)
An LLC can be one or more owners. This structure transfers business liabilities to the business and away from the owner. They pay self-employment and personal taxes with this business structure.
An LLC protects personal assets from liabilities the business may face. Owners pass profits through personal taxes without paying corporate taxes. The IRS considers LLCs self-employed and they pay those taxes.
Partnerships are two or more owners. Unless you are a limited partner, this structure pays self-employment and personal taxes. This structure has unlimited personal liability for business operations under certain parameters.
This structure is simple for co-owners. There are two types: limited partnerships and limited liability partnerships.
A limited partnership has one partner with unlimited liability and other partners have limited. Limited partners have less control over the business and pay self-employment taxes.
A limited liability partnership limits liability for each partner. This structure protects partners from debts so each person is not responsible for the actions of other partners.
S-Corps have between one and one hundred owners. Every member must be a US citizen. With this structure, owners are not personally responsible for business liabilities. They pay personal taxes.
S Corps avoids double taxation. Owners pay taxes on profits through a personal tax return without facing corporate taxes. There are strict filing and operational requirements for S Corps that business owners must meet.
Not all states recognize S Corps, so owners must research the best structure for their business before choosing this option.
There are a few differences between an S Corp and C Corp setup. You can read more about the differences between an S Corp and a C Corp here.
C Corps pay corporate tax and the owners are not personally liable for anything for the business. A C Corp can consist of one or more owners. The C Corp is a separate legal entity that pays corporate taxes and is held liable for debts.
It does cost more to manage a corporation and there are more reporting requirements. Corporations pay taxes when the company makes a profit and when it pays dividends to shareholders. Corporations can sell stock to increase capital.
B Corps are becoming a more popular business structure. B Corps are responsible for paying corporate taxes. Owners are not personally responsible for liabilities and the business can have one or more owners.
A B Corp, or benefit corporation, pays taxes the same as a C Corps. This structure does differ in that a B Corp is held to higher standards and must contribute positively to the public in some way. Shareholders hold the business responsible and some states require proof of the benefit.
A non-profit business structure is tax-exempt. There is an exception and that is they can’t distribute company profits with this structure. Non-profits can have one or more owners and none of them are responsible for business liabilities.
A non-profit is a company that benefits the public. These businesses do charity, religious, education, literary, or scientific work. The IRS has strict requirements around non-profits that businesses must maintain.
2. Create a Tax Plan
Most businesses pay too much in taxes simply because they don’t know better. A regular tax preparer may not be aware of the tax deductions or benefits available to businesses, so they aren’t used. Business owners can mitigate this by working with a tax planning professional to ensure more money is staying with the business while ensuring they pay legally required taxes.
By conducting a thorough assessment of business operations and past taxes, a tax planner will be able to clearly see where your business can make improvements. It’s important to remain updated on current tax law changes so your business uses all business deductions. Of course, for many business owners, this seems like an impossible task.
But it’s not if you work with a tax planner and expert. You don’t have to worry about tax law changes because they do it for you. And you can worry less about how much taxes you’re paying because the planner helps you create the best system for your business.
Want to ensure your business has the most effective tax plan in place but aren’t sure where to start? Click to learn more about our tax planning services.
3. Contribute to a Tax-Efficient Fund
Tax-efficient funds are a great way to increase your investments and decrease your tax liability. These funds are mutual funds or exchange-traded funds that have low-level dividends and capital gains. Examples include:
- Growth stock funds
- Small-cap stock funds
- Index funds
- Municipal bond funds
When you contribute to a 401k, you are adding funds to a plan without current taxation. If you have investments that are not set up this way and do produce taxes, changing what you contribute may be beneficial.
Growth Stock Funds
This type of tax-efficient fund does not produce dividends or capital gains, so investors do not pay taxes on them. This type of fund reinvests any profits made into the business to increase revenue through new ways.
Small-Cap Stock Funds
Shareholders do not receive dividends with this type of fund. It is similar to growth stock funds in that it reinvests profits into the business.
Index funds are passively managed, so it produces lower capital gains. When the fund generates capital gains, shareholders receive a distribution.
Municipal Bond Funds
This type of fund pays interest on your investment that is non-taxable. Some municipal bonds are also exempt from local and state taxes.
4. Reduce Tax Liability With More Expenses
You can quickly invest more in your business and reduce your business’s tax liability. Some businesses are eligible to deduct up to $1M in capital expenditures. You could be bettering your business and lowering what taxes you pay every year!
Invest in Equipment or Furniture
Why not renovate your building? Or buy updated computers and equipment? Companies can invest in equipment, machinery, computers, or office furniture to increase business expenses.
Does your business have plans to grow and invest, but are faced with a looming tax bill in the last part of the year? Then it may be a good idea to speed up the investment. This is where effective and strategic tax planning is beneficial.
Timing when you make these purchases is just as important as how much you spend to improve your business.
Give Employees More Benefits
You can lower tax liability by offering your employees more. You can provide an end-of-year bonus, increase salaries, or improve benefits packages. Many companies offer fringe benefits to help offset taxes while also ensuring employees stay happy.
It’s important to note that some employee benefits are taxable. To better understand what is and isn’t, it’s best to talk to a tax expert. You don’t want to offer a new benefit to employees and then learn you owe even more in taxes!
Offer Employees a Retirement Plan
When you create a retirement plan for your workers and open accounts, you can get a significant tax deduction. Small businesses with fewer than 100 employees can take a 50% deduction for the startup costs associated with a newly created retirement plan. Businesses can claim the startup costs for the first three years of the plan.
5. Write Off Bad Debts and Old Inventory
Bad debts, such as outstanding accounts payable, can be written off to decrease your tax liability. Your business can also dispose of and write off old inventory for tax purposes.
Bad debts are debts that are uncollectible. Your business has to have made reasonable attempts to collect these receivables before you can write them off. Not all debts are eligible, but credit for customers, supplier credit, and loans to clients or suppliers are all considered bad debt that businesses can write off.
Do you have old inventory that isn’t selling? You can dispose of it and write off the loss. The inventory disposed of must no longer have any value for the company.
There are common occurrences when companies write off old inventory, including:
- It spoils
- It is lost
- It is stolen
- It is obsolete
- It is damaged
Companies can use two methods to write off old inventory: the allowance method or a direct write-off. If you dispose of the inventory, businesses should use the direct write-off method. If the inventory has lost value but you can sell at a lower cost, the allowance method may be more beneficial.
6. Use Business Credits
The IRS has many business tax credits available for companies. Credits are refundable or non-refundable. Credits are directly applied to your tax liability to decrease how much you pay.
A few example business credits include:
Work Opportunity Credit
Employers can claim this credit for the first two years of wages paid to certain groups of individuals. The targeted groups included for this credit are:
- Long-term family assistance recipient
- Qualified recipient of Temporary Assistance for Needy Families (TANF)
- Qualified veteran
- Qualified ex-felon
- Designated community resident
- Vocational rehabilitation referral
- Summer youth employee
- Supplemental Nutrition Assistance Program (SNAP) benefits (food stamps) recipient
- SSI recipient
- Qualified long-term unemployment recipient
Targeted group members must work for at least 120 hours, cannot be related to the business owner, and can’t have previously held a position in the company. There are many requirements and exclusions for this credit you can find here.
Employers that provide qualified childcare facilities or resources for employees. This credit is 25% of the expenses incurred for a child care facility. It also includes 10% for qualified resources and referral expenses paid.
The childcare credit has many nuances and requirements. On this IRS page, you can review the definitions for qualified facilities, resources, and referral expenses.
Employer Differential Wage Payment Credit
This is a credit for up to 20% of $20,000 in differential wages paid to each qualified employee. To be considered a differential wage, you must make payments to qualified employees performing service in the uniformed service for the United States. The employee must have been on active duty for more than 30 days.
The payment must also be all or a portion of wages the employee would have received if working directly for the employer during this time. Employees that are a part of the Armed Forces, Army National Guard, or Air National Guard are all a part of uniformed services.
Paid Family and Leave Medical Act Credit
Employers can claim a credit for paid wages while an employee takes leave under the Family and Medical Leave Act. The credit ranges from 12.5% to 25% of qualified wages paid during this time. You can learn more about the requirements of qualified employees here.
The basics for this credit include the employee has worked for the employer for at least a year. The company has to have detailed processes and information available for all employees in the handbook.
If your company has decided to increase its research activities, your business may be eligible for a tax credit. This credit is available for qualified research activities. Those cannot include:
- The research was conducted after the beginning of commercial production
- Research adapting an existing product or process to a particular customer’s need
- Duplication of an existing product or process
- Surveys or studies
- Research relating to certain internal-use computer software
- Research conducted outside the United States, Puerto Rico, or a U.S. possession
- Research in the social sciences, arts, or humanities
- Research funded by another person (or governmental entity)
Research must be technological in nature. Businesses must use the findings to develop or improve some aspects of business operations.
Qualified small businesses may elect to use up to $250,000 of the credit to offset the business’s social security liability. Qualified businesses have less than $5 million in gross receipts for the year. They also must not have more than 5 years of gross receipts.
Credit for Taxes Paid on Tips Earned by Employees
Some food and beverage companies can claim a credit for the social security and Medicare taxes paid on tipped wages. Employers cannot claim this credit for tips that are used to make up the federal minimum wage requirement.
For amounts over the minimum wage, employers can claim the full amount of social security and Medicare taxes paid for employees. The employees must have received tips for providing, serving, or delivering food or beverages. Businesses can only claim this credit if it is customary in the industry to receive tips for this work.
Small Business Healthcare Premium Credit
Qualified small businesses can claim this credit for two consecutive years. To be a qualified employer, your company must have paid health insurance premiums for employees under a qualifying arrangement. Businesses cannot have more than 25 full-time employees for the year and average wages must not be more than $56,000.
There are many requirements and definitions related to this credit. You can review them on the IRS website or speak to a tax expert for more information.
Low-Income Housing Credit
Businesses that provide low-income housing to the community may be eligible for this credit. The building must meet certain requirements for 15-years to retain this credit. It is generally spread out over a 10-year period and can’t exceed the building’s value.
You must ensure your low-income housing building qualifies for this credit before taking it. The details regarding what types of properties qualify can be found on the IRS website.
7. Avoid Tax Planning Mistakes
There are several tax planning mistakes business owners make that can cost them in the long run. Missing the tax deadline can mean your business is facing additional fees and is no longer allowed to use certain deductions.
Businesses can also face potential issues and penalties for claiming deductions they weren’t actually eligible for. Or claiming expenses that are not allowed for businesses.
It’s important your business meets all deadlines, from submitting tax documents to workers to submitting tax returns to the IRS. And remaining updated on changing tax laws is a must if businesses want to avoid unnecessary taxes or potentially difficult situations.
You can avoid these potential mistakes and easily navigate tax time by working with a tax professional.
8. Save for Higher Education
Business owners can start a 529 higher education savings plan for themselves and their employees. These plans allow you to contribute to a fund to save for higher education. Contributions are not taxable.
With a 529 plan, you and your employees contribute after-tax funds to the plan. These funds then grow tax-free to pay for college tuition, board, and other related expenses. As long as people use the withdrawn funds to pay for education, they will remain tax-free.
It’s important to talk to a tax expert before starting a 529 plan for you and your team. Some states offer credits for employers that contribute to their employees’ plans. Understanding the process and implications ahead of time is a must.
Increase Your Tax Efficiency With Bennett Financials
We covered 8 tips that can help your business increase tax efficiency and reduce tax liability. With a little planning and operational structuring, you’ll be on your way to tax efficiency! We hope you learned new ways to improve your tax planning process.
At Bennett Financials, we understand how important it is for your business’s success to have effective tax efficiency in your business operations. We pride ourselves on our ability to streamline and increase cash flow for organizations through tax planning. Only 50% of companies succeed and we want to make sure your business is one of them.
Are you ready to increase your tax efficiency and lower liability? Schedule a free consultation today to learn more about our tax planning services.