You can offset a large chunk of your small-business income if you contribute it to a tax-deferred retirement account…some options for you:
a. IRA: up to $6,500
b. SEP IRA: up to 25% of your business profit
c. Simple IRA: up to $15,500 plus 3% of your business profit
d. Solo-401K: up to $24,500 plus 25% of your business profit
e. Cash Balance Pension Plan: up to approximately $300,000
Imagine that you made $300K/year as a wage-earner – you can defer a maximum of $24,500 into your 401K or 403b plan at work and then will have to pay tax on the rest of your earnings. Instead, consider buying a franchise for $100K and expensing nearly all of the $100K purchase price in the year of purchase. Doing so is like deferring $100K into a 401K…you earned $100K and invested it in a small business and so get a $100K deduction/deferral. Then as the franchise produces profit, you take that profit and another year’s earnings from work and use those funds to purchase franchise #2 in order to defer tax on even more earnings. Repeat year after year.
Almost all small businesses and rentals get a new deduction equal to 20% of their profit if the taxpayer’s married-filing-joint taxable income is less than $315,000. If the taxpayer’s taxable income is above that amount, then the deduction could be limited based on the nature of the small business and whether or not the small business pays wages to its employees. We can calculate this deduction for you and share ideas with you that may allow you to still enjoy some of the deduction if your income is over $315,000.
In the old days, when you bought a $700 computer, you potentially were forced to depreciate that computer over 5 years. These days, you can immediately expense all business asset purchases utilizing one of 3 tax methods or elections: Section 179, 100% bonus depreciation, and the $2,500 de minimis expensing safe harbor election. These methods or elections apply to new or used assets purchased for your business. Example: If you buy a new track loader and finance it over 5 years with the bank, then you can write off the entire cost of the track loader in year 1 even though you only had the cash outlay of the down payment in year 1.
Your general goal is to smooth business-profit between years. Instead of recognizing profits of $100K, $200K, and $100K over a 3-year period, you generally will pay less tax if you recognize profit of $133K, $133K, and $133K over that same 3-year period. Time the recognition of income and expenses at year-end and the timing of large asset purchases to achieve this.
Assume you bought shares of stock 20 years ago that have appreciated. If you sell the shares, you might pay up to 23.8% Federal tax on their gain if you are in a high tax bracket. Consider gifting those appreciated shares to your child who is in a lower tax bracket so that child can sell them and pay tax at a 0% capital gains rate? This works as long as the child is not your dependent (i.e., that child is over age 18 or age 23 (if still in college)). This strategy also works when a retired parent or charity is the recipient of the gifted shares.
If you plan to continue to pay a salary to an employee on family or medical leave, you could enjoy up to a 25% credit computed on the salary that you pay that employee while they are on leave if you adopt a written plan and jump through a couple of hoops.
Buy your first property for $50K. When it is worth $80K, trade up to a better property. When that property is $110K, trade up for another property. By the time you die, you will have real estate worth $2M for which you only paid $50K. If you utilize the like-kind exchange rules when transferring between each property, then you can pass away holding the last property and the nearly $2M of gain could potentially vanish upon your death. If you would rather enjoy that appreciation for your own personal use while you are still alive, then you can borrow against the $2M property in retirement and enjoy the use of the borrowed funds without selling the property and being forced to recognize a gain…and, to top it off, the gain could potentially still disappear upon your death.
The audit rate of sole-proprietorships is 3%. The audit rate of partnerships and S Corporations is .4%.
If all of your cash is trapped in an IRA, then you might be forced to have your IRA buy your next business. This is powerful if done correctly, but is disastrous if you aren’t super-careful (one mis-step and the entire value of the IRA is now taxable to you). Alternatively, if you think your life will be simpler by holding the business in your name, then you can withdrawal the funds needed to purchase the business from your IRA and offset that income by the losses generated by the immediate depreciation of the of the purchase of the business assets.
If you are a sole-proprietorship, all of your profit is subject to the 15% self-employment tax. If you gift 50% of your business to your spouse who isn’t working in the business, then suddenly that 50% share is no longer subject to the 15% self-employment tax (if your spouse meets certain conditions). In addition, you will enjoy a substantially-diminished risk of audit since partnerships are audited far less often than sole-proprietorships.
Have an employee in college? Reimburse up to $5,250 of that employee’s college expenses and avoid paying FICA tax on that reimbursement-compensation. In addition, that employee will not need to count this $5,250 as income. In rare circumstances, this also works for your non-dependent children over 21.
You can form a small business HRA and reimburse your employees up to $10K/year of their medical insurance and expenses. For example, if you pay your employees a wage of $50K, consider paying them $40K plus up to $10K of medical expense reimbursement. You will save your share of the FICA tax on the $10K (savings of $765) and the employees won’t pay FICA tax or income tax on the $10K. This works well for businesses that are owned and operated by a husband and wife only.
If you have a spouse that has employer-sponsored health insurance, then you are one of the lucky ones. For all other business-owners, you will have to choose between traditional health insurance, a Christian based healthcare sharing ministry, or a short-term medical plan. There are pros and cons to each of these choices. If you decide to choose traditional health insurance purchased from Healthcare.gov, then you will need to try to keep your adjusted gross income below a certain level so that you qualify for subsidies (the government pays part of your health insurance) – we can help come up with some ideas (contribute to an HSA, make a Traditional IRA contribution, etc.) to help you lower your adjusted gross income.
If you are a sole-proprietor and you own the building where your business is located, consider gifting the building to your spouse while keeping the business in your name. This allows you to pay your spouse rent that can be deducted from your business profit in order to save self-employment tax on your business profit.