Reduce Taxes as Your Own Business

Running your own business is a lucrative venture. Benefits of having your own include freedom to pick your hours, Being your own boss, and most importantly: a higher earning potential. But with higher earnings may come higher taxes. Listed below are five important methods to reduce your taxes as someone self-employed.

Write Off Your Business Expenses

First and foremost, your business expenses are deductible. Whether it be office supplies or software, utilities, employees wages and many others. Make sure to write off your business expenses to reduce your net earnings.

     

A best practice is to have a separate business bank account and business credit card; do not mix your business and personal accounts. If you use an accountant, they can easily writeup your books and prepare a set of financials. Have receipts ready for cash purchases. 

Self Employed Health Insurance Deduction

As an employee of a company, your health insurance is deducted pre-tax. In the same manner, your health insurance is deductible as someone who runs their own business. This deduction is taken on your form 1040 schedule 1, line 17. This deduction allows you to buy insurance from the marketplace. You can directly deduct the cost against your self-employed profits. The deduction is limited to the profit. Any additional cost of insurance is reported on schedule A itemized deductions.

Invest in your SEP IRA Retirement Account

The SEP IRA is the self-employed equivalent of a company employee’s 401k. Similar to a traditional IRA and 401(k), these contributions are deductible, but fully taxed at distribution. This is an excellent method to deduct retirement savings upfront from your business. Your contributions in the SEP IRA are limited to 25% of net earnings (before the contribution), with a maximum of $66,000 in 2023.

Note: Starting in 2023 as part of the Secure Act 2.0: we now have the Roth SEP IRA. Similar to Roth IRAs and ROTH 401(k), the contributions are not deductible, but will be fully tax free when distributed at retirement. Tax free distribution pertains to the principal contributions, interest, dividends, and capital gains in the account.

Pass Through-Entity Tax (PTET)

The PTET is a popular concept since signing of the Tax Cuts and Jobs Act effective in 2018. Over thirty states have enacted this or proposed it. In essence, if you pay your state taxes through your business, you will be given a federal deduction for the state payment. The state taxes eligible for PTET are primarily for income from the business. This is a high demand work around of the $10,000 SALT cap; available regardless of whether the taxpayer itemizes on their return.

Please consult with your accountant to find out if your state offers a PTET deduction, and if you qualify. As of the time of this writing, Only S-corporations and partnerships with at least two partners qualify for this deduction. Single member LLCs do not qualify, in which case making the S-election may be beneficial.

   File as an S-Corp to Reduce Self Employment Tax

As an LLC or a partnership, your profits are subject to 15.3% Self-employment tax subject to limits. One may argue this is an extra tax disincentivize entrepreneurship, but that would be incorrect. This is the same tax that is paid as an employee.

Take a look at an old paystub of yours. You will see social security withholding of 6.2% and Medicare withholding of 1.45%. These amounts add up to 7.65%. Now most people do not know this, the employer is required to match social security & Medicare tax withheld. 7.65% * 2 = 15.3%. This is the basis of self employment tax. You are paying both the employee half and employer half.

Do not just shrug and believe you have no choice to pay the full amount.

If you file as a S-corporation, your business will be taxed as a flow through entity, but it will not be subject to self employment tax. The caveat with this; you need to put yourself on payroll and pay yourself a salary. This salary will be subject to the self employment tax, but the salary may be lower than your business profits. Your salary will need to be ‘reasonable’ based on profession and industry.

While on payroll, you will be required to file quarterly federal 941 forms, quarterly state payroll returns, annual federal form 940, and produce W-2s. It is highly recommended to consult with your CPA to compare the benefits based on cost of filing against potential tax savings.

These are five of the biggest ways to reduce your taxes as a business owner; But they are not the only way. Consult with your CPA to find all methods to reduce your tax liability and maximize your earnings.