Tax Loopholes for Small Business Owners You Might Be Missing

Small business owners face the challenge of minimizing tax liabilities while maximizing profits. Utilizing available tax strategies can significantly impact a business’s financial health. These often-overlooked methods provide opportunities for substantial savings.

Choosing an Entity Structure

Selecting the right entity structure is crucial for small business owners as it affects taxes, liability, and operational flexibility. Options include sole proprietorships, partnerships, limited liability companies (LLCs), S corporations, and C corporations. For instance, LLCs offer pass-through taxation, meaning profits are taxed only once at the individual level, avoiding the double taxation faced by C corporations.

S corporations can reduce self-employment taxes by designating a portion of income as salary and the rest as distribution. However, the IRS requires the salary to be reasonable to avoid penalties. Partnerships provide flexibility in profit distribution, which benefits businesses with varying levels of partner involvement, but partners are personally responsible for business debts, requiring careful consideration of liability.

Applying the Qualified Business Income Deduction

The Qualified Business Income (QBI) Deduction, introduced under the Tax Cuts and Jobs Act of 2017, allows eligible businesses to deduct up to 20% of their qualified business income. This deduction applies to pass-through entities like sole proprietorships, partnerships, and S corporations. For the 2024 tax year, the income threshold is $182,100 for single filers and $364,200 for married couples filing jointly. Exceeding these thresholds can phase out the deduction, particularly for specified service trades or businesses (SSTBs) such as health and law.

Calculating the deduction involves assessing qualified business income, W-2 wages, and the unadjusted basis immediately after acquisition (UBIA) of qualified property. For businesses above the threshold, the deduction is limited to the lesser of 20% of QBI or the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of UBIA. Accurate records are essential for compliance and maximizing benefits.

Leveraging Asset Expensing

Asset expensing helps small business owners optimize tax positions. Section 179 of the Internal Revenue Code allows immediate expensing of qualifying asset purchases. For 2024, the maximum deduction is $1.16 million, with a phase-out starting at $2.89 million. This provision accelerates deductions for tangible personal property like machinery and equipment, improving cash flow.

Bonus Depreciation offers additional benefits, allowing businesses to deduct 80% of the cost of qualifying property acquired and placed in service during 2024. Unlike Section 179, it is not limited to business income and can create a net operating loss, which is advantageous for capital-intensive industries. It applies to new and used assets, expanding its applicability.

Using Home-Based Deductions

Business owners operating from home can convert personal expenses into business deductions. The home office deduction allows deductions for expenses related to the portion of the home used exclusively for business, such as mortgage interest, utilities, and repairs. To qualify, the space must be the principal place of business or where clients are regularly met.

The deduction can be calculated using the simplified option, which allows $5 per square foot up to 300 square feet, or the regular method, which allocates actual expenses. The choice depends on the complexity of expenses and the potential deduction amount.

Optimizing Employee Compensation

Strategic employee compensation structures can reduce taxable income and payroll tax burdens. Offering retirement plans like a Simplified Employee Pension (SEP) IRA or a 401(k) allows tax-deductible contributions. In 2024, businesses can contribute up to 25% of an employee’s compensation or $66,000 to a SEP IRA. For 401(k) plans, employees aged 50 or older can defer up to $23,000, with additional employer matching contributions.

Health-related benefits also provide tax advantages. Offering a Health Savings Account (HSA) with a high-deductible health plan allows tax-free contributions. For 2024, contribution limits are $4,150 for individuals and $8,300 for families, with an additional $1,000 catch-up contribution for those aged 55 or older. Employers can deduct contributions, while employees enjoy tax-free withdrawals for qualified medical expenses. Flexible Spending Accounts (FSAs) and dependent care programs also provide pre-tax benefits, reducing payroll taxes. Structuring compensation packages with these benefits enhances tax efficiency while meeting employee needs.