Small Business Ownership is the Best Tax Deal in America
The bedrock principle of small business ownership tax savings is the ability to take expenses that exist in your personal life and allocate a portion of them to your business as a bona fide business deduction. Prior to owning a business, these expenses have always existed in your life and were paid after tax.
Owning a small business is one of the best paths to wealth creation. Not only are you providing for your family, customers, and employees, but it also brings significant tax advantages not available to W-2 workers.
In this post we discuss some of the best tax perks for business owners, and provide examples to bring them to life. Paying expenses out of your business affords you the opportunity to to pay prior to tax, saving over 50% in some instances!
Here are some of the categories of expenses that will help you save:
Home office deduction
One of the best tax deductions for small business owners is the home office deduction.
You can take this deduction even if you have a store or shop that serves as your primary place of business. The key is whether you complete administrative tasks at home.
Where do you complete all your management and administrative tasks? If you do these at home, then your home office will qualify as your principal place of business. To get a tax deduction, you’ll need to use your home office only for business.
Expenses you were already paying, like utilities, insurance, and property taxes become tax-deductible.
Assume an auto mechanic has a shop where he fixes cars. But instead of doing paperwork and administrative tasks at the shop, he uses a spare bedroom at home.
The annual expenses to keep his house up and running are $2,000 a month. That’s $24,000 per year. The bedroom he uses as an office occupies 20% of the total square footage of his home. He’ll have a tax deduction of $4,800 ($24,000 * 20%).
Car expenses are another expense you’re already paying that can become a tax deduction. When you use your personal vehicle for business, some of your costs earn you a tax deduction.
The simplest way to track your vehicle expenses is through the IRS prescribed standard mileage rate. Instead of tracking all your expenses for the year, you’ll use the rate of $0.56 per mile for 2021.
Regardless of whether you use the standard rate or actual expenses, it is best to keep a mileage log to track when you’re traveling for business. The log can be a physical notebook or a mileage tracking app on your phone.
For example, you drove your car a total of 20,000 miles in a year and 10,000 of those miles were for business. So, half of your car expenses become a tax-deduction.
Expenses like fuel, insurance, and registration fees provided no tax benefit before. Now they reduce your taxes and can possibly increase your tax refund.
If your annual expenses to operate and maintain your car were $15,000, you’d be able to deduct $7,500 ($15,000 * 50%).
Medical benefits and retirement savings
Small business owners can pay medical benefits for themselves. And when they do, they record these costs as business expenses. Consider getting your family members on the payroll. This way the business can pay their medical insurance and get the tax benefit.
The same goes for retirement plans that your small business administers. The company can set aside a max of $58,000 in 2021 into a retirement plan for you and each of your employed family members.
For example, if you and your son work for your business, then $116,000 ($58,000 * 2) can be saved for retirement. And it provides the company with a business deduction.
Family members as employees
Any wages you pay a family member for work become deductible. A bonus comes when employing your children.
Children under age 18 aren’t subject to FICA tax. And children under age 21 aren’t subject to federal unemployment tax.
This means you won’t need to match the minor child’s FICA contribution or pay federal unemployment tax. State unemployment taxes may apply, so be sure to check with your tax professional.
Paying your 17-year-old daughter $15,000 a year to manage your social media saves you $1,567.50. ($1,147.50 for FICA and $420 for federal unemployment tax)
When long-distance travel is a part of your business, you’ll also receive a tax deduction for your out of pocket costs. Airfare, taxi, rental cars, and lodging costs all get written off 100%.
And costs for traveling to attend a conference or trade show are tax-deductible as well.
Be wary of meals though. Generally, meals are at most 50% deductible for taxes. But this changed with the passage of the stimulus package in December 2020. Business meals eaten at a restaurant are 100% deductible for 2021 and 2022.
These are only some of the tax benefits for small business owners. These tax breaks will keep more money in your pocket and let you reinvest in your business. Always remember to plan and document all your expenses. In the unlikely event of an audit, you’ll want to have your receipts to justify all your business expenses.
As with all tax matters, things get complicated fast. There are many nuances and caveats to these tax breaks. If you have questions about how any of these affect your business, let us know.