You know the cliche, only thing that is certain in life is death, and taxes. Unfortunately, sometimes it is death BY taxes.
For those of you that know me more than just the content posted on this blog, you know I’m not a fan of taxes and a never-ending expansion of the federal government.
While most business related blogs will make a post about taxes in April, I think at that point it’s too late.
Waiting until April to look for tax strategies is useless.
In this post your will learn:
- Which business entities are best for tax savings
- Little known deductions that reduce your taxable income without reducing income
- Different strategies to legally “hide” money
- What you can expect from your CPA
- and Much more
Before we dive into how you can save a ton of money, I need to give a disclaimer, as recommended by my attorney. I am not a tax attorney, I am not an attorney of any kind, I am not a CPA. However, I have paid a lot of money to all of the above. While everything I mention here is legal, laws and regulations change all the time and it is best to consult with a CPA or tax attorney. Just make sure you use the resources I provide, to guide them in the right direction.
Unfortunately, this post is only relevant to those in the United States. I know many of you are from other countries, so this won’t apply to you. However, tax law is very similar in many developed countries, and you may want to look into some of the information provided.
The Sad Truth About Tax Lawyers and CPAs
I have a few CPAs and attorneys that follow this blog. I love you guys… so please don’t take offense to the broad generalizations I’m going to use.
Here’s a sad truth… Most tax attorneys and CPAs aren’t paid to save you as much money as possible. They are paid for a specific job. They aren’t paid for research and tax strategies, and believe me, if you paid them for research you would have a high 5 figure bill.
If you’re paying a CPA for book keeping services, and to file your taxes, they aren’t getting paid to look up uncommon deductions you can use to put more money in your pocket, they are paid to do the job of filing your taxes. That’s it.
It’s not that I think they’re useless… It’s just the fact that people in business, have the wrong impression of what their CPA or tax attorney will do when hired.
Does your CPA save you money? If your hourly rate is higher than theirs, then yes, they save you money by you delegating a soulless job to someone else.
It’s important to understand the job of your CPA come tax time.
If you want to keep the most money possible, it’s about reducing your taxable income. The lower your taxable income, the lower your taxes. In order to do this, it isn’t about hiring the best CPA, it’s about educating yourself on what you can do, then providing the information to your CPA to take advantage of the tax law and deductions available.
Your CPA will NOT go the extra mile to go through the 74,000 page tax code to save you some money. Can we all agree on that?
They’re busy filing returns for their clients, doing audits, working on a hundred different things at a time. It isn’t their job to look for uncommon deductions that are applicable to a very small percentage of their client base.
Which Business Entity Is Best To Use?
This topic could be a post by itself, with a lot of differences and intricacies that I’m not going to bother mentioning here.
I want to keep a complicated topic, as simple as possible.
You essentially have 4 options:
- Sole Proprietor
Sole Proprietor – This type of business structure is when you’re just operating the business yourself. Maybe you’re a freelancer selling SEO services using just your name or maybe you have a DBA (Doing Business As).. this entity isn’t really an entity. There are no tax advantages of being a sole proprietor, no liability protection, and will unfortunately cost you more at tax time.
LLC – For some reason, a lot of business owners believe that running an LLC is ideal. At the federal level this is a disregarded entity. Many attorneys and CPAs recommend an LLC, simply because they like charging you to file the articles of organization in whatever state you live in. Ask around and you’ll get quoted between $500-$1,000 for a 10 minute filing that anyone with a computer and internet connection can do for themselves through the secretary of state website, in any of the 50 states.
To add insult to injury, LLCs have absolutely no tax advantage.
Owning an LLC is practically pointless (when it comes to taxes), unless you ask the IRS to treat the LLC as an S-Corp for tax purposes, which allows a bit more flexibility, some tax advantages, and less paperwork than a traditional S-Corp. Even if you do have your LLC setup to be taxed as an S-Corp, you are more likely to get audited as an LLC than a traditional S-Corp. Your CPA expenses will also be higher come tax time than if you went with a traditional S-Corp.
C-Corporation – This is the type of entity used by publicly traded companies, but can also be used by other privately held companies. This isn’t really the ideal entity format for most people following this blog, because you get taxed at 2 different levels; the corporate level, and the shareholder level. Fortunately, you can hold money in the corporation without taking any dividends or distributions. There are a number of credits available that aren’t available to other entities.
Regulatory nightmares, paperwork, formalities, double taxation, and increased chances of audits make this entity easy to avoid. The true advantage to a C-Corp is the amount of shareholders you can have, and less restrictions on foreign investments, which is why this is the entity type used for publicly traded companies.
This entity can be used by anyone… but, you probably don’t want to choose a C-Corp… most honest CPAs and Tax Attorneys or any corporate attorneys will advise people like us to avoid this entity.
S-Corporation – An S-Corporation is actually filed as just a normal corporation aka C-Corp. After it is filed, you file another form, regarding the special tax election with the IRS. It sounds complicated but it’s rather simple, you just fill out the form 2553 and that’s it.
S-Corporations do have a tax advantage, and it’s a BIG tax advantage. S-Corps are considered a “pass through” entity. That means that profits and losses are passed through to the shareholders. There is no tax at the corporate level, just the individual level.
This requires you to pay yourself a “reasonable salary”, then all other profits can be distributed without having to pay employment taxes both on the individual and company level. Reasonable salary applies to all shareholder employees, however, if your S-Corporation doesn’t require you to take an active role, the income is passive and you avoid self employment taxes altogether.
Unfortunately, some states do tax S-Corps unfairly, like MA, NY, and NJ. However, S-Corporations do not have to be filed in the state you live in, you can file in nearly any state in the USA and avoid those state taxes.
Business Entity Real Life Comparison
Let’s just use an easy example here… You have a business that generates $50,000 in profit.
As a sole proprietor or LLC, the entire 50,000 is subject to self employment taxes, costing you $7,650 at tax time.
As an S-Corporation, you can pay yourself a reasonable salary of $20,000, with $30,000 coming from dividends and only have to pay $3,060, saving you over $4,000.
I’m not going to bother with the C-Corp breakdown because it will be even higher than the Sole Prop/LLC outcome.
For most people visiting this blog, if you’re making money then an S-Corporation is the official Income Bully recommendation. This is especially the case for web designers, SEOs, bloggers, and local service area businesses. If you are a local service area business or contractor that handles the majority of work yourself, your “reasonable salary” should be 40-50% of your profit. If you have workers that complete at least half of the work, 25-40% should be very acceptable. Same applies for SEOs and web design companies.
For bloggers and niche site owners, S-Corps still make sense because you can make an argument that after year 1, most of your income is passive. Be careful though, it’s better to pay a higher “reasonable salary” than going through an audit!
Reducing Your Taxable Income
The secrets of the ultra rich rarely are the things you read in all the get rich books. It’s not about some regimen, or habit building exercises to maximize their productivity. Sure, those things matter and get talked about often, but the true secret of the wealthy, is to minimize their taxable income.
If you follow some of the left leaning activists, you would think that all these business owners are super greedy, heartless people that try to rip off the country that has helped them succeed. After all, remember, they didn’t build their businesses, the government did! /sarcasm
A common outcry is that corporate taxes should be increased, loopholes should be closed.
The fact is, a smart business owner knows that the money they can keep is better invested by themselves instead of counting on the government to spend the money wisely. It’s not a loophole that allows business owners to do this. It’s the exuberant tax code!
So, to allow all of you to take advantage of the tax code, I’m going to share with you some uncommon but very beneficial deductions you can use for your business.
Let’s Talk Deductions / Write Offs
For those of you brand new to this business stuff, I want to be clear. Your business profits are taxable, it is your net profit, not gross income. Your gross income would be your total sales or total revenue generated. That doesn’t factor in your costs and expenses. That’s where deductions come in to play.
I’m going to assume that all of you are already aware that your hosting, domains, SEO tools, ebooks and physical books, conventions, employees and even outsourcers, are considered normal business expenses. These are things you should be deducting from your gross revenue. CPAs and lawyers are included in “outsourcers”.
Whatever is a “cost of doing business” expense, is deductible. That is basically a big umbrella that covers a lot of different things, but you probably already know that.
Here are some of the more uncommon, less talked about things you can write off!
1.) Gifts Are Deductible!
Maybe not to your kids, but if you want to give holiday gifts to your clients or leads you want to close, you can do so and you can write it off as an expense!
Want to send a bottle of wine? You can deduct that.
You can deduct $25 per gift/person for the year.
This is a great way to sneak in some client retention strategies while spreading joy in the season.
What if you spend more than $25 on the gift? Well, the IRS says you can only deduct $25, so if a gift costs $50, then you can only write off $25. However, the cost of shipping is also deductible, along with packaging of the gift and it doesn’t count towards the $25.
2.) Deduct Your Health Insurance
Paying out of pocket for health insurance and not deducting it? Well, its okay, most business owners aren’t aware that you can deduct the costs.
What most people do, is use itemized deductions on their personal return, and they can only get the deduction if they meet their deductible. Some of you will be able to do that, and others won’t. That’s NOT what you should do.
You can write these costs off entirely, if your S-Corp pays the premiums of your health care plan directly to the insurance company, or, the easier way, just reimbursing you for what you pay. If your S-Corp pays directly, you would unfortunately have to use the SHOP marketplace, whereas if you signed up for insurance and the company reimburses you, you would benefit from the individual tax credits and cheaper rates.
There’s one caveat though, you have to report the premiums as income but it isn’t subject to social security taxes. While this adds a bit of complexity to your taxes, it actually isn’t that bad. Earlier in this post, I mentioned S-Corps have to pay the owners a “reasonable salary”, and this would be part of the reasonable salary except this segment of income would not be subject to social security taxes.
For the single entrepreneur, your premiums may not add up to much but every little bit counts and can easily reduce your taxable income by a grand or two. For the family man, your taxable income can be reduced by $5,000-$10,000 and maybe even more!
3.) One of the Best Tax Shelters is a Health Savings Account
Yes, you should try to hit the maximum investment in your IRA’s, and my preference is a traditional IRA. This is what I consider to be a pretty basic method of reducing taxable income, as well as somewhat common knowledge, so I won’t go in detail here. If you have questions, ask in the comments.
The best tax shelter though, isn’t an IRA… it’s a health savings account, that requires no limit on how much you can save (overall), nor a limit on how much you can carry over year after year.
You can take a payroll deduction to automate the saving and it can be used out of your “reasonable salary” that gets saved pre-tax.
There is an annual contribution limit, for singles it is $3,350, families it is $6,750 and if you’re over 55 then add another $1,000.
The interest these accounts receive, are tax free.
This is what you can use a health savings account for according to the IRS:
- Doctor Fees
- Hospital Fees
- Prescriptions (co pay or out of pocket)
- Dental visits and dental care
- Physical therapy / mental therapy
- Vision care
- AND MUCH MORE
This is a great way to reduce taxable income for all ages, but it’s also a necessary step in planning as well as saving for your retirement since medical costs inevitably get more expensive.
Note: I haven’t found an attorney or CPA that can definitively answer my question on whether an S-Corp owner can inflate their “reasonable salary” using pre-tax contributions to a health savings account. While the reasonable salary is supposed to be income subject to FICA taxes, the health savings account contributions are pre-tax, couple this with the premium reimbursement mentioned in #2, this can take a bite out of payroll taxes Uncle Sam wants to steal from you. My assumption is that a CPA or tax attorney won’t tell you it’s okay, because they’re afraid it might not be, but their lack of certainty makes it seem to me that it is a legitimate argument and would survive an audit.
4.) Let’s Talk Home Office Deduction
This is fairly common knowledge for most entrepreneurs working at home, that you can deduct your home office. However, the amount of tax savings is usually quite small but I guess every little bit helps.
For the past 6 or 7 years I’ve been trying to determine the best method for saving money in your home office.
There’s a couple different strategies.
Have your S-Corp pay rent to yourself as an individual is one way that seems popular, but the problem with it is it creates a wash. You’re paying rent to yourself, and since the S-Corp is a pass through entity, the income paid to yourself would still be taxable income.
So save yourself from even attempting that option.
The only option where paying rent to yourself would make sense, is if an LLC owns the home and rents it out to your S-Corp, or if it were a C-Corp that is at a lower tax rate than you as an individual, then you could take the extra income as a dividend and save a few hundred bucks in taxes.
Still, it doesn’t make sense. That’s a lot of work for a minuscule amount of savings.
The best option you can use is: Your S-Corp will reimburse employee-owners for their home office expenses.
Here’s how it works…
Instead of calculating square footage in comparison to rent or mortgage payments, and the % of your internet and utilities, you can use the square footage to calculate reasonable value of other commercial real estate in your area, as well as your full internet/phone/utility expenses.
The S-Corp shareholder-employee will submit an expense report to the S-Corp, and the S-Corp reimburses the expenses. These expenses are on behalf of the S-Corp, which results in no additional taxable income for you as an individual.
For example, if you pay $800/mo, your S-Corp will reimburse you for the full $9,600/year, which is a business expense for the S-Corp and creates $9,600 in money that isn’t subject to taxes.
Sounds too good to be true? You can look at IRS Regulation Section 1.62-2(d)(1).
5.) Renting Out Your Home… To Yourself?
One of the best and most secret ways of saving in taxes and reducing your taxable income, is renting out your home to your S-Corp.
It’s not related to the home office deduction or reimbursement program. It’s different.
According to the IRS, you can rent out your home for 14 days out of the year without reporting it as income. So why not rent it out to your S-Corp for “training purposes”?
First thing you should do, is call around different places in your city to get an estimate on how much it will cost to rent a conference room for a day, or a very small banquet room. Now you have price estimates and can charge your S-Corp an amount that is similar to some of the places you have called.
For example, a conference room for a full day may cost $250-400. A banquet room may be rented out for $600. Don’t call co-working places, or virtual offices, as their rates will be the cheapest and your goal here is reducing taxable income.
If you settle on $500 per day, that would be a savings of $7,000 a year. It’s a deduction for your S-Corp, and shielded income for yourself as an individual.
For 2 of the days, you can include a holiday party in the winter, and summer picnic, while also writing off the cost of food and entertainment. The remaining 12 days, food is not deductible and can not be classified as entertainment purposes.
6.) Deduct Lawn Care, Landscaping and Driveway Repairs
Ever meet a customer at your house? Do you have a customer that is a friend, and has come to your house every now and then?
Well, if you claim the home office deduction, you can deduct a lot of things associated with your home office, like a share of property taxes, mortgage interest, repairs, lawn care, landscaping and even if you are having a brand new driveway being paved.
It’s all deductible!
This only applies to the home office though.
I suppose if you had office space that required lawn care or landscaping, you would also be able to deduct that, but you likely wouldn’t be able to deduct the home lawn care and landscaping costs.
7.) Child Care…Tax Credit!
This is a credit, not just a deduction.
Employer provided child care allows your S-Corp to pay for the child care of the employees. Even if it is just you as the only employee of the S-Corp.
These are expenses you would normally pay yourself, as an individual and the personal tax credit sucks compared to the business tax credit.
The S-Corp can pay up to 150K and get a 25% tax credit… meaning if you owed $37,000 in taxes, the 25% in this tax credit would provide you with a credit of $37,500, meaning, you owe 0 in taxes.
However, most of you probably aren’t going to be spending 150k in child care.
The credit is still the same though, it would apply to 25% of the amount spent, as a credit. Your S-Corp can spend up to $5,000 without this “benefit” being reported under your gross income, and effecting your self employment taxes.
Credits are always better than deductions though, since deductions reduce your taxable income, but credits directly reduce your actual tax bill.
For example, if you have $10,000 with $1,000 in deductions, a 10% tax rate would tax you on $9,000 equaling a $900 tax bill. Having that same $10,000 with $0 in deductions but a 10% tax credit, and at a 10% tax rate would bring your tax bill to $1,000 minus the 10% tax credit of $1,000 bringing your tax bill to $0.
What I don’t know for certain and have not been able to get a clear answer on is whether these expenses are also deductible or not. If you provide the child care in your own facility, then everything is deductible and I (think) you still get the tax credit. However, if you use an off site facility, I’m unsure of whether that would still allow you to deduct these as ordinary expenses while also getting the tax credit.
8.) Write Off Your Vacation
I know the CPAs reading this are probably having a heart attack since I putting it out there like this…
But the truth is, you can write off a family vacation if you want.
Every S-Corp has a board of directors. Each officer position in an S-Corp or members of the board of directors, can consist of you, you and you. One person, can fill up each position. Or… you can also add your spouse to the board of directors, maybe even your kids if you want.
There’s this little requirement of S-Corps and all Corps to have an annual meeting. This annual meeting can be held anywhere you want, and is entirely tax deductible.
So you want to go to Aspen and hit the slopes with the fam? You can deduct transportation costs for anyone on the board of directors, as well as lodging and 50% of your meal expenses.
But what about the pleasure expenses? You can’t write off the slope pass, spas or massages, but everything else I listed is A-Okay.
After all… this is your company’s annual meeting. The purpose is the company’s annual meeting. It is, and isn’t a vacation.
But.. this isn’t limited to vacations. You can attend conferences throughout the year and the transportation and lodging along with 50% of meals are also deductible.
There’s so many things that could be included in this post, but at nearly 4,000 words, I decided to call it a day. Taxes are complicated. There’s a lot of ins and outs but there are few areas of business that would be more profitable to you than learning about taxes and the tax code, along with different types of deductions and credits that can save you as much money as possible.
I’m not an accountant, I don’t pretend to be one.
You should ask your accountant about all of these things.
Find this useful? This took a lot of time, and I have no affiliate offers or product recommendations in this post. If you enjoy it and benefit from this, buy me a beer! Sadly, it isn’t tax deductible.