How Can You Reduce Your Small Business's Effective Tax Rate?
If you've recently launched your first small business, you're probably doing all you can to cut costs -- shopping different suppliers for the best product prices, hiring part-time workers to avoid paying benefits, and even investing in energy-efficient lights and appliances to help cut the amount of electricity your storefront uses. However, your annual federal, state, and local tax bills could be among the largest expenses your business pays, and making a few easy maneuvers to lower these tax rates could be much more effective at saving money than clipping coupons or turning off lights. Read on to learn more about some useful ways to help reduce your business's tax rate and put more money back into your pocket.
What is your tax bracket?
During your years in the workforce, you may have occasionally heard complaints about overtime payments or other lump sums of cash "pushing someone into" a higher tax bracket. Because the federal government's tax on both business and personal income is a progressive tax, this means that the more you make, the higher your taxes as a percent of your total business or personal income.
There are several income tax brackets ranging from 10 percent to nearly 40 percent. Moving into a higher tax bracket won't require you to pay this bracket's rate on all money earned by your business, but will tax a portion of your earnings at a much higher level than the rest of your earnings. Therefore, you'll want to take advantage of as many deductions as possible to ensure your business remains in one of the lower, "cheaper" tax brackets.
How can you use deductions to push your revenue into a lower tax bracket?
While many business tax deductions are common knowledge, there are a few that may not be as evident -- but can provide you with significant tax-advantaged savings.
- Bad business debts
If you find that your staff's time is often monopolized by trying to track down payment from non-paying customers, you may be able to conserve your business's resources while gaining a tax advantage by writing this off as a tax-deductible bad debt. While the rules on which types of debts can be written off vary, in general, a debt incurred for a product or item is deductible while a debt incurred for a service is not.
- Retirement accounts
If you're a sole proprietor, there are several options that can allow you to lower your business tax rate by setting aside pre-tax funds for retirement. As a self-employed person, you may qualify for the Simplified Employee Pension (SEP), a SIMPLE IRA, or even increased contributions to your existing 401(k) account. As these funds are all set aside before federal taxes are assessed, they're not counted in your business's income for that calendar year and won't ever be taxed until you begin taking withdrawals. And because you're able to contribute to these funds at any time during the year (and even up through April 15 of the following calendar year), this can be a great way to reduce the amount of business income taxed at your highest marginal rate if your recent profitability has taken you by surprise.
For further assistance, contact a local accounting firm, such as Bliss & Skeen CPAs.