Effective tax planning strategies help your business save more money that can be reinvested for business growth and expansion. A key part of managing your business’s finances is adopting tax savings initiatives.
The following tax planning strategies can help your business plow back money into lucrative operations.
Hiring your children as employees
An applicable tax planning strategy you can adopt is to hire your children that fall with lower tax brackets. When you hire your children as legitimate employees to carry out actual work for your business, this allows you to deduct their salaries as business expenses and reduce your taxable business income.
To use this tax planning strategy, the job roles that you employ your children for will have to be actual roles that are related to the business. Also, the wages paid will need to be at a reasonable ongoing market rate. Examples of jobs that your children can do for your business include: personal assistant, digital marketer, social media manager, photographer, cleaner, etc.
When you hire your child who between the ages of 7 and 18, you can eliminate payroll taxes on their wages if you utilize a family management company to pay them. Doing this helps you to transfer money from your higher tax bracket to your child’s lower tax bracket. As a result, you can save a significant amount that would have otherwise been paid as income or payroll tax.
Additionally, your child will not have to pay income tax on the wages if the amount paid is less than the standard deduction amount. The 2021 standard deduction amount is $12,550, if your business pays your child an income that exceeds this amount, then they will pay tax at the applicable tax rates.
In other words, the wages paid to your child(ren) could be completely tax free if you set everything up properly.
More importantly, you will need to keep important documents such as role description, employment letter showing the market-rate salary, etc., to show that you have employed your child legitimately for the position.
To be eligible for the tax savings advantages, key things to note when you hire your child are:
- The job position for your child should be reasonable and the child will need to perform actual business-related roles.
- The Internal Revenue Service (IRS) does not recognize a child that is younger than 7 as employable.
- You need to keep documentation of actual hours worked, timesheets, role descriptions, etc.
- The compensation must be fair and reasonable. The salary you pay your child should be what you will pay someone else to perform that same job.
- Fill all the necessary forms to comply with legal requirements such as Form W-2, Form W-4, U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification, etc.
- Your child will need to have a Social Security number and your registered business must also have an Employer Identification Number (EIN).
Home Office Deduction
As a tax planning strategy, many business owners are aware that they can claim the home office deduction when filing their tax returns for the year. Using the home office deduction, you can claim expenses such as utilities, repairs, mortgage interest, etc. up to the portion that relates to your business use.
In addition to the home office deduction, if you have a second business location aside from your registered home office, such as a retail warehouse, or a restaurant, you can claim mileage expenses from your home —your registered business address, to your other business location.
The deductible cost for using your vehicle for business use can add up over time as you commute between business locations. You can use either the standard mileage rate or actual expense method to figure how much to claim for a business deduction.
The 2021 standard mileage rate for using your car for business purposes is 56 cents per mile.
As a tax savings plan, the commuting expense deduction also applies if you have to go from your home, which is your principal place of business, to a client’s location, or customer’s place of business.
(Pro Tip: other business locations can include your home office if it is your administrative home office. Your mileage that was previously labelled as “commuting” is now business mileage and 100% tax deductible.)
Late S Corp Election
When you register your business as an S Corporation (S Corp), you can get access to certain tax benefits. For federal tax purposes, an S corporation is a business that can pass corporate income, losses, deductions, and credits through to shareholders.
In other words, the business is not taxed on income or losses. Instead, the shareholders include their share of the corporation’s income in their personal tax return and get taxed at their individual income tax rates. This helps business owners avoid getting double-taxed on business income for profits generated and personal income for dividends received.
An effective tax planning strategy will be to file for a late S Corp election. If you run a business as a LLC or a C Corp, you can opt for a late S election. However, your business needs to meet certain conditions such as:
- Your business will need to be an eligible entity that did not qualify as an S corporation only because you failed to do the election on time
- Your business must have a reasonable reason for the late election
- All owners of the business must have reported income in a manner that is consistent with an S corporation election for the years you intend to elect as an S Corp.
- You do not intend to claim the S Corp election for a period that is more than 3 years and 75 days from the effective date of the election. If your entity is already a corporation (not an LLC), there may be exceptions to this timeline requirement.
To take advantage of tax benefits through a late S Corp election, you will need to fill and submit Form 8832, Entity Classification Election.
Your business can use self-insurance through a captive insurance company as an effective tax planning strategy. Through captive insurance, you work with a subsidiary-owned insurance company that is set up as another entity to provide insurance coverage for your main business entity.
This type of insurance can cover specific business risks that a third-party insurer is not covering. With captive insurance, you will have more control over your insurance policy compared to getting insurance from a third party.
Your business pays insurance premiums over to the captive insurance, which can be a C Corp. The C Corp insurance company will then manage the funds and payout to your business when there is a qualifying claim.
You can use captive insurance to get tax savings by claiming the eligible insurance premiums as deductible expenses.
After a year, the insurance company can distribute any unpaid money back to the business owner. These distributions are subject to capital gains tax rates.Paying capital gains tax rates vs. income tax rates saves you money on taxes.
Captive insurance works best when your business has an interest not only in tax savings but also in insurance activities.The IRS requires that the company operates as an actual insurance company with policies for actual insurable risks.
To discourage tax scams, the IRS requires that your captive insurance entity meet the risk distribution and risk shifting conditions for an insurance transaction to qualify.
Employee Retention Tax Credit
Due to disruptions in business operations as a result of COVID-19, the IRS introduced the employee retention tax credit (ERTC). The ERTC is a refundable tax credit that incentivized employers that retained their employees despite the pandemic challenges. To be eligible for the credit, your business must have suffered a full or partial suspension of operations or a significant decline in gross receipts within a specified period.
The ERTC represents a tax planning strategy that businesses can apply to reduce employment taxes by 50% of the qualified wages they pay to employees. This tax credit remains available for wages paid between March 2020 and June 2021.
You can reduce your employment tax deposits, if you’re eligible for the credit, because it is a refundable tax credit, you can get a refund payment from the IRS if your income tax payable is less than the credit.
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