I don’t want to pay taxes. What can I do?
Tax planning goes beyond calculating what you may owe and deals with a significantly more important issue – how to save you money! Previously, we discussed the benefits of Tax Planning and the considerations that need to be taken into account. Read about it here.
Before we begin, it is worth noting that not all of these strategies may be applicable or as beneficial, depending on your location and circumstances. For a more personalized tax strategy, please call us at 864-351-0852 or email us at info@waterfordbusiness.com to schedule an initial tax consultation.
When considering tax-saving strategies, a simple ratio needs to be considered: Risk vs. Reward. There are countless strategies to save money on taxes, but many of them may put you at risk of an audit, which could cost you more than you would have saved! Below is a list of potential tax strategies, in order of increasing risk, along with a brief explanation of the underlying ideas and caveats that must be considered.
1). Retirement Plans
The first strategy to consider is setting up and funding a retirement plan! Not only is having savings for retirement generally good financial advice, but it also allows you to potentially save on taxes. If you do not have a retirement plan set up, you may want to consider a traditional 401(k).
With a traditional 401 (k), you can defer $7,000 of income (or the current annual maximum contribution) – meaning that you will not have to pay income taxes on these $7,000 today but rather when you pull this money out of your retirement account.
This has two primary benefits:
First, because you will not have to pay income taxes on this amount now, you will be able to invest a higher amount, which in turn can continue to grow and accelerate your compounding interest!
Second, and the main reason this is listed, is if your tax bracket is higher now than you expect it to be when you retire, then you will pay this income tax at a reduced rate! These two tax benefits go hand in hand and put you in a great position when you are considering retirement.
However, a traditional 401 (k) is not the only retirement account available to you. For a comprehensive list of all potential retirement plans, visit the IRS website at this link: https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans .
Something to consider is setting up a 401 (k) plan for your business! A 401 (k) plan allows you to put more money away than any of the other retirement plans. If you’re looking to defer a lot of income, a 401 (k) plan is going to generally be your best bet.
An additional benefit is that if you’re starting a 401 (k) plan for your company, there’s a tax credit available to you for the first five years of that 401 (k). Tax credits are significantly more valuable than tax deductions, as tax credits directly reduce your tax liability dollar per dollar!
If you are interested in deferring a higher amount, two options you should consider are a Simple IRA and a SEP IRA. These are both larger retirement accounts with their own special requirements and limitations. We have videos describing both retirement plans on our YouTube channel!
https://www.youtube.com/watch?v=-hV0Z0O8PQU
https://www.youtube.com/watch?v=3BF18F5Tx_A
2). Benefits
The next option to consider is offering benefits to yourself and your employees! These benefits can include health, dental, vision, paid time off, tuition reimbursement, etc. These benefits are tax-deductible and can reduce your taxable income, while also providing yourself and your employees with useful programs to increase welfare, save money, and reduce turnover.
On a similar note, you can gain tax credits for hiring members of certain targeted groups who have faced significant barriers to employment through the Work Opportunity Tax Credit (WOTC). These targeted groups include qualified veterans, qualified summer youth employees, qualified ex-felons, qualified SNAP recipients, and many more!
To learn more about these targeted groups, you can see the full list on the IRS website here: https://www.irs.gov/businesses/small-businesses-self-employed/work-opportunity-tax-credit . This is a great option to consider, as it directly lowers your tax burden, allows you to assist a member of a community in need, and may lead to the recruitment of an amazing employee you may not have considered previously.
3). Depreciation & Tax Timing
Another way to reduce your current tax liability through deferral is by accelerating depreciation and expenses. Although this option is more short-term than with a retirement plan, it can still allow you to gain tax savings. If you purchase a vehicle or other fixed assets, you can use bonus depreciation or Section 179 depreciation to increase your annual expenses.
A common way to accelerate expenses, besides depreciation, is to stockpile materials and supplies at the end of your fiscal year. Both would lower your taxable income for the current year, but could cause your taxable income to increase next year. Another way to achieve this would be to delay invoicing until the end of January.
Before implementing these tactics immediately, consider the benefits you will receive by delaying income recognition until the next year. If you expect that your effective tax rate will be lower next year, then this is an obvious choice. However, if you expect your business to grow, then you can put yourself in a worse situation next year. This is why effective budgeting and tax planning are critically important for the success of your company.
4). Child Salaries
If you have children, have you considered making them employees? If you make your children employees and pay them a salary that is equal to the standard deduction, then you will reduce your taxable income by that amount, as well as giving your children $15,750 (or the current standard deduction) annually of federally untaxed income. This strategy is even more effective if you live in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming, as these states do not have state income taxes.
However, these wage payments do have some caveats.
Firstly, these payments are not totally free and clear. You will need to pay Social Security and Medicare on these wages, so you and your child will both pay approximately ~7.5% for these taxes. HOWEVER, compared to a 30-35% tax bracket, a 15% tax loss is significantly less! Although state income taxes must still be considered.
Secondly, your child will *actually* have to work for you. They can be performing simple tasks, such as answering the phone, filing and/or shredding documents, or even basic cleaning. You cannot pay your children if they do not provide any services for you or your company. If you do not have evidence of your children’s work, it may appear unfavorable during an audit.
5). Home Rentals
Last on our list is renting your home to your business through the Augusta rule. Simply put, you can rent your home for 14 days, and this income would be non-taxable. This means your business could pay you to rent your home for 14 days, and you would not incur any personal tax liability, which would also lower your business’s taxable income.
However, you must keep in mind that the rent must be normal and reasonable. Think, how much would a few hotel rooms and a conference room cost to use for two weeks? This should get you to an appropriate range for rent.
Another stipulation is that you must document your usage of your property. I doubt the IRS would accept your word if you simply state that the business rented your property without providing pictures or documents to substantiate your claim. Due to these additional hurdles, we do not recommend this practice unless you have the time and resources available to prepare your documentation.
There are more complicated, fringe, and detailed tax strategies that you could utilize, but those strategies would be better suited to be personalized based on your individual situation. If you’re looking for more complex, but potentially more rewarding, options, then we recommend consulting with a tax professional who is familiar with you, your situation, and your goals. If you don’t have a tax professional already, feel free to reach out to us here at Waterford Business Solutions.
