10 tax hack tips you didn't know about

As the saying goes, nothing is certain but death and taxes. While business owners can’t eliminate taxes, they can certainly minimize them. By using some key tax hacks businesses can significantly reduce their tax bills. And, the less you pay in taxes, the more you keep in your pocket – a goal of every business owner!

As such, we’ll use this article to explain 10 tax hack tips. If you own a business, you should absolutely know about all of these.

Tax Hack #1: R&D Tax Credit

The Research & Development – or R&D – Tax Credit provides businesses an incredible opportunity to reduce their annual taxes. And, many businesses don’t even realize that they qualify for this benefit. 

According to the IRS, any businesses that develop, design, or improve products, processes, formulas, or software can claim this credit. Unfortunately, a misconception exists that you need to conduct ground-breaking scientific research to qualify. But, any companies conducting the below work likely meet the minimum requirements:

  • Develop or design new products or processes
  • Enhance existing products or processes
  • Develop or improve upon current software and prototypes

The credit is then calculated based on the wages of the employees conducting this qualifying work. As a dollar-for-dollar reduction in your tax bill, this means you can save a ton of money with this credit. 

Tax Hack #2: Tax-Loss Harvesting

When people sell investments at a gain, they trigger a capital gains tax. Short-term capital gains (year or shorter holding period) are taxed at your ordinary income rate. Long-term ones (longer than a year holding period) receive more favorable treatment, with rates of 0%, 15% or 20%. 

For taxpayers in the highest tax bracket, taxes on short-term capital gains can add up quickly. To offset these gains, investors use a strategy known as tax-loss harvesting. With this approach, you sell one investment at a loss to offset the gain on the sale of another. For example, assume an investor sells a mutual fund and realizes a $50,000 gain. If he or she sells another fund at a $25,000 loss, that loss can reduce the gain by $25,000. 

Then, taxpayers need to rebalance their portfolio. That is, they need to purchase another holding similar to the one they sold at a loss. In this example, the investor would use the proceeds on the loss-incurring trade to purchase another similar mutual fund. This maintains the general profile of the portfolio. However, the IRS has declared that these rebalancing purchases cannot be made within 30 days of the sale.  

Tax Hack #3: COVID-19 Tax Breaks

Due to its effect on the economy, the government has authorized several COVID-related tax credits for businesses. The Credit for Sick and Family Leave can prove particularly valuable. 

Many employees cannot work due to having COVID-19 or dealing with related quarantine requirements. As such, the government has guaranteed paid sick leave up to 10 days. For this leave, employees are entitled their full pay or, if higher, federal minimum wage. To offset this expense, the IRS offers the Credit for Sick and Family Leave. Businesses who’ve paid this sick leave can receive a dollar-for-dollar reduction in their tax liability. 

Additionally, certain employees who need to take time off to care for sick family members qualify for paid leave. If employers have made these payments, they can also receive an associated tax credit.  

Tax Hack #4: Section 139 Deductions

Section 139 of the Internal Revenue Code offers a way for employers to make tax advantaged payments to employees. If the government has designated an event a “qualified disaster,” Section 139 applies. Under this umbrella, employers can provide tax-free payments to employees while still deducting the payments themselves. Accordingly, Section 139 payments offer a double benefit: tax deduction for the business, and tax-free income for the employee.

However, regular wages, even in times of the COVID-19 qualified disaster, do not qualify as Section 139 payments. Employees would receive these wages regardless of disaster. Rather, the IRS has defined a qualified disaster relief payment as: any amount paid to or for the benefit of an individual to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster

If you have made one of these payments as an employer, you can deduct it for tax purposes. And, make sure your employees know that they can exclude the payments from their taxable income.  

Tax Hack #5: Bonus Depreciation

Typically, companies need to depreciate capital assets over their useful lives. This aligns with the accounting principle of matching, where expenses should offset income as generated. If you buy a piece of manufacturing equipment for $250,000, you wouldn’t normally deduct $250,000 that first year. Rather, the IRS argues this machinery will provide you multiple years of income, so the expense should be spread out accordingly. 

With bonus depreciation, businesses can immediately deduct a large percentage of these major purchases. This means that, rather than depreciating over time, businesses can immediately expense and significantly reduce their current tax bill. Following the Tax Cuts and Jobs Act (TCJA) of 2017, the government increased this bonus depreciation to 100% of cost basis. In other words, businesses could deduct all $250,000 of the above machinery costs in the year of purchase. If in the 21% tax rate, this would save you $52,500 in taxes ($250,000 x 21%). 

Tax Hack #6: Section 1031 Exchanges

As stated above, selling assets at a gain triggers a capital gains tax. For businesses with real estate, selling a property can lead to a major tax bill. For instance, say you have a retail store, and you own the building, as well. If you decide to sell this building to relocate, you’ll need to pay A) depreciation recapture taxes, and B) capital gains taxes. 

With Section 1031 Exchanges – or like-kind exchanges – you can defer these taxes. You must meet strict compliance guidelines to qualify. But, if you sell a property and purchase another within a certain period of time, you can roll the taxes from the sale into the new property. As a result, you defer the tax payment, potentially saving tens of thousands (or more) in current taxes. 

Tax Hack #7: Qualified Business Income (QBI) Deduction

The TCJA of 2017 also significantly reduced the corporate tax rate. This created some push-back from small businesses structured as pass-through entities (i.e. LLCs, partnerships, S corps, and sole proprietorships). The corporate tax reduction didn’t help these businesses at all.

As a result, the final version of the bill included a deduction for certain pass-through entities. Known as the qualified business income (QBI) deduction, this lets certain pass-through businesses deduct up to 20% of their net earnings. Income limitations exist, but this can be a tremendous way for small businesses to reduce their tax bill.  

For example, say your sole proprietorship made $100,000 in net earnings. Assuming you meet income qualification criteria, you can take a $20,000 deduction based on this business income ($100,000 x 20%). 

Tax Hack #8: Home Office Deduction

Home offices are considered qualified business income deduction

If you own a business and work from your home, you likely have another option to lower your tax bill. For years, the home office deduction received a bad name. Due to the complicated calculations, it was often viewed as an audit red flag. 

The IRS recognized this reality, and they simplified the process. While business owners can still use the standard, complicated calculation, an alternative exists. Beginning in tax year 2013, the IRS allowed individuals to apply a simplified option for claiming the home office deduction. Rather than maintain detailed records for calculation purposes, this simplified option offers the following:

  • Standard deduction of $5 per square foot of home used for business (maximum 300 square feet).
  • Allowable home-related itemized deductions claimed in full on Schedule A. (For example: mortgage interest, real estate taxes).
  • No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

With the standard deduction alone, business owners can reduce their taxable income by up to $1,500. But, regardless of whether you use the traditional or simplified method, individuals must still meet key criteria to claim the deduction. That is, the home office must:

  • Be regularly and exclusively used for business purposes.
  • Serve as the principal place of your business.

Tax Hack #9: Self-Employment Tax Adjustment

When you work for a company, you only pay half of the total payroll, or FICA, tax bill. The total amount is 15.3%, meaning that you pay 7.65% as an employee. Unfortunately, self-employed individuals need to pay both the employer and employee portion of these taxes. This means that self-employed individuals face a 15.3% tax bill – on top of their income taxes. 

To offset this larger tax burden, the IRS provides self-employed individual a partial benefit. For large businesses, the employer-portion of payroll taxes qualifies as a deductible expense. Accordingly, self-employed individuals can deduct half of their self-employment tax – or 7.65% – to determine adjusted gross income. Say, for example, a self-employed individual has $100,000 in net earnings. He or she will need to pay $15,300 in self-employment taxes on that amount ($100,000 x 15.3%). But, the IRS says half of that can reduce AGI, meaning that the taxpayer still receives a $7,650 reduction in taxable income. 

If you’re self-employed, do not overlook this tax break. 

Tax Hack #10: Solo 401(k)

For most employees, contributing to an employer-sponsored 401(k) plan can significantly reduce taxable income. But, what about self-employed individuals? How can they receive a similar tax benefit? 

Recognizing the costs and administrative burden associated with standard 401(k) plans, Congress created a streamlined alternative, the Solo 401(k). This plan provides self-employed individuals an option for a tax-advantaged retirement account. And, it doesn’t include nearly the start-up and administrative hassle as a normal plan. 

To be eligible for a Solo 401(k), you must be a business owner with no employees (though you can cover a spouse). And, as of 2020, you can contribute up to $57,000 per year, with a $6,500 catch-up if 50 or older. This limit increases to $58,000 in 2021. If you establish a Solo 401(k) as a traditional retirement account (opposed to Roth), all of your contributions up to that limit reduce your current taxable income. 

This system provides a dual benefit for self-employed individuals. They A) reduce their taxable income, while B) saving for retirement in a tax-advantaged account. 

Get Tax Help Now

Businesses can’t escape taxes, but these tax hacks can certainly make them more manageable. And, we’d love to help you with that goal! At Tax Hack, we live and breathe taxes for small businesses, so contact us to set up a tax planning strategy session. 

Book your session now!

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