Many people stress out about taxes, but as a small business owner you can use taxes and the deductions only businesses can claim to your benefit. We talked to a CPA to figure out the top 10 tax laws small business owners need to know about especially after the Tax Cuts and Jobs Act (TCJA) that was passed in December 2017.
When to Pay Taxes
If you’re a new business owner, one of the most important things you need to know about taxes is when to pay them. New business owners may not be aware that the US income tax system is a “pay-as-you-go tax system” which means that you must pay income tax as you earn or receive your income during the year. In other words, rather than waiting to pay all of your taxes on April 15 each year, if you’re a business owner, you need to pay your taxes quarterly. For more information about paying your taxes, when they’re due each quarter, and how to avoid penalties click here.
If you’re a cash basis tax payer (as opposed to accrual based tax payer) you can deduct the cost of your inventory. Therefore, if you are trying to reduce your tax burden at the end of the year, you can stock up on inventory in December and then use it throughout the following tax year.
Home Office Expense
If you primarily work out of your home you are able to deduct certain costs associated with having a home office. Start by determining the percentage of your home that your home office occupies by dividing the square footage of your home office by the total square footage of your house. For example, if your home office occupies 15% of your home (based on square footage) you can deduct 15% of things like mortgage interest, house cleaning, home owners insurance, utilities, gardening, and home repairs, against your business income. It’s important to save your receipts or keep a running total of these kinds of expenses so you can deduct the right amount at the end of the year.
In the past, many business owners would buy season tickets at sporting events because if a client went with them those expenses were tax deductible under the guise of entertaining clients. Unfortunately, that has been changed under the new tax laws. Now, entertaining clients is no longer deductible. The good news is that if you take a client out to eat, you can still deduct 50% of meal costs as long as the meal isn’t overly lavish, and business was conducted at the lunch meeting.
Qualified Business Income Deduction (Section 199a)
The Qualified Business Income Deduction is part of the TCJA that was passed in December of 2017. In this new provision, certain types of business owners that profit less than a certain amount gets a deduction of 20% off the profit of the business. In other words, if you own a yoga studio, for example, and it shows profit of $100,000 with this new tax provision you would get a tax deduction of $20,000 and only be taxed on $80,000 of your profits. There are income limitations and restrictions for this deduction to be aware of. Check this website for more information on Section 199a and check with your tax preparer to see if your business qualifies.
If you buy a piece of equipment, you can take a tax deduction in the first year of 100% of the cost. Why does this matter? Let’s say you buy a 3D printer (or any other piece of equipment) for your business that costs $5,000. With this provision you take a deduction for the full cost of the printer instead of waiting five years to get the deduction. In the past a business owner would have to spread the deduction out over five years. In simple terms, being able to deduct it in the first year saves business owners money. For more information about this provision, click here.
In this provision of the tax law, you are allowed to take 100% depreciation (fully expense) on equipment and on certain non-structural improvements. For example, if you own a jewelry store and you built a display case in your store, you could elect to depreciate the cost of that fully in the year you incurred the cost.
Cash Method of Accounting
Before the new tax provision, if you averaged sales over $5 million you were generally required to report your taxes using the accrual basis of accounting. Under the new tax law, the threshold has been raised to $25 million. This allows business owners to pay their taxes based upon the cash they’ve received and spent instead of factoring their receivables and payables. In other words, it’s a more simple accounting system that aligns with the cash flows of the business and now businesses with more revenue can continue to use this system as they grow and scale their business.
Timing of Retirement Contribution
Business owners are able to deduct retirement plan contributions so long as they’re made before filing their tax return. For example, if a business owner decides to put $5,000 as a profit sharing contribution into their company 401(K), they could deduct it on their 2019 taxes but not make the contribution until they file their taxes (which could be as late as October 15, 2020). This can benefit business owners because it can help them keep more cash in their businesses and give them more time to save up the money to put into their retirement account.
Acceleration of Expenses
If you’re a cash basis tax payer and you want to save on your 2019 taxes, you simply need to purchase items in the current tax year. For example, many business owners will stock up on office supplies and other items they use throughout the year in December so they can reduce their profit for the year thereby decreasing what they will be taxed on.
While taxes may be stressful, as the owner of a small business you have the advantage of being able to claim many more deductions than the average person without a small business can. Educating yourself on business tax laws, and having a savvy CPA can help you take advantage of the tax code and ultimately help you keep more money in your pocket.