One of the hardest parts of being a business owner is keeping as much of your hard-earned money as possible. Uncle Sam always wants his cut, and I don’t think you shouldn’t give him any more than the bare minimum required by law.
You might think you could just hire an accountant and they would tell you every tip and trick, but that’s really not the case. I’ve hired business CPAs and tax attorneys that charge $400/hr, and very few of them recommended any strategy that would save us money. I ended up reading books and doing online research myself, and THEN going to my accountants and attorneys to see if what I found applied to my business, was legal, and could save us money.
I’ve found that most CPAs are better at filing taxes properly and keeping up to date with the changes in the process year to year and tax attorneys are great help if you get audited or need help arguing your case with the IRS. Sure, if you had unlimited funds and a team of attorneys and accountants you could probably find a way to pay no taxes just like the billionaires, but for most of us small business owners, we’re stuck figuring this out on our own.
So below, I’m going to show you my 10 best strategies for reducing your taxable self-employment income up to $100,000.
Now, I’m not an attorney or accountant, and this is NOT legal, tax, or financial advice, just some information from a fellow entrepreneur with over 20 years of experience. Do your own research, and I recommend you run these strategies by your CPA to make sure they apply to your individual situation. Because every business is different.
Now, let’s get into it…
- Keep track of ALL business expenses
- Track Your Mileage
- Self employed health insurance deduction
- Save for retirement
- HSA contribution deduction
- Section 179 and Bonus Depreciation
- Take the S-corp election
- Qualified Business Income Deduction
- Pay quarterly taxes on time + 10%
- Choose business sponsorships over personal charitable donations
Keep Track of ALL Your Business Expenses
First – Keep track of ALL business expenses using a business bank account and dedicated business credit card! Keep your personal and business finances completely separate.
I can’t tell you how many small business owners I have met that put personal expenses on a business card or business expenses on their personal card.
This is the most important thing you should do immediately after registering your business… go open a business checking account. As for the credit card, well it’s very possible you wouldn’t be approved for a business credit card as a brand new business with no history of revenues, and it’s okay to use a personal card for business expenses, as long as you choose one card and only use that card for business expenses. It will make it so much easier to reconcile the transactions later when they are all organized into dedicated accounts.
And remember, pay off your balances in full every month – only reason using credit cards is for security, to get points/miles or to increase our cash flow by 30 days
And you want to use a real double entry accounting software – I recommend using an online service like Xero or Quickbooks Online. Xero starts as low as $5.50 a month so there is really no reason not to use it from the start. Real accounting software is so important because it categorizes both your income and expenses, but also your assets and debts. It can easily connect to your bank accounts and credit cards to pull down transactions automatically, you can create rules for categorizing revenues and expenses.
It also allows you to easily generate financial reports for your business to see how profitable you are, which can really help you determine your tax liability throughout the year and plan properly for tax time. Remember, you are taxed on your total net profit regardless of whether you have taken that money out of the business or put it all into new inventory. Using an online bookkeeping software platform will also make it much easier for your accountant or tax preparer to file your taxes, which will likely save you money at tax time.
Really, this sounds too simple, but it’s critically important. If you don’t have all your revenues and expenses categorized properly, you are 100% going to miss legitimate business expenses and pay too much in taxes, or worse yet, get audited and have to pay back taxes, penalties, and interest because you didn’t have good records.
Throw the box of receipts away – use a good bookkeeping platform and just scan them and toss them and never worry about it again. A few minutes of setup now will save you hours and thousands of dollars later.
Track Mileage
A lot of “experts” recommend buying a car or truck for your business, and if you drive close to 100% of the time for work that makes sense. If you’re a traveling salesperson, real estate agent, independent insurance adjuster, or own rental real estate in multiple states and drive between them all the time, it might make sense to just purchase the vehicle through the business.
As the owner of a small business, you are only able to deduct the business use of a vehicle. So for those of us that only occasionally use our vehicle for business use, it makes much more sense to simply deduct the business mileage for the time we do drive – which is $0.56 per mile in 2021.
We all know someone bought a brand new car through their business but the only “business travel” they do is to and from the office. If you only travel 10% for work and ever get audited, you will have to pay the back taxes, penalties and interest when the expense is disallowed. Better safe than sorry, in my opinion.
Plus, if you did purchase a vehicle through your business and fully depreciate it, and later then sell that vehicle, you have to pay taxes on the basis of the sale over the depreciated value. Taking the mileage deduction is so much easier if you don’t drive for work a majority of the time.
You can use an app like MileIQ to track your miles, and simply generate a report at the end of the year and reimburse yourself from your business. It’s important to note that you can’t deduct mileage driven “to and from work” i.e. your daily commute, but you can deduct any other business miles. For instance, if you frequently run to the post office or UPS, Costco, or to visit clients, all of that mileage is deductible. We take trips to Costco about twice a month for our business, and it’s about a 100 mile round trip. If we take two trips a month, that alone is $672 a year just in trips to Costco. Simply installing an app like MileIQ and tagging your business trips could reduce your taxable income by thousands of dollars a year.
Self-Employed Health Insurance Deduction
I wish I had known about this deduction when I started my business. When our 2nd child was born, my wife quit her job with a Fortune 500 company to stay home with the babies, and we lost our source of health insurance. We have been paying out of pocket since then, and gave up thousands of dollars in deductions simply because we didn’t know about it.
If you are self-employed, you can deduct the premiums you pay for health insurance directly on your 1040, reducing your AGI and your federal and state income taxes substantially. We pay over $1,000 a month just in premiums for our high-deductible health insurance plan, that’s a huge deduction in AGI!
The process is a little different for LLC taxed as an S-corporation – but you can still do it. The S-corporation either has to obtain and pay for the insurance premiums or reimburse the over 2% shareholder for the premiums and that compensation has to be included as taxable compensation in the shareholders W2. Then the shareholder (owner) can take the above-the-line deduction on their W2.
This saves us thousands of dollars a year in taxes, everyone that is self employed and pays for health insurance out of pocket should take this deduction.
HSA Contribution Deduction
An HSA, or Health Savings Account, is another great way to reduce your taxable income while also increasing the amount of money you can save and invest every year. HSAs are typically attached to a high-deductible insurance plan – ours is $10,000 deductible – and you pay medical expenses out of pocket until you hit your deductible. The insurance still reprices many doctor’s visits and prescriptions, so you get the benefits of your insurance company’s negotiated rates, but you pay for all doctor visits and prescriptions 100% until you hit your deductible, then it’s either a copay percentage or, like in our case, your insurance would pick up 100% after the deductible.
This works great if you are young and relatively healthy, because any money you don’t use from your HSA every year for medical expenses can be invested in the market and grow. Contributions to your HSA are pre-tax just like a 401k, and contribution limits are $3,600 for an individual and $7,200 for a family in 2021.
Save for Retirement
Saving for retirement is probably the single best way to reduce your taxable income, because you’re taking money that would be taxed at high rates, investing it for retirement, and theoretically when you pull it out, your annual *earned* income will be much less. Even at the same or higher tax rates, the gains over the years make it worthwhile.
You can put away tens of thousands of dollars per year into a retirement account, reducing your taxable income substantially. If you are a solopreneur and don’t have or plan to have any employees, you should look into a Solo 401k or SEP IRA which you can use to save as much as $58,000 in 2021.
For those of us with employees, you can still open a traditional 401k, and it’s a lot easier than you might think. We opened a Safe Harbor 401k with Guideline a few years ago and offer it to all full-time employees after a year with our company. We match the 100% of the first 4% of all employees – including owners. Since we are an S-corporation, we pay ourselves reasonable salaries and my wife and I are business partners and both on the payroll. We are able to save a substantial amount of money every year – individual contribution limits are $19,500 each but that does not include the 4% employer match. So we’re able to reduce our taxable income by close to $50,000 per year with our 401k.
Guideline is incredibly simple to setup if you choose to use a Safe Harbor plan, integrates seamlessly with many payroll providers like Gusto, and the service is very affordable. I highly recommend it.
Section 179 and Bonus Depreciation
If you purchase equipment, furniture, machinery, computers, or other long term assets, they typically have to be depreciated over many years. Using Section 179 and bonus depreciation rules, you can often deduct up to 100% of the cost of these kinds of capital investments in the first year, which can save you substantially on your taxes compared to spreading out the deductions out over multiple tax years.
The downside is that you forego the deductions in future tax years, and if you ever sell the asset, you would be responsible for capital gains taxes on the profits of the sale, or the difference between the depreciation basis and the sale price. If you fully depreciate a $100,000 asset (like a Tesla) and eventually sell it for $50,000, you will have a $50,000 basis for capital gains.
S-Corp Election
Once your business has grown to the point where you have enough net profits to pay yourself a *reasonable* salary, you should consider making the s-corporation election. Now, you have to put yourself on payroll as a W2 employee and with a resonable salary, taking out all federal, state, social security, and medicare taxes, but all the net profits above your reasonable salary are exempt from self-employment taxes.
When your business reaches the point where you are making a decent net profit every year, making the S-corp election can save you thousands of dollars a year in taxes.
I highly recommend Taxpayer’s Comprehensive Guide to LLCs and S-corps by Watson CPA Group. I’m not affiliated in any way – I purchased this book years ago and it’s worth it’s weight in gold.
Qualified Business Income Deduction
This is a recent addition from the Tax Cuts and Jobs Act – IRC Section 199A also known as the “qualified business income deduction” is a 20% deduction of qualified business income up to about $300,000. This applies to most business income, and can reduce your taxable income by tens of thousands of dollars. There *are* a handful of excluded service businesses, but most types of businesses can benefit from this deduction.
Pay quarterly taxes on time + 10%
I personally know quite a few business owners that not only **file** an extension they also don’t **pay** their taxes until they send in their personal return in October every year. Some, even later than that. I’ve been guilty of this myself a few times, and the penalties and interest for not paying enough in quarterly taxes adds up to a substantial amount over the course of a year if you are making a decent profit.
If you have a growing business, and you pay at least 100-110% of your previous year’s taxes in quarterly taxes, *even if that is not equal to your tax burden this year*, you will not be charged penalties. And as long as you pay in full by the tax due date, usually April 15, you will not be charged any interest.
If you don’t pay enough estimated taxes and don’t pay your taxes until the extension deadline in October, you could pay as much as 5% more just for paying late and that number keeps growing every month you wait to pay.
With a business net profit of $200,000 paying late could cost you over $10,000. Do yourself a favor and get on a schedule of paying quarterly taxes on time, every time.
Business Sponsorships over Personal Charitable Donations
Now, first off I am NOT saying stop supporting any causes you believe in.
But with the recent tax changes doubling the standard deduction to $12,550 for an individual and $25,100 for families, it’s becoming increasingly difficult to itemize deductions and see a tax benefit personally from charitable giving. Even with a mortgage interest deduction and state taxes, unless we give substantially we do not hit the standard deduction every single year.
One way we have changed our giving to maximize the tax benefits is by choosing to sponsor events and programs with organizations we support through our businesses. By doing business sponsorships, we get both the recognition and business expense deduction through the business, where if we donated privately we would essentially be doing it with after-tax dollars if we had not hit the standard deduction.
This allows us to still support the causes we believe in, while also generating a little good will and marketing exposure for our business. It’s really a win win for everyone.
Conclusion
I know that’s a lot of information at one time. You don’t have to implement all of these strategies immediately. If you’re just starting out, there’s a good chance you won’t make enough profits the first few years to apply them all, but keep these strategies in your back pocket and use them when applicable to reduce your taxable self-employment income up to $100,000.
If you have any questions, put them in the comments down below.
