Author: Dan Nicholson
Uncertainty can make taxes stressful for small business owners – whether it’s waiting on documents to show up in the mail, experiencing a life event (like buying a house), or simply not knowing how much you owe. It may go without saying but navigating the tax landscape for the newly self-employed can be especially daunting.
Like approaching any other obstacle, having a plan you’re confident in can make all the difference. Creating a framework that includes strategies to lower your tax liability can be a serious advantage, generating savings that can be reinvested in the business or deployed in other positive ways.
Components of an effective tax plan
The U.S. has a pay-as-we-go tax system. For employees, taxes are withheld from their paychecks, but most self-employed individuals need to pay throughout the year. Your tax plan should include quarterly estimated taxes so there are no surprises when Tax Day rolls around. Your tax plan should also include strategies on how to lower your tax liabilityand how you will execute those strategies throughout the year. In this article, we have laid out several strategies that you should consider incorporating into your tax plan.
Optimizing your entity structure
For many entrepreneurs, the selection of entity type isn’t a topic of focus until tax time (or concerns surrounding personal liability) comes around. Asking for advice on what entity structure is best is like polling friends on their favorite food truck: you’ll get many strong opinions. The optimum entity type certainly depends on your goals for the business and the ownership group.
When we take on a new client, more often than not they are sole proprietors or single member LLCs. For many of our clients, we recommend electing to be an S Corporation. Unlike a sole proprietorship or LLC, the S Corp has its own tax return. By moving operations off your individual tax return, you potentially minimize your exposure to the Self Employment tax which starts at 15.3 percent of the profits of a sole proprietorship.
In an S-corporation, the business owner is on the payroll (unlike a sole proprietorship or LLC). Generally, our clients are fantastic self-promoters, and while that is a great attribute for an entrepreneur, it can make setting your own salary a difficult task. For tax purposes you are incentivized to maintain the lowest justifiable salary you can. Your accountant should be able to create a reasonable compensation study, or you can use comparable market data for the roles that you fill in the business to justify the salary you set. In addition to the limitations on self-employment tax and the ability to set your own salary, an S-Corp has a wide selection of deductions and credits available.
Leveraging the Augusta Loophole
An additional way an entrepreneur can lower their tax liability is by implementing forward-looking tax strategies such as the Augusta Loophole. The namesake of this loophole is Augusta, Georgia, a city of 200,000 that is also home to the Masters Golf Tournament.
With the golf tournament attracting 250,000 guests each year, the demand for lodging swells. Many residents look to capitalize on the inflated rental prices and rent out a room or the whole home during the tournament. The tax code that the loophole leverages is the section that allows taxpayers to rent out their residence for less than 15 days without recognizing taxable income.
Thanks to an effective lobbying campaign, a business owner can rent her home to her business for 14 days at the fair market value. The rental then becomes a deduction for her business, creating a tax-free distribution to the owner. In Augusta, this deduction can add up to thousands of dollars in savings. Although most of us don't live in Augusta, the deduction can still generate significant savings. We consider this strategy a home run, or a hole in one, for any S-Corporation or C-Corporation.
Making to Most of the Administrative Home Office Deduction
Most taxpayers are familiar with the home office deduction, where a taxpayer can deduct costs associated with the business use of the home, but the strategy that is often missed by entrepreneurs is the Administrative Home Office Deduction.
Taxpayers who work outside the home but complete administrative work (I.e. answering emails, scheduling meetings, taking calls) can designate their home as an administrative home office, allowing for travel between their home and place of work. Clients who have long commutes or are traveling to varying worksites can greatly benefit from this tax strategy.
Before committing to a tax strategy, discuss it with your accountant or tax attorney to make sure that it makes sense for your business. In addition to strategy, we recommend you schedule times throughout the year to organize your tax documentation and record all of your business expenses (perhaps as you enjoy a mimosa).
Dan Nicholson, CPA founded Nth Degree CPAs in 2008 with the objective of building a successful practice by helping small business owners to achieve their financial goals.
A Northwest native, Dan grew up in Renton and attended Seattle University where he graduated Summa Cum Laude with emphases in both Accounting and E-Commerce Information Systems.
Upon graduation, Dan was selected out of a pool of nominees from the nation’s top 50 accounting programs for an exclusive fellowship with the Governmental Accounting Standards Board (GASB). As a member of the GASB team, he was responsible for managing all technical inquiries and assisted what has become Statement No. 53, "Accounting and Financial Reporting for Derivative Instruments."
To learn more about Dan and his firm, visit Nth Degree CPAs.
About Money & Mimosas: Money & Mimosas was started as a passion project by Danetha, a former NFL cheerleader and CFO. After a brunch conversation with girlfriends, Danetha was inspired to launch a resource to learn how they could all enjoy life while being smart with their money. Because who doesn’t want to have their money and mimosas, too?