5 Ways to lower your taxes as a business owner in Kentucky.
I’ll get right to it here, because I value your time. What are the biggest tax deductions for business owners in the 2020's? How do you reduce your business taxes? What are the best tax reduction strategies for LLC's, Sole proprietorships and S-Corps?
Before i show you the 5 best tax reduction strategies, you need to know what really causes you to overpay in taxes.
You will overpay in taxes if someone’s not diligently helping you make tax savings decisions throughout the year.
If you’re not aggressive through the year, and you wait till year end, you’re hosed.
Waiting to talk taxes till year end means you will overpay in taxes.
How much might you overpay in taxes?
- Making 60k in net profits? We often find $4,500 in savings
- Making 100k in net profits? We often find more like $10,000 in overpaid taxes
And that’s overpaid taxes EVERY YEAR
If you’re not working with an aggressive tax reduction planner like myself, and you’re not engaged throughout the year, chances are that you’re definitely overpaying in taxes
If you reach out, we’ll provide a free tax return analysis, where I’ll examine your tax return from last year and I’ll really analyze it for opportunities to save on taxes.
Let us make sure you’re not getting taken advantage of by the IRS!
So without further ado, here are the five most important tax reduction strategies for small businesses in the state of Kentucky.
5 Tax Reduction Strategies that dramatically reduce your taxes
1 - Maximize the S-Corp
Are you maximizing the tax reduction opportunities of an S corporation?
If you're making net profits higher than about 40 or 50,000, you will want to work with an accountant in order to maximize an S corporation because it can lead to tens of thousands in tact savings every single year.
- Making $50,000 in net profits?
An S Corp. could save you $4,500 a year! - Making $120,000 in net profits?
An S-Corp might save you $11,000 a year!
S-Corps are amazing tools for Kentucky business owners to reduce their self employment taxes.
In order to tap into the tax savings of an S-Corp, you need to make sure that you maximize your salary and distribution decisions.
When you're initially taxed as a schedule C, or as a traditional so proprietorship, 100% of your net profits will be subject to self-employment taxes.
What are self-employment taxes?
Self-employment taxes are a combination of your social Security taxes and Medicare taxes.
You will owe Social Security taxes and all your wages up to the Social Security limit.
The Social Security limit for 2022 is going to be $147,000.
The social security rate, for self employed folks, is 12.4%.
That means you will pay a 12.4% Social Security tax on all of your wages up to $147,000, and then you will not owe any more Social Security taxes.
The second portion of your self-employment taxes is the Medicare tax. You will owe Medicare tax on all of your wages because there's no Medicare tax limit like there is on the Social Security side.
The medicare tax rate for self employed people is 2.9%
That means you will owe 15.3% on all of your wages as a sole proprietor ship.
Remember, out of the gate, you are always taxed as a sole proprietor which is done on a schedule C.
You will need to convert to an S Corp. in order to tap into the tax savings of an S corporation.
The power of the S corporation comes because there are two types of income rather than simply the net profit wages on your schedule C
The S Corp. is split into two incomes
- a salary (subject to SE Taxes)
- owners distribution or dividend
The corporation will actually pay you a salary, which will be need to run through a payroll system and you'll have to pay your Social Security and Medicare taxes through the payroll system, and then you will be able to take owner draws.
The salary IS subject to self-employment taxes of 15.3%, and
Distributions are NOT subject to the 15.3% self-employment tax
You will want to take as low of a salary as possible, but the IRS has instituted rules and laws to make sure that owners take what's called a reasonable salary from the S corporation.
How to take a reasonable salary from your S Corp.
You will have to work with an accountant, and take a reasonable salary, which is tied to your participation rates in the business, the going rate on your type of work, and do what is legally required by IRS caselaw and best practices.
Maximizing the s-corp comes down to making wise decisions in terms of your salary and distribution throughout the year, depending on how you participate in the business, and depending upon your overall business profitability.
Sentinel tax and accounting will help you maximize your salary and distribution decisions within your S Corp.
Converting from a regular soul proprietorship over to an S Corp. in Kentucky.
Here's how you would convert from a soul proprietorship LLC over to a S corporation in the state of Kentucky.
You will need to make sure that you have a great accounting system, and then what you'll do is file a 2553 form and register with your state.
There are some rules around when you could actually convert to an S corporation, and when we are working with our customers, will make sure that they know exactly how to convert to an S Corp., set up the proper paperwork, manage their escort properly, run their payroll, and then file the important year and taxes and financial statements.
What do you need to know is that a business owner and their accountant should be engaged throughout the year to make excellent decisions around their S corporation in order to maximize its tax reduction effectiveness.
2 - Using Super Tax Effective Retirement Plans
Your business could dump $58,000 into a retirement account for you, and avoid taxes.
Small business owners that are so proprietorships or S corporations have access to monumental tax mitigation tools with specialized small business retirement plans.
Unlike the regular 401(k)s and IRAs available to W-2 employees, a self-employed or business owner has access to totally different retirement plans
For 2022 - you could write off $58,000, avoid taxes on it, and put it in your retirement account (many rules and caveats here)
How to use a retirement plan to reduce your taxes
A business owner, can use one of these specialized small business retirement plans to not only invest in traditional stocks, bonds, ETFs and mutual funds, but they can also set up self-directed IRA’s.
What makes these small business retirement plans so tax efficient?
Because the government wants to make sure that people get help living in retirement, the United States government and even the Canadian government have set up incentives for businesses to encourage retirement savings and to make it beneficial for employers to match.
Employer & Employee Contributions
The tax savings comes in with an employer contribution from the business to the employee.
Remember when you worked at a corporate job and they offered a 4% match? The money that the company put into your retirement fund as a match, was called an employer contribution.
An employer contribution into a 401(k) plan, sep IRA, or simple plan, is a direct write-off within the business.
The money that the corporation puts into the retirement plan for the employee, essentially avoids many different types of taxes and then it will grow tax-deferred through the years until it’s dawn upon.
The employer contributions will essentially avoid self-employment taxes, and you will enjoy a large deduction within the business in the calendar year.
It's important for small business owners to remember that they cannot provide juicy retirement plans to themselves and their families, without offering it to their employees as well.
Single owner companies versus companies with statutory employees
When you have statutory employees, which are full-time employees that are not family members, you will be two non-discriminatory testing of your retirement plans.
You must offer your employees similar retirement plan contributions based on percentage of salary, you can't discriminate.
What you really need to know is that you cannot be greedy with your companies contributions to retirement plans and what your provide for yourself, to a degree, you will have to provide to your employees.
Generally speaking, you will choose a percentage of employee salary that will be used as a profit share contribution or a safe harbor match.
For example, using a sap IRA or a 401(k), the company can make a profit share contribution into every employees retirement account as a percentage of their wages, up to 25%. Not only can it not be over 25% of their salary, but it must not exceed the annual limits, or the catch-up limits, which for 2022 will be $58,000, with a $5,000 catch up for employees over the age of 50.
So you could decide to provide a 1 - 25% profit share contribution to everybody's SEP IRA or even 401k plan, and it will be a direct write off within the business.
Employer contributions to retirement plans are one of the most tax efficient transfers of wealth between companies and their employees.
What if you don't have employees?
If you don't have any employees, and it's just you and your family, or you and your shareholders, then you don't have to worry as much about the non-discriminatory testing.
In fact, if it's just you and you don't have any employees, a solo 401(k) or a sept IRA can provide massive tax write off's every year for you, and it will help you build significant amounts of wealth.
So to conclude, utilizing the proper small business retirement plans are an excellent way to reduce your taxes as a business owner and provide amazing benefits to your employees and yourself.
3 - Hiring your children
Family businesses get some tax reduction perks that nobody else does.
They are able to hire their minor children, and they won't have to pay self-employment taxes.
As long as the children are actually doing real work, and have a formal engagement, and they are not over the age of 18, and your business is not set up as a corporation, the wages you pay your children will not be subject to self employment taxes.
That means if you've converted over to an S Corp., you won't get quite as juicy of a tax situation as you would with a sole proprietorship, but usually, the S corporation is going to provide some significant tax savings.
Even if you can't take advantage of the family member self-employment tax benefits, hiring your children in your business, and paying them up to the standard deduction, can be a sweet way to start building wealth, start building employment history, involving them in the business and avoiding some taxes.
Remember, if you pay your kid (or anyone) up to the standard deduction, they don't owe any federal income tax on their wages.
Not only that, but you would be able to start providing different retirement plans, as well as bringing them along on company trips and they would also have the opportunity to invest in Roth and deductible IRA's.
So if you've gotten to the point where your federal income tax is getting pretty dramatic, you should hire your children in your business, in a formal manner, and start shifting that money out of your 1040, and onto the Childs.
Benefits of hiring your child:
- In a sole proprietorship, minor children won’t owe social security or medicare tax
- In an s-corporation they WILL owe FICA and Medicare
- With the standard deduction, they won’t pay income taxes on the wages up to that standard deduction (which is $12,950 in 2022)
- For single filers (that would be your kids!), they only owe 10% tax on the next $14,650 in wages.
You should pay your kids up to the standard deduction, and even into the 10% tax bracket.
If often makes sense to get kids earning $27,600 a year.
That's the combination of hte standard deduction tax bracket, along with the 10% tax bracket.
You'd owe only $1,465 in income tax on the $27,600*
(*for example purposes only, not legal advice)
That means, 0% owed on the first $12,950, then only 10% owed on the next $14,650 in wages (per 12/21 for the 2022 season)
Pay your kids up to $27,600 in a year, and they’ll owe the SE tax, plus only $1,465 income taxes.
Now imagine that $27,600 in wages given to your children’s wages were simply passed through to you, meaning you didn't pay your kid but paid yourself as usual.
If you were paying an effective rate of 30% , you would end up paying around $8,280 in income taxes.
Example of Paying Child vs. Paying Yourself
A: Pay the child $27,600 example:
15.3% SE Tax on the $27,600 = $4222
10% income tax on the 14,650 = 1,465
TOTAL TAX PAID BY PAYING CHILD: ~$5,680
B: Owner Takes the Pay in an S-Corp example:
If 50% fo the 27,600 was taken as salary - $13,800 is subject to the 15.3% SE tax.
SE Tax to the owner: ~ $2,100
If owner has 30% effective rate:
Income Tax to owner: $8,280
Total Tax if Owner Took it - $10,380
TOTAL TAX SAVINGS by paying a child $27,600 in an S-corporation:
$10,380 taxes paid by you vs $5,680 taxes paid by child
TOTAL TAXES SAVED: $4,700
If you were in a sole proprietorship and didn't have to pay the kids SE taxes, it would be DRAMATICALLY more.
BOTTOM LINE:
Hiring your minor children, to perform LEGIT business activities, might be a fantastic way to reduce your taxes, and build up your children’s income, work ethic and credibility. QUICK NOTE ON HIRIN YOUR CHILDREN:
You must set them up in a formal employment, pay them wages that are reasonable for the work, keep immaculate records and treat their finances like a real employee.
You don’t want to mess this up, and we can help you do it properly.
4 - Maximizing your Home Office
Since the pandemic, more and more people are using a higher percentage of their home to do business.
Many small business owners might not even have an outside office, and they're starting to invest heavily in transforming their home into a place of business.
If you do it right, you can transform your home office into an absolute Goldmine for tax reduction.
Generally speaking, you can summarize the tax reduction capabilities of your home office like this:
You can deduct the proportional amount of your utilities, mortgage interest, and other expenses that go into your expenses.
You cannot write off your principal payment on your mortgage no matter what.
In proportion to the amount of your home used for business, you write off everything that goes into your home by that percent. (decide what space, for what portion of time, is used for business)
There are a couple of different options you can take when determining your home office situation. In general, many folks are starting to take the proportion of square footage committed to 100% business activities, and then using that percentage to dictate the proportion of utilities, expenses and mortgage interest they would be able to deduct against the business income.
Improvements to 100% business use areas are HUGE write offs.
A new thing that has risen since the pandemic is people performing significant improvements to areas in their home that are 100% work environment.
For example, people are starting to build covered structures, pole sheds, small external buildings, and even transforming their basements into amazing studios and home offices.
While you're unable to write off the principal payment of your mortgage, any improvements that you make to these areas, could be able to be depreciated against your business income.
You should be working with an aggressive accountant that really understands the nuances around the home office deductions, generally speaking, there's some significant opportunities for write off's if you decide to transform and spend money building out business use portions of your home.
5 - Getting involved in investment real estate
Buy-and-hold real estate can be an incredibly difficult business, but our government has created massive amounts of tax reduction opportunities to incentivize folks who take the plunge.
Why are there so many great tax benefits for landlords and real estate investors? It's because our government wants to incentivize entrepreneurs and capital to help provide housing and infrastructure.
If you have a company that owns a building and then rents it out, whether it's a commercial building that would lease to a business, or if it's a building that you would lease out to residential tenants, the income generated from being a landlord is considered passive income.
The passive income generated from rental activities is not subject to self-employment taxes.
In order to become incredibly tax effective as well as shrewd in your business, it makes sense to work up to a point where you have one company that owns real estate, and then create a lease agreement between that company and your regular business company.
EXAMPLE
LLC owns a building
Your S-Corp Rents from it.
The LLC doesn’t pay SE Taxes
Not only will the income from the rental real estate not be subject to self-employment taxes like it would in a regular business activity, but you also get the benefits of leveraging depreciation, bonus depreciation, cost segregation and other sweet tax benefits that tends to lower your effective tax rate on that income.
Not only is the income from your real estate incredibly tax efficient, in general, you simply had to put up 20% as a down payment in order to borrow much much more from your lender.
You only have to put up 20% of the total investment, while the bank does the rest.
That means you can use leverage to get income producing properties.
It might seem really overwhelming to think about getting involved in real estate, but we can't emphasize enough, that real estate provides business owners incredibly effective tax reduction opportunities and it's worth planning for and saving up for in the future.
Let us Deep Dive Your Tax Return for Tax Savings
If you like the idea of reducing your taxes, than please book a consultation with us here at Sentinel, and we'll make dark sure you're doing everything possible to reduce your taxes, and we'll also make your life much easier by tackling all the bookkeeping, accounting, payroll and reporting.
We're here to help your business be more profitable, scale to new heights, and truly thrive.
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