Starting a new business is stressful enough without worrying about all of the tax compliance that comes with it. Between sales taxes, payroll taxes and income taxes, it’s enough to start your head spinning. Fortunately, you can take advantage of these five tax benefits to keep more of your hard-earned income in your pocket and keep your new business growing!
#1 – Using losses to create a tax benefit
Most businesses that start from scratch project losses in the first couple years while they build up brand awareness and develop the business infrastructure. Often these losses can be used against other taxable income on your tax return to reduce your overall tax bill. Let’s show an example of how you can figure out the tax benefit of your losses:
Let’s say you have losses in the first year of your business of $20,000 while your spouse earned income from his or her job of $90,000. You may be able to use the $20,000 of expenses to offset the $90,000 of income your spouse made during the year. To figure out the tax impact of the losses, figure out your marginal tax rate (your highest tax rate or in other words, the rate at which your last $1 of income was taxed) and multiply the amount by your loss to get a rough estimate of your tax benefit. In this case, if your marginal tax rate is 25% and your state tax rate is 6%, a loss of $20,000 would roughly save you $6,200 in taxes. If you are creating a cash flow business plan for the first years of your business, don’t forget any potential tax refund from planned business losses the first year. Refunds can be reinvested into your business to speed up your growth.
There are other factors that go into which expenses you can deduct currently as you open your business and which expenses you must wait to deduct. There are expenses that you may incur which will require capitalization and amortization over time and also rules on when you can deduct start-up expenses. If your loss is large enough, it could create a net operating loss (NOL) which has complicated rules as well. Working with a CPA that can go over your new business expenses and understands these tax rules is key to getting the most tax benefit.
#2 – See if your business is eligible for tax credits
There are many tax credits out there for certain business expenditures depending on the industry. I’ve listed a few below you should check out and see if they apply. Check on the state level as well.
- Research and Development Credit – A credit for companies that incur research and development costs.
- Work Opportunity Credit – a tax credit available to employers who hire and retain veterans and individuals from other target groups with significant barriers to employment.
- Credit for Small Employer Pension Start-up costs – Employers can claim the credit for qualified startup costs incurred in establishing or administering an eligible employer plan like a 401(k).
#3 – Deduct the costs of growing your business
As you hustle to increase your business, keep track of important tax deductions you can use as you meet with clients. Hotels, travel, parking are all 100% deductible as long as the travel is associated with ordinary and necessary travel for your business. Meals alone away from home are 50% deductible while traveling but once you come back home, meals alone are no longer deductible. Consider bringing a client or prospect and talk business to make your meals 50% deductible again! You can also deduct the business use percentage of your cell phone. So if you use your cell phone for business 50% of the time, you can deduct 50% of the bill.
Business mileage is also deductible. You can take a deduction for your actual business mileage multiplied by the IRS Standard Mileage rate that adjusts for inflation each year.
Make sure you keep good documentation of your business expenses. For business meals, document who you were with and what business you discussed. For business mileage, use a mileage log. There are several good apps such as Mileage IQ you can use to help make documentation a breeze.
#4 – Large deductions are available for equipment
For years, the IRS has allowed very favorable deductions for equipment associated with your business. A large up-front deduction can be a cash flow saver early on for your business.
Section 179 deduction – Named after the code section to which it relates, the Section 179 deduction allows you to completely expense most equipment in one year. However, your business will need net income to take the Section 179 deduction.
Bonus depreciation – A 50% deduction in the first year purchase of new equipment.
Deciding which depreciation method is best for you is something your CPA can help you consider. Considerations such as expected future income and large deductions other than depreciation could move you to defer your depreciation to later years once your business ramps up and you are in a higher tax bracket.
#5 – Deferring income with a retirement plan can create large tax deductions
Retirement plan contributions offer a large tax deduction if you have the cash flow available. Although start-up businesses are often reinvesting profits early on, utilizing the right strategy can create an excellent tax benefit.
For instance, if you and your spouse are already in the highest tax brackets and have other money outside of your retirement plans, using the net income from your business to fund a retirement plan can give you the opportunity to defer your income from tax rates as high as 50% when considering federal, state and employment taxes. The next step is selecting what retirement plan is right for your business. The funding level and plan type can always change as your business changes.
Embarking on a new business opportunity can be an invigorating experience! Take the frustration out of taxes by implementing these five steps for savings.