The Brass Tacks on Small Business Taxes - Part 1, Ep #35
Small business owners have much to consider to maximize their tax savings. In this episode of the One for the Money podcast, I share strategies that small business owners can consider to save on taxes. As there are many strategies to consider, this will be the first of two episodes on the subject. In the tips, tricks, and strategies portion, I share an additional business tax strategy utilizing the home office deduction.
In this episode...
Small businesses and the economy [01:10]
What are payroll taxes? [03:20]
Saving for retirement as a business owner [04:58]
Personal Defined Benefit Plans[10:29]
The home office tax deduction [13:37]
The importance of small businesses
Most of us are familiar with prominent companies here in the United States, but the majority of companies in the U.S. are much smaller. In fact, 99.9% of businesses across the country are small businesses. Despite their minimal size, their importance cannot be understated. Over the past 25 years, small businesses have added nearly two out of every three jobs to the economy. Because of the incredible importance of such businesses, I want to share some provisions the tax code has that small businesses should know.
Taxes for the self-employed
Nearly eight in ten businesses have no employees besides the owner. Often individuals are paid as independent contractors or 1099s. However, these individuals may want to add themselves to the ranks of business owners and incorporate instead of being paid as a 1099 employee. Being a corporation can save money on payroll taxes. Social Security and Medicare are the two most common examples of these taxes paid to the government for social programs. Collectively, they are called your FICA taxes. Employees contribute 6.2% to Social Security, and employers make a matching contribution. Employees also make a 1.45% contribution towards Medicare, which employers also match. Altogether that’s 15.3% of a person’s income being contributed before any state and federal income taxes.
Taxes are even more expensive for the self-employed because they must pay both the employee and the employer contributions. Individuals who receive a W2 pay a total of only 7.65%, while sole proprietors pay double that. But, self-employed individuals can form a corporation, and the IRS allows corporations to pay employees a reasonable wage. The rest of the funds can be transferred as a quarterly distribution instead. There are expenses to consider and rules on reasonable wages and distributions, so you would want to enlist the work of accounting professionals with this area of expertise.
Retirement plans for business owners
As the business owner, you are solely responsible for saving for your retirement as there isn’t a company making a matching contribution from your employer. Many business owners reinvest much of their money into their businesses but miss out on years of investments compounding in the stock market. Diversifying investments outside of your business is critical, and doing so early, even in small amounts. The best thing you can do to increase your investment returns is to increase your time horizon. Small amounts can grow to enormous sums given a lot of time.
A self-employed individual has several options for saving for retirement, and choosing the right one ultimately depends on income. The simplest option is an Individual Retirement Account, either Traditional or Roth. These types of accounts are only taxed once with ordinary income taxes. You decide when. With a traditional IRA, taxes are applied in retirement. With a Roth, taxes are applied now. There are many factors to consider, so it’s recommended that you check with a certified financial planner.
Securities and Advisory services offered through LPL Financial. A registered investment advisor. Member FINRA & SIPC.
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