Key Takeaways
• Running a small business can provide several lucrative opportunities to lower your tax bill.
• Compared to filing taxes as a W-2 employee, small business owners can deduct more expenses to keep money in their pockets.
• Self-employed people can split some expenses shared for business and personal use as deductions on their tax returns.
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7 ways to lower your tax bill as a small business owner
Owning a small business means wearing multiple hats. You’re likely more focused on running the business than optimizing your tax efficiency. However, you’ve got several options for lowering your tax bill through popular small business tax deductions. In turn, you can reinvest these savings back into your business.
Below are seven small business tax deductions you can use to lower your tax bill.
1. Pay for health insurance
There’s no denying it, buying health insurance can be costly. Fortunately, the IRS has special advantages for self-employed people who pay for their own insurance. If you work for yourself and pay for your own health insurance, you may be able to lower your tax bill.
Workers who receive health insurance coverage through their employer often share the cost of those premiums. But if you work for yourself as a freelancer, independent contractor, gig worker, or generally as a self-employed person–and you can’t receive health insurance coverage through your spouse–you may be able to claim the self-employed health insurance deduction.
If you meet the requirements for claiming this deduction, you may be able to deduct all or part of your insurance premium. The adjustment you claim might be limited to your net profit and any other earned income from the trade or business under which the insurance plan is established. This can lower your tax bill, saving you money each year you qualify for claiming the deduction.
The deductibility extends to self-employed individuals for medical, dental, vision, and long-term care insurance premiums. You can also claim the deduction for your spouse or any qualifying dependents age 26 or younger at the end of the tax year.
2. Save for retirement
As a small business owner, you have several tax-advantaged retirement savings options to consider for maximizing your retirement savings and reaping tax benefits. If you are self-employed without any employees, you might consider establishing a single-participant 401(k) plan, often called a “Solo 401(k).” This allows you to save up to 100% of your income as an employee contribution, up to the annual limit. In addition to the employee contribution, you might also be eligible for an employer contribution based on your net income from self-employment.
In 2022, you may be able to contribute up to $61,000 to your solo 401(k), up from $58,000 in 2021. Additionally, you can contribute an extra $6,500 if you’re 50 or older through a catch-up contribution.
Another option to consider is the Self-Employed Person Individual Retirement Account, or SEP IRA. This retirement account allows you to save up to 25% of your income in the account and has similar contribution limits as a solo 401(k) ($61,000 and an additional $6,500 for those age 50 or older).
You’d want to consider a Solo 401(k) if you’re self-employed or working a side gig in addition to your primary employment because you can often set aside more money than through your employer’s retirement plan.
You’ve also got the ability to contribute to Traditional and Roth IRAs, further lowering your tax bill.
And if these tax savings aren’t enticing enough, you may also be eligible for claiming the Saver’s Credit worth up to $1,000 ($2,000 married filing jointly) just for contributing to your retirement account. The Saver’s Credit can be claimed for your contributions to a 401k, 403(b), 457 plan, a Simple IRA, or a SEP IRA. Your contributions to a traditional IRA or a Roth IRA are also eligible for the Saver’s Credit.
3. Claim the qualified business income deduction
If you report business income on your personal tax return, you may be eligible to claim the qualified business income deduction, also known as the Section 199A deduction. Entities eligible to claim the qualified business income deduction include:
The qualified business income deduction allows eligible self-employed people and small business owners to deduct up to 20% of their qualified business income on their taxes. Generally, if your taxable income is under $164,900 for single filers or $329,800 for joint filers in 2021 or $170,050 and $340,100 in 2022, respectively, you may qualify. If you earn more than your applicable income limit, you may receive a prorated deduction.
If you meet the above requirements, you’ll also need to understand what goes into your “qualified business income.” Generally, the IRS defines it as “the net amount of qualified items of income, gain, deduction and loss with respect to any trade or business.” That means income, gains, losses, and expenses incurred as part of your business.
What it doesn’t mean is:
- Capital gains or losses
- Dividends
- Interest income
- Income earned outside the U.S.
- Certain wage and guaranteed payments are made to partners and shareholders
If your business is considered a specified service trade or business, the Section 199A deduction does not apply when taxable income is above $429,800 for joint filers and $214,900 for other filers in 2021. If your taxable income is between $329,800 and $429,800 for joint filers and between $164,900 and $214,900 for other filers, claiming the deduction is partially allowed as a specified service trade or business. Examples of specified service trade or business include doctors, lawyers, financial planners, consultants, and other professional services.
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4. Using your car for business purposes
Depending on the nature of your business, you may need to drive as part of your work. If you choose to buy a company vehicle, it could result in lower taxes through deductions the IRS makes available to small businesses.
You can generally figure the amount of your deductible car expense by using one of two methods:
- Standard mileage rate. The IRS allows you to deduct expenses related to operating and maintaining your business vehicle per mile driven. In 2022, the standard mileage rate is 58.5 cents per mile from January 1 through June 30 and 62.5 cents per mile from July 1 through December 31. To determine the number of miles driven for business, you’ll need two numbers for your business vehicle (or vehicles): the total number of miles driven during the year and the total number of miles driven just for business. You’ll need to log your business miles to make sure you only deduct those miles driven and not for personal use. This will also need to be mileage driven above and beyond your normal commute between your home and workplace.
- Actual expenses. The IRS allows you to tally all of your auto-related business expenses and use this method for calculating the allowable deduction on your car as an alternative to the standard mileage rate. Deductible expenses include costs like gas and oil, maintenance and repairs, tires, registration fees and taxes (also deductible under the standard mileage deduction), licenses, rental or lease payments, insurance, and more. Again, you’ll need to keep track of how much you used your vehicle for business versus personal use. Based on the percentage used for business, you can deduct the applicable amounts of your actual vehicle expenses if it saves you more money on your taxes.
5. Depreciation expense
Owning equipment is often an essential part of a functioning small business. As these assets age and experience normal wear and tear, their value depreciates. The IRS allows you to offset a portion of your income equivalent to the asset’s reduction in value over its useful life.
However, depending on the assets you buy, you might have a few means for claiming a deduction for depreciation:
- Section 179 deduction. Section 179 expensing simplify your bookkeeping, giving you a large deduction in the first year the asset is placed in service. In 2022, you can deduct up to $1,080,000 from your business income.
- Bonus depreciation. This differs from Section 179’s fixed maximum deduction amount by allowing you to deduct a large percentage of the purchase price of eligible assets. The Tax Cuts and Jobs Act of 2017 doubled the bonus depreciation deduction from 50% to 100%, meaning you can deduct the entire purchase price of new or used equipment you’ve purchased and placed into service.
- MACRS depreciation. The Modified Accelerated Cost Recovery System allows businesses to take larger tax deductions in the early years of an asset’s life and smaller deductions in later years. This allows businesses to reduce their taxable income today but increase it later as compared to using straight-line depreciation. This gives you a lower net present value of your tax burden, saving you money.
Investing in your company allows you to deduct these expenses all at once, or over several years. In either situation, the depreciation deduction lowers your taxable income, reducing your tax bill.
For vehicles used for your business, you may be able to claim a deduction for depreciation from your income. But before you splurge on a fancy vehicle to write off your taxes, you should be mindful of the rules the IRS has in place regarding luxury autos.
For new and pre-owned vehicles put into use in 2021 (assuming the vehicle was used 100% for business), the maximum first-year depreciation write-off is $10,200, plus up to an additional $8,000 in bonus depreciation.
If you’ve purchased an SUV with a loaded vehicle weight of over 6,000 pounds, but no more than 14,000 pounds, 100% of the vehicle’s cost can be expensed in the year of acquisition using bonus depreciation, which is treated as an actual expense.
TurboTax Tip: Congress extended certain bonus depreciation rules until January 1, 2023. Unless it is further extended, the first-year bonus depreciation goes down by 20% each year until disappearing on January 1, 2027.
6. Home office deduction
A home office deduction is a valuable tool small business owners can use to reduce their tax bill each year. Claiming it requires you to meet one of two criteria:
- Exclusive and regular use: You must use a portion of your house, apartment, condominium, mobile home, boat, or similar structure exclusively for your business on a regular basis. This also includes structures on your property, such as an unattached studio, barn, greenhouse, or garage. It doesn't include any part of a taxpayer's property used exclusively as a hotel, motel, inn, or similar business.
- Principal place of business: Your home office must be either the principal location of your business or a place where you regularly meet with customers or clients. Some exceptions to this rule include daycare and storage facilities.
Exclusive use means only business activity is conducted inside the office. This doesn’t mean you need to rush out if you get a personal call unrelated to business or no family member can go into your office. Instead, the IRS looks for you to meet the spirit of the exclusive use test as long as personal activities invade the home office no more than they would be permitted to happen inside an office building.
The office needs to be clearly defined and separate (even with a wall partition) from other areas of your home to qualify. Further, you need to use the home office as your principal place of business regularly.
7. Financing costs for the business
The IRS allows you to deduct most of the financing costs you pay for your business, such as fees and interest on loans, credit cards, and other forms of credit. However, you’ll need to meet certain requirements on some finance charges you pay on loans you take for capital assets used in your business. Further, you might not be able to deduct interest on any loans that charge non-deductible interest. That said, unless the interest you pay is subject to special limitations, it counts as a deductible business expense on your taxes.
Some examples of deductible financing costs you might need to take on for your business are mortgage interest on an office building, financing charges built into a lease contract, or fees associated with calculating invoices with extended payment terms.
Employ tax planning for your small business
In small businesses, every penny counts. If you can lower your tax liability, it may result in extra profit you get to keep—or reinvest in your business. Fortunately, the IRS has provided several opportunities to lower your tax bill as a small business owner.
Some of these require tax planning in advance, such as choosing the right vehicle for your business, suitable retirement account contributions, and more. To make the most of the deductions available to you, consider working with a tax professional who can identify your unique needs.
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