Tax Loopholes for Small Businesses
“I’m looking for as many tax loopholes for small businesses as possible” the prospect exclaimed and grinned as He sat across from me.
“Tax loopholes for small businesses you say?” I replied, “I think I know what you mean by tax loopholes for small businesses, but here’s a better way to think about taxes.” I dove into what I cover with all of our prospective clients to help them start to think about how to reduce the biggest bill you’re ever going to pay – TAXES.
Tax Loopholes for Small Businesses
First off, we are Nuance Financial Tax & Accounting out of Lakeville Minnesota. We help small businesses focus on what they do best, by serving as their outsourced accountants, tax advisors, bookkeepers and payroll specialists; that’s our mission or “what” we do. Our purpose is twofold, to help maximize their efforts and help them build a business that will last for generations.
There are three outcomes we hope to have for our small businesses:
1 – Taxes Reduced: They would save in taxes, paying their fair share and not a penny more.
2 – Compliant: They would be 100% compliant in all measures of payroll, tax, bookkeeping and other financial ares
3 – Empowered: They would be empowered to effectively manage, lead, and steward their company by having helpful financial information.
Tax Loopholes for Small Businesses are things that entrepreneurs are often looking for because the media has used the word “tax loopholes” to describe the advantages that mega corporations have arranged. Mega-Corporations have advantages that the small businesses will never have, but that’s primarily because of corporate cronyism and sweetheart laws. But “everyday Joe’s” can align themselves to get the same “Tax loopholes for small business” that the big guys get.
What are the Tax Loopholes for Small Business? NOTHING! There are no “tax loopholes”, but business owners and investors can build a tool-box of tax mitigation tools. So instead of tax loopholes, I’m going to show you two great tax mitigation tools that empower a business owner to take advantage of the tax laws meant to create jobs and housing.
Tax Loopholes for Small Businesses is all about building a tool box of tax mitigation tools and tax advantaged strategies.
The Two Biggest Tax Loopholes for Small Business:
The government wants to stimulate jobs, housing, agriculture, energy and some other public services. This means that the IRS code is written in a manner to give tax advantages to parties that would like to get into the business of creating jobs, housing, food, development, and other stimulating ventures. The two primary tax advantages that can be taken advantage of for the small entrepreneur (and large) is the tax advantages for creating profitable corporations and housing through buy-and-hold real estate or “rental real estate”.
The Two Primary Tools in the Tax Mitigation Tool Box:
TAX LOOPHOLE FOR SMALL BUSINESS #1 – Become an S-Corp
A great book called the E-myth, lays out a simple road map that entrepreneurs should try to follow.
Start as the “technician” of your business, doing all the work yourself.
Move to be the “manager”, by hiring some people to help you so that you can leverage the efforts and time of other people. Building your brand over time.
Then the last step is when you’ve systematized your business and replaced yourself as the manager so that the business operates itself.
When you do these types of things, you create jobs. You were once an employee, but now you’ve gone on to create multiple jobs. This is REALLY good for the economy, and is truly the root of what economic growth is all about. The government knows this, and has created some broad incentives to business owners to make some of these types of steps.
One of the greatest opportunities to mitigate taxes is to move from being a self-employed sole proporiter or LLC taxed as a sole proprietor, to become an S-corp. The first tax loophole for small businesses is to become an S-Corp if your profit is appropriate.
REQUIREMENTS of S-Corp
a – Payroll: you need to have a payroll system to pay in those social security and medicare taxes on a consistent basis since the government has spent that money already (I can’t resist chiding the insatiable federal government).
b – Legal Documents you need to have some corporate documents, meetings, and take minutes. You’ll also need some operating documents to ensure you’re really acting like a corporation.
c – Bookkeeping: you’ll need to have really good accounting, so that you’re making bona-fide actions to the IRS, states, unemployment insurance, etc. The idea is to be careful of what you’re doing.
The tax loophole for small business which is the S-Corp requires some planning. Essentially you’re own income can be taken in two parts; you pay yourself a salary and then take owners “distributions” or “dividends”
Two types of ownership income from an S-Corp:
a – A Reasonable Salary according to many tests
b – The owner’s distribution or dividend.
The salary is subject to the 15.3% self employment tax up to the social security limits, and the distribution is NOT SUBJECT to the self employment tax. That means for every $10,000 in net profit that is taken as a distribution rather than a salary, you’ll see $1,530 in self employment taxes.
THE KEY – you need to take a “Reasonable Salary”. The market conditions, your industry norms, the economic environment, your competitors, and your Profit and Loss statement should all inform this. You need to be taking a salary throughout the year through a payroll system to truly make this the smoothest and most complaint situation.
The firs tax loophole for small businesses can save you MASSIVE amounts in self-employment taxes.
Tax Loopholes for Small Businesses, Not for W-2 Employees
Final Thought Here- if you are a W-2 employee for a corporation, you are extremely limited in the amount of “tax loopholes” you can use. In fact, there is pretty much nothing besides your retirement plans, 401k, IRA’s, and mortgage interest deduction for major tax mitigation.
The W-2 employee often has some temporary security in their job, and they have a simplified situation tax and logistics wise. But employees are subject to the decisions making of the business owners, and their simplicity means that you are a slave to the marginal income tax system of the united states; the more you make, the government gouges you more and more. The tax code provides very bad incentives to employees, and provides them to business owners and real estate professionals.
Much of why entrepreneurs and certain industries have tax code sweetheart deals is because of corporate cronyism and lobbyists, but the core is that there are few incentives for regular employees in the tax code as of now.
Tax Loophole for Small Business #2 – Get into Rental Real Estate
The second tool for tax mitigation that could be called the second of the “Tax Loopholes for Small Business” is real estate.
The government has many reasons to ensure that people are taking time to provide an array of housing. They want housing that spans the entire price gamut, and they want options for people who want to buy and for those who want to rent.
The result is that people who invest in real estate get some key advantages that other industries cannot have.
Two Basic Types of Real Estate Investing:
a – you can Buy and Hold Real Estate, renting it out to tenants of various types.
b – you can buy, “fix up”, and then sell. This could be developing land, or it could be buying distressed inventory and doing what Chip and Johanna Gaines do in “Fixer-Upper”
Three Benefits of Rental Real Estate – The real tax loophole for small businesses.
a – Passive Income: Income from a property that has been rented out is considered “passive income”, which means that it is NOT subject to self employment taxes. This is incredibly important because it means that this income is not like your small business activities that would generate taxes.
b – Depreciation: The income from renting out real estate is passive income, and you also get to take the value of the things that wear out, and write them off over a number of years. You can take the value of the property minus the land, and depreciate it over 27.5 years for residential property and 39.5 years for commercial. Not only do you get to depreciate the property, but you can also have a “cost segregation” performed, where an engineer and CPA examine the building for certain items that decay faster, so that they can be depreciated faster than the 27.5 or 39.5 years.
The result is that the passive income can be offset by lots of depreciation, which reduces your taxable income.
c – Entrepreneur: This is the prime opportunity for a person who is not a business owner to become one. You can create property management companies, lawn companies, construction companies, snow removal, accounting, bookkeeping, and other companies that could service the LLC which holds the rental property.
These other companies can mean that you and your spouse start to work together in a manner that you enjoy, that also makes profit. You could hire children or grandchildren in these other companies, and there are tremendous opportunities to pay them in a tax advantaged manner depending on the situation.
The bottom line is that rental real estate can be the start of becoming a new Real Estate Professional, which has even more benefits that allow you to carry over huge paper losses against ordinary income IF you qualify as a bona-fide real estate professional.
IF you want to find tax loopholes for small businesses, the best way is to position yourself to take advantage of the tax tools available to reduce taxes; rental real estate and the S-Corporation. After this, there are man other strategies available, but these are the big nuggets!