5 Key Tax Strategies for Entrepreneurs: What You Need To Know

DGLimages / iStock.com

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

The United States tax code can be a complex beast, and many small business owners and entrepreneurs don’t take advantage of all of the deductions and strategies at their disposal.

Getting a handle on which taxes you may face is the first step toward managing them effectively. Primarily, you’ll deal with two types of taxes: income tax and self-employment tax.

• Income Tax: Just like anyone else who earns an income, entrepreneurs must pay income tax. This tax is based on your earnings, but calculating it isn’t as straightforward as it sounds because not all income is taxed the same way.
• Self-Employment Tax: If you’re self-employed, this tax covers your contributions to Social Security and Medicare. Many people are surprised by their self-employment tax bills because, unlike employees who share this tax burden with their employers, entrepreneurs are responsible for the full amount.

One of the first things you should do is check the tax brackets for your state and federal taxes. Tax brackets are ranges of income taxed at particular rates, which progress higher as income increases. The first portion of your income will be taxed at a lower rate; as your income grows, the excess is taxed at higher rates. Sometimes, if you have a record year, you may be able to defer some of your income to the next tax year so you end up paying less overall.

Before implementing any tax strategies, it can be a good idea to consult with a qualified tax professional. Here are a few key strategies you can use as a business owner to save on your tax bill.

Reducing Adjusted Gross Income

Your taxes are paid on your adjusted gross income. Your AGI is your total gross income (all the money you or your business receives) minus specific deductions you’re allowed to take before your taxes are calculated. Lowering your AGI can reduce how much you owe in taxes and help you qualify for tax benefits that phase out at higher incomes.

Contributions to retirement accounts such as traditional IRAs or 401(k) plans are deductible and directly reduce your AGI.

If you have a high-deductible health plan, contributing to a health savings account is another way to reduce your AGI. These contributions are pre-tax or tax deductible, and the funds can be used for a wide range of medical expenses.

Look into other deductions for which you might be eligible. Common examples include the home office deduction, educational expenses and business expenses such as travel, supplies and equipment necessary for your business.

Make the Most of Vehicle and Home Office Deductions

Many entrepreneurs and small business owners already use their own homes and vehicles for their companies. However, many of them don’t take full advantage of that come tax time.

For many entrepreneurs, using personal assets such as vehicles or homes for business can create opportunities for deductions that reduce taxable income. To maximize deductions for the business use of a personal vehicle, track all business-related mileage and expenses.

The IRS allows you to choose between the standard mileage rate deduction or actual expenses like gas, repairs and depreciation. Which one makes sense for you may depend on your location and the real costs of your vehicle and gas. If you have an expensive vehicle, you might benefit more from deducting real expenses. If your vehicles are cheaper and you drive long distances, you might benefit more from the per-mile deduction. 

Remember to keep detailed records in either case — you will need them to support your claims in case of an audit. 

If your principal place of business is a home office, you might be eligible for the home office deduction. This allows you to deduct a portion of expenses such as rent, utilities and maintenance proportionate to the size of your home office. The space must be regularly and exclusively used for business to qualify.

Pick the Right Retirement Plan

You might be able to save more money on taxes by choosing the right retirement plan and contributing to it regularly.

A traditional IRA plan allows individuals to make pre-tax contributions, which reduce taxable income for the year those contributions are made. The funds grow tax deferred until retirement, when withdrawals are taxed as ordinary income. 

More robust than a traditional IRA, a 401(k) allows for higher contribution limits — in 2024, that’s $23,000 vs. $7,000 for an IRA. Like the IRA, contributions to a traditional 401(k) are made pre-tax, reducing taxable income. Many businesses can also set up a 401(k) to match a portion of employee contributions, enhancing benefits for employees and providing additional tax deductions for the business.

Cash balance plans can be a good choice for higher-income earners. These plans are a type of defined benefit plan that credits the participant’s account with a set percentage of their yearly compensation plus interest charges. Contribution limits can be significantly higher than those for IRAs and 401(k)s, depending on age and income.

Use Benefits as Part of Employee Compensation

Fringe benefits are additional compensations provided to employees beyond their standard wages. Under certain conditions, these can be excluded from taxable income. If you offer benefits as part of total compensation you may reduce the total amount of payroll taxes you owe.

Some of the most common tax-exempt fringe benefits include medical insurance, life insurance up to certain limits, educational assistance and transportation reimbursements. If you provide your employees with health insurance, the premiums you pay are deductible for the business, thus not subject to payroll taxes.

Transportation benefits, such as transit passes or parking fees, also can be provided tax-free up to a certain limit each month. Retirement benefits, dependent care assistance and even meals provided for the convenience of the employer (like meals during work hours) might qualify as tax-exempt benefits.

Optimize Employee Reimbursement

If your business has employees and you ever need to reimburse them for business expenses, you should have an accountable plan. An accountable plan is a system that allows you to reimburse employees for out-of-pocket expenses without those reimbursements being counted as income. This means your employees don’t pay taxes on the reimbursement, and you don’t pay extra payroll taxes. 

For a reimbursement to be covered under an accountable plan, the expenses must be business-related and adequately accounted for to the employer within a reasonable time. Any excess reimbursement must be returned to the employer.

Share This Article: