5 Ways Small-Business Owners Can Reduce Their Taxable Income

While the Tax Cuts and Jobs Act of 2017 eliminated or reduced tax deductions for many individuals, if you own a small business you still have a variety of breaks available to you. Here are five simple ways to reduce your taxable income and keep more of your money.

1. Employ a Family Member

One of the best ways to reduce taxes for your small business is by hiring a family member. The Internal Revenue Service (IRS) allows for a variety of options, all with the potential benefit of sheltering income from taxes. You can even hire your children.

For example, if your business is a sole proprietorship, you can hire your spouse as a paid employee. Their income will be subject to federal income tax and Federal Insurance Contributions Act (FICA) taxes for Social Security and Medicare but not to federal unemployment tax (FUTA), as long as they are a legitimate employee and not a partner in the business.

How your children will be taxed depends on their age. All children will be subject to federal income taxes on their wages. Children under 18, however, are not subject to FICA taxes, and those under 21 are not subject to FUTA taxes. Part of the benefit to you in hiring a child under 18 is that FICA taxes on employee wages are generally split between employer and employee, with the employer paying half; currently each pay 6.2% for Social Security and 1.45% for Medicare. In this case neither of you has to pay. Note that different rules apply if your business is set up as a corporation.

Hiring a child can mean an even bigger benefit for them. Having earned income allows them (or you on their behalf) to put money into an individual retirement account (IRA). While their retirement may be many decades in the future, starting early can give them a big jump on building a sizable fund for when the day finally comes. In particular, you may want to consider a Roth IRA, which will allow them to take their eventual withdrawals tax free.

2. Fund a Retirement Plan for Yourself and Others

Small-business owners have several retirement plan options that aren’t available to people who work for someone else and can result in a significant tax deduction. They include:

• One-participant 401(k) plan: A one-participant 401(k) plan allows you to defer as much as $69,000 (for 2024) in income if you’re under 50. If you’re 50 or older you’re eligible for an additional catch-up contribution ($7,500 in 2024). Although called “one-participant” or “solo” plans, this type of 401(k) can cover both you and a spouse. If you have other employees, you can set up a conventional 401(k) plan as an alternative.
• Simplified employee pension plan (SEP): A SEP IRA is easy to set up and administer, making it a good choice for busy small-business owners. Unlike one-participant 401(k) plans, a SEP can also be used to provide retirement benefits for other employees (in some instances you are required to provide them). Contribution limits in 2024 are the lesser of 25% of compensation (net earnings from self-employment in the case of self-employed individuals), capped at $345,000, or $69,000. In addition to being able to contribute to their own account and take a deduction, business owners can also take a deduction for their contributions to their employees’ accounts.
• Savings incentive match plan for employees (SIMPLE) IRA: Small businesses with 100 or fewer employees are eligible to set up a SIMPLE IRA, which, unlike the two plans described above, can be funded by both employer and employee. The employer must either match up to 3% of eligible employees’ contributions, which can’t exceed $16,000 for 2024 ($19,500 with a catch-up contribution), or contribute 2% of compensation to every eligible employee’s account, regardless of whether the employee contributes (up to a salary of $345,000). As an employer is also an employee of the business, they may choose to match their own required employer contribution.

3. Save Money for Healthcare

Another good way to reduce the taxes on your small business is by putting money aside for your future healthcare needs. Medical costs continue to increase, and while you may be healthy now, having some extra money on hand for medical bills could be a lifesaver. You can accomplish this through a health savings account (HSA) if you have an eligible high-deductible health plan (HDHP). What’s more, those who are self-employed can often deduct the cost of health insurance premiums for themselves, their spouses, and children up through age 26.

You fund an HSA with pretax dollars, thereby reducing your taxable income, and any withdrawals you make are tax free as long as you spend the money on what the IRS considers “qualified medical expenses.” In the meantime the interest or other earnings on the account grow tax free. For 2024 the contribution limits are $4,150 if your high-deductible plan covers only you, or $8,300 if it covers you and your family. As an added benefit, the funds in your HSA account roll over from year to year and never expire.

4. Change Your Business Structure

You can choose to structure your small business in a number of ways, and changing that structure may be able to save you some money in taxes. The major options include:

Each can have tax advantages and disadvantages from both a federal and state perspective. Some businesses are taxed on the corporate level, while others pass their income through to their owners, who are then taxed on it as individuals. Pass-through entities generally include sole proprietorships, partnerships, LLCs, and S corporations.

Florida, for example, doesn’t have a personal income tax, but the state imposes a 5.5% corporate income tax on certain businesses. Ohio, on the other hand, taxes personal income but allows taxpayers to deduct up to $250,000 in business income from sole proprietorships and other pass-through entities. Texas doesn’t tax either personal or business income, but it does impose a franchise tax on corporations, S corporations, and LLCs.

5. Deduct Travel Expenses

If you travel as part of your business, you may be able to reduce your taxes. Business travel is fully deductible, as long as it isn’t “lavish or extravagant,” but personal travel doesn’t enjoy the same benefit. However, to maximize your business travel deductions, you can combine personal travel with a justifiable business purpose. Any frequent flier miles you earn on your credit cards from business travel can also be redeemed for personal travel later on.

The Bottom Line

If you own a small business, the above five strategies will reduce your taxable income and keep more of your money working for you. In some cases, such as deciding on a business structure, consulting a tax professional who is knowledgeable about small businesses can be well worth the cost.