Why We Love Small Business Taxes

(And why you should too!)

Written by Tom Yeung, CFA | CDFA Investment Advisor & Fund Manager, Jurnex Financial Advisors

Small business owners have always had a tax advantage: their ability to deduct expenses to reduce taxable income. And in 2018, the US government made these deductions even MORE powerful through the Tax Cuts and Jobs Act (TCJA). These changes transformed how small business taxes worked, making small business tax deductions even better than before. These new deductions came with certain caveats, however, so it’s essential for you to reach out to a qualified tax pro before starting to use them to their full extent.

But to get you started, we’ll cover why we love small business taxes, and why you should too.

What are small business taxes?

When it comes to taxes, what’s the difference between small businesses and large corporations?

In general, the IRS views any company with less than $25 million in gross receipts as a small business. However, the lines aren’t always clearly drawn. For example, the IRS uses the Affordable Care Act guidelines when it comes to giving healthcare tax credits (less than 50 employees). But when it comes to deciding S-Corporation status (covered later in this article), the IRS uses a 100-member cutoff instead.

Regardless of the definition, most people will agree that small business taxes include ANY taxes paid by:

• • Sole proprietorships
  • Partnerships
  • S-Corps
  • LLCs

That’s because these four entities have unique tax treatments that differentiate them from regular C-Corporations.

What makes small business taxes different?

Rather than passing through corporate tax, small businesses tax their owners on an individual level. That means profits aren’t subject to corporate taxes and double taxation.

What Are The Benefits Of Small Business Taxes?

The number one reason people should love small business taxes: it allows you to deduct ordinary and necessary expenses.

For example, a SALARIED employee who’s paid $150,000 per year would get taxed on the full $150,000. Small business owners, on the other hand, can deduct expenses such as a vehicle, home office, contractor, or any employee expenses (if you have them).

So if a small business has $80,000 in expenses, their taxable income becomes just $150,000 – $80,000 = $70,000. That’s a great reason to want to start your own business!

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Top Tax Deductions For Small Business Taxes

So what are the top items that small business taxes can deduct?

20% Qualified Business Income

In 2018, the Tax Cuts and Jobs Act added a special provision for small businesses. Any business owner earning up to $315,000 (or $157,500 if filing single) can deduct 20% of all qualified business income from the taxes. For example, a consultant earning $100,000 per year could deduct $20,000 from his or her profits when calculating taxable income.

Keep in mind, however, that the QBI deduction phases out for high earners. Individuals earning more than $415,000 in business income (or $207,500 if filing single) generally don’t qualify for the 20% QBI deduction. You should consult with your business accountant before taking these deductions.

Read more about Business Deductions

Section 179 Deduction

Under most circumstances, the IRS disallows deducting items with multi-year lifespans, such as office and manufacturing equipment.

But there’s a built-in loophole for small business taxes.

In 2008, Congress introduced Section 179 of the US tax code. The new rule allowed small businesses to deduct up to $125,000 of property as an expense, rather than requiring the property to be capitalized and depreciated.

In the 2018 TCJA, Congress increased Section 179 deductions $1 million, providing small businesses with a powerful tool in reducing and deferring taxes.

Business owners, however, should be careful about what qualifies as Section 179 property. Certain assets won’t qualify, such as home offices and rental properties.

Home Office Deduction

Under the TCJA, small businesses can now take a standard deduction for home offices of $5 per square foot, up to 300 square feet. These deductions are not subject to depreciation recapture, and so act as a full tax break.

Travel Expenses and Meals

Small business taxes can also deduct applicable travel expenses and meals. For example, an author researching a story can expense the cost of his or her trip if it’s relevant to the book. Salespeople can deduct full travel expenses for seeing clients. And business owners can deduct up to 50% of business meals.

Record-keeping is essential for businesses deducting travel expenses. That’s because IRS auditors can ask for receipts or other proof of costs.

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Small Business Tax Entities

Another benefit of small business taxes: owners can change corporate structures every five years to maximize their tax deductions. Each of these structures provides different types of benefits to their owners.

Sole Proprietorships

Sole proprietorships are the most elementary form of a corporation. There are no additional reporting requirements since all profits and expenses get reported on the taxpayer’s Schedule C of Form 1040.

Keep in mind that sole proprietorships don’t protect the business owner from liability or risk. So many business owners choose to incorporate as an LLC, LLP, or S-Corp.

Partnerships

Partnerships are business agreements between two or more people and are generally taxed as pass-through entities. In other words, all profits and losses pass through to their owners, rather than getting taxed at the corporate level.

Partnerships can make full use of business deductions, such as the 20% qualified business deduction and all other expenses. However, the IRS limits deductions in certain areas, such as health care and investment income.

Partnerships must file Form 1065 annually, and issue K-1 Forms to their owners. Tax accountants will then use K-1 forms to prepare individual tax returns.

S corporations

S corporations are distinct legal entities. That means company owners are no longer liable for business risks and liabilities.

The IRS taxes S-Corporations under subchapter S of the US Tax Code. S-Corps have many of the same benefits that regular corporations have, such as being able to deduct the cost of fringe benefits and health care costs to their employees. Yet, they retain the advantage of pass-through entities, so they aren’t subject to corporate tax rates.

Keep in mind, S-corporations still have limitations. For example, fringe benefits to shareholders are still taxable; shareholders owning more than 2% of the company cannot deduct health care expenses on the corporate level. Also, shareholders who work for the company must still pay themselves a fair wage, which will incur payroll taxes.

LLCs

LLC’s are business entities registered with the State. They can elect to get taxed in three different ways.

• • Disregarded entity: taxed like a sole proprietorship, where all income and expenses get directly reported on the taxpayer’s Form 1040
  • Partnership: files form 1065 like a regular partnership and issues K-1 Forms to the partners
  • Corporation: submits Form 1120 and taxed as a regular corporation

LLCs provide small businesses with legal protection as well as the flexibility in choosing their tax method.

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Conclusion

Given the number of potential business tax deductions, a tax accountant can help you save both time and money when it comes to filing taxes. Reach out to me, or a qualified business tax accountant today for more information.

Where to find more resources

If this seems like a lot of information, don’t worry. The great news is that help is available. That’s because here at Jurnex, we work with individuals and families just like you to make the most out of investing.  I’ve helped invest client money for over a decade in the same old-fashioned way. And that’s to seek out great companies in great industries that can you can buy at a discount to their fair value.  Sounds too simple to be true? Give me a call today, and I’ll show you that it’s still possible after all these years.

About Jurnex

We are an independent registered investment advisor and asset manager.  We have the securities backing of Charles Schwab, yet we retain our operational independence from any third party. This means you can have the confidence your money is safe with one of America’s best brokerages and still receive knowledge and advice from an independent firm focused on YOU.

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