Tax-Savings Plans for USA Small-Business Operators

Many small-business owners are concerned about paying too much in taxes. Yet, reducing those taxes is often as easy as ensuring you are taking full advantage of all of the benefits you are entitled to take.

If you are looking for a few tax breaks this year, consider these tips.

• Depreciating assets: One way to save on taxes is through a deduction identified as the Section 179 Expense. This deduction allows you to write off the entire cost of certain business assets, excluding real estate, up to $100,000.
  
  For example, a vehicle used for business purposes that weighs more than 6,000 pounds would qualify. This is a windfall for those who own a company and want or need a large vehicle. Many of the larger sport utility vehicles on the road today would qualify for this type of business deduction.
  
  
• Using draws: As a small-business owner, using cash draws to pay yourself instead of compensation through a W-2 will help avoid taxes. As a sole proprietor, a cash draw has no tax consequences - and is similar to taking money from your left pocket and putting it into your right pocket. FICA taxes are avoided entirely with a draw, saving 15.3 percent of your total owner compensation.
  
  A small-business owner paying himself $75,000 year would save $11,475 annually just by utilizing a cash draw rather than a W-2 payment.
  
  
• Flexible spending accounts: These are allowed by the Internal Revenue Service as a type of Section 125 cafeteria plan and have numerous benefits. First, they allow participating employees to utilize pre-tax dollars to pay for several benefits and expenses, including some insurance premiums, non-reimbursed medical expenses and child- or dependent-care expenses.
  
  For instance, if a worker anticipates needing expensive dental work in January, the costs can be spread over the entire year through this plan. Recently, over-the-counter drugs were added to qualify for flexible spending accounts.
  
  Also with FSAs, employees save on both income and FICA taxes. Employees have control over how much to contribute to the flexible spending account and the qualified expenses for which they choose to use it. (Qualified expenses are specified in Section 213.)
  
  Based on employees' decisions, the cost for the plans is deducted from their paychecks before taxes are figured, thus saving federal and state income taxes, as well as the Social Security levy.
  
  These employee dollars in tax savings can be used to increase contributions to a 401(k) plan, which further reduces income taxes, or they may be used as increased take-home pay.
  
  For employers, the administration costs of this type of plan often can be paid for by the reduction in the employer payroll tax expenses and lower workers' compensation insurance premiums. Employers' savings are gained through reduced federal and state unemployment and FICA taxes.
  
  
• Profit-sharing plans: These plans allow employers to make contributions at their discretion that may vary each year. Generally, each employee receives a contribution of a certain percentage of their compensation.
  
  These plans have obvious financial benefits for the employees, but can also allow employers to save on taxes. Contributions to a profit-sharing plan are tax deductible and earnings accumulate on a tax-deferred basis.
  
  If a company decides to establish a profit-sharing plan, it may include a 401(k) plan provision. The profit-sharing plan alone allows the employer to protect profits from taxes and the addition of the 401(k) plan allows employees to save on taxes, too.
  
  Federal law currently allows employees to shelter 100 percent of their income up to $13,000 in 2004 from federal and state income taxes.
  
  Profit-sharing plans work well for a sole proprietor.
  
  Consider this oversimplified example: Perhaps your business earned $100,000 in profit. If you paid $100,000 to yourself, depending on how your business is structured, you would pay federal, state, city, Social Security and Medicare taxes on the entire amount. Thus, you could pay 40 percent in taxes.
  
  If you instead considered $25,000 as profit and paid the remaining $75,000 as salary, you could defer up to $13,000 on taxes in 2004. In this example, you'd pay closer to $28,000, compared with $40,000 in taxes.
  
  
• Other tips: When deciding how to organize your business, consider the tax implications. Structuring as a pass-through or S-corporation allows you to pay FICA taxes only on the salary you take. A qualified business adviser can help you determine the best way to organize your business.
  
  Most important, as you organize to save on your business taxes, keep detailed records. When tax time comes around, you'll be glad you did.
  
  

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  Scott Everhartis a partner of Everhart Financial Group, an independent registered investment advisory firm in Columbus. Reach him at 614-717-9705 or scotte@everhartfinancial.com

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This page last modified: 15 Mar 2008