Maximizing Deductions: A Strategic Approach for Small Businesses

One of the most common questions I get as an accountant is about deductions. I like to think about deductions in phases: small business owners usually first need to get used to being a business owner before then can take the next steps towards maximization. This guide is designed for first-time business owners, solopreneurs, and those looking to take the next steps beyond the basics.

Phase One: Establishing Good Hygiene

In this foundational phase, focus on setting up robust financial practices. Here’s what you should consider:

1. Separate Personal and Business Expenses: Maintain clear boundaries between your personal and business finances. Use separate bank accounts and credit cards for business transactions. This not only simplifies record-keeping but also ensures compliance with tax regulations. One account and one card are usually enough to get started.

2. Business Account Usage: Treat your business account with care. Make sure to deposit and pay things in “gross” and do not net transactions against each other. Regularly reconcile and categorize transactions promptly. Utilize a tool you’re comfortable with, like Excel, Rocket Money, Wave, or QuickBooks, to keep things organized.

3. Reimbursements: When appropriate, reimburse yourself for business-related expenses. Keep detailed records and ensure that these reimbursements are well-documented.

4. Business Mindset: Think like a business owner. Even if you’re a sole proprietor, adopt a professional mindset. Regularly review financial statements, track cash flow, and plan for growth.

5. Make a Plan for Paying Taxes. New business owners are typically used to a paycheck where taxes are automatically deducted. Getting used to setting aside funds to making tax payments on your own can be a hard habit to learn (and painful later on).

Phase Two: Claim What You’re Already Spending On

Now that your financial hygiene is in order, let’s focus on capturing deductions you might be missing:

1. Mileage Deductions: If you use your personal vehicle for business purposes, track your mileage. Whether it’s client meetings, deliveries, or errands, every mile counts. Deduct the applicable standard mileage rate or actual expenses. Remember though: commuting is not deductible.

2. Home Office Deductions: If you have a dedicated home office, you can claim a portion of your housing expenses (like rent, utilities, and insurance) as business deductions. Ensure you meet the IRS criteria for a home office.

3. Phone Bills: If your phone is essential for business communication, deduct a portion of your phone bills. Keep records of business-related calls and texts.

4. Other Low-Hanging Fruit: Don’t overlook smaller expenses like office supplies, software subscriptions, and professional development courses. These add up over time.

Phase Three: Benefits and Credits

Now let’s explore the benefits associated with your business:

1. Health Insurance: As a business owner, explore health insurance options. Deduct premiums paid for yourself, your family, and eligible employees. Additionally, consider Health Savings Accounts (HSAs) for tax advantages.

2. Retirement Plans: Maximize retirement contributions. Whether it’s a Simplified Employee Pension (SEP), Solo 401(k), or SIMPLE IRA, these plans offer tax-deferred growth and potential employer contributions.

3. Small Business Credits: Investigate available credits. For instance, the Small Business Health Care Tax Credit can offset health insurance costs for eligible small businesses.

4. Startup Retirement Plans: If you’re just starting your business, explore retirement plans tailored for startups. These can provide tax benefits while helping you save for the future.

Phase Four: Income Shifting Strategies

1. Wage vs. Distributions: Balance your income between wages (subject to payroll taxes) and distributions (often taxed at a lower rate). Consult with a tax professional to optimize this balance.

2. Family Income Shifting: If you have family members involved in the business, consider shifting income to their lower tax brackets. Be cautious and follow legal guidelines.

3. Tax-Deferred Assets: Explore tax-deferred or tax-exempt assets like life insurance policies or annuities. These can provide financial security while minimizing tax liability.

4. Own vs. Rent: If you operate from a physical location, evaluate the benefits of owning the building instead of renting. Mortgage interest and property taxes are deductible.

Remember, consult with a tax advisor to tailor these strategies to your specific situation. By strategically navigating these phases, you’ll not only maximize deductions but also enhance your overall financial well-being.