7 Best Ways to Reduce Taxable Income

Tax season is much easier for businesses that know the best ways to reduce taxable income. Taking advantage of credits and deductions to lower your tax burden is a savvy way to get significant tax savings for your small business.

The tax system is complex. However, understanding how to strategically reduce your taxable income and keep more money in your pocket is one of the easiest ways to boost your bottom line.

1. Maximize Retirement Plan Benefits

Small business owners have several retirement plan options open to them. These could lead to a significant tax deduction by lowering your taxable income. Eligible plans include:

Solo 401(k) Plans

Solo 401(k) plans are open to individuals who run their own business or who run their business with their spouse. Sole proprietors, independent contractors, and freelancers are typically the main beneficiaries.

Under-50s can defer as much as $69,000 for 2024 ($66,000 for 2023). If you're 50 or over, you can contribute a further $7,500 on top of this in the form of catch-up contributions.

There are two different types of 401(k) plans: the traditional 401(k) and a Roth 401(k). These two options have different tax implications. Ask a professional in tax planning services which would be most advantageous for you.

Simplified Employee Pension Plan (SEP)

A SEP is essentially a simplified version of an individual retirement account (IRA). Its main advantage for busy small business owners is how easy it is to set up and manage. A SEP can provide retirement benefits for you and any employees you have. 

Contribution limits are the lesser of $66,000 or 25% of total compensation (your net earnings from self-employment).

Tax Credits for Employers Starting Retirement Accounts

Employers who start retirement plans like a SEP, 401(k), or a SIMPLE IRA may qualify for a tax credit of up to $5,000 for three years. This credit will cover the starting costs of your chosen plan.

2. Change Your Business Structure

Each business structure comes with its own tax rules. Your choice of business structure could significantly lower your taxable income. Remember that the business structure you choose when you start out isn't binding. 

We recommend regularly reviewing your choice of business structure with a tax professional to ensure your current setup offers the most beneficial tax outcomes for your business.

Example

Imagine you decide to operate as a sole proprietorship when you set up your small consulting business in Jacksonville, Florida. When your consulting business takes off, you may benefit from restructuring your business as an LLC with an S corp tax classification to reduce your self-employment tax liability.

One of the many benefits of hiring a tax professional who knows your business inside out is that they can help you identify the most tax-advantageous structure for you and help you change it when necessary.

3. Qualified Business Income (QBI) Deduction

If you've chosen a "pass-through" business structure, you may be able to deduct up to 20% of qualified business income (QBI) on your federal income tax return. Pass-through entities include LLCs, S corps, sole proprietorships, and partnerships.

The QBI deduction can offer substantial savings when the time comes to pay taxes. However, some service businesses like medical, legal, or accounting practices may not be eligible for this deduction. 

4. Open a Health Savings Account (HSA)

An HSA is a great way to lower your tax bill while setting money aside for any future healthcare needs. Self-employed individuals can also often deduct health insurance premiums for themselves, their spouse, and any children up to the age of 27.

How Does an HSA Work?

HSAs work with the following principles to reduce your taxable income:

• HSAs are funded with pretax dollars. This reduces your taxable income in the short term. 

• Withdrawals from your account are tax-free, with the provision that you spend the money on “qualified medical expenses.” 

• Any interest you make on your account grows tax-free.

• Funds in an HSA roll over from year to year. 

• If you previously worked as a salaried employee, you may have had access to a flexible spending account. Be aware that self-employed individuals don’t have access to flexible spending accounts and must use an HSA.

HSAs are subject to contribution limits. A plan that only covers you is subject to a $3,850 limit while plans that cover your family have a limit of $7,750 for 2023. This rises to $4,150 and $8,300 respectively for 2024.

5. Maximize Business Deductions

The list of potential business deductions is extensive. This means there are many opportunities for small businesses to lower their taxable income. Make it a daily business practice to document all your business expenses, from advertising costs to business use of your vehicle. This will allow you to take full advantage of the mileage tax deduction which is bound to add up for on-the-go business owners.

Get Expert Help to Minimize Your Tax Bill 

Both above-the-line and below-the-line deductions can reduce your taxable income. An accounting professional can explain how above-the-line deductions affect your adjusted gross income before reducing your tax liability by applying below-the-line deductions. 

6. Find Out About Tax Credits

Tax credits allow some small business owners to reduce their income taxes dollar for dollar. For example, the earned income tax credit is available for qualifying individuals who earn less than $63,398 and also meet other criteria. 

7. Time Your Income Strategically

Timing your income strategically is a savvy way to optimize your tax return. Making effective decisions regarding the timing of both revenue and expenses can make a huge difference to your federal income tax bill. This is especially true if you anticipate changes in your income or tax rates. Depending on the nature of your business, either deferring or accelerating income can maximize your tax benefits.

Example

Let’s say you run a translation business with a certain amount of leeway with invoicing. If you’re currently in a higher tax bracket, but foresee benefitting from a lower bracket in the following year, you could defer income until January. This effectively shifts income recognition to the year with lower taxes, thus reducing your tax liability.

Keep More Money in Your Business

Getting the most out of the tax system is a savvy way to ensure you don't overpay on your tax return. This leaves you with more money to invest in your business and help it grow.

Remember, reducing your taxable income is a legal and strategic way to save money on your taxes. By implementing these strategies and consulting a tax professional, you can navigate tax season with confidence and keep more of your hard-earned income.