Small businesses face many challenges, especially in the early days, including developing a product or service, targeting it to the right market, hiring the right employees and keeping expenses under control. Meanwhile, taking the right approach to taxes is a crucial factor that sometimes is overlooked.
We asked Anna Sergunina, a financial advisor and part of NerdWallet’s Ask an Advisor network, for some tips on how businesses can grow while keeping taxes low.
What steps can small businesses take to decrease their tax burden?
I recommend setting up a retirement plan for your business — for example, a Simplified Employee Pension (SEP) IRA or a Savings Incentive Match Plan for Employees (SIMPLE) IRA or 401(k). With a SIMPLE IRA or 401(k), you can add matching contributions of 1% to 3% on top of the normal employee deferrals. This approach kills two birds with one stone: You and your employees are encouraged to save for retirement, and you and your business save on taxes because matching contributions are tax-deductible.
Also work with a tax professional to make sure you are taking advantage of all available exemptions and tax breaks. Using your home or car for business, for example, can provide legal business deductions.
How should businesses deal with payroll tax?
Being a small-business owner myself, I always look for ways to minimize payroll taxes. Depending on the industry, consider working with independent contractors, whom you can pay directly without having to run payroll, rather than adding employees. At the end of the year, you would issue 1099 forms to these contractors, who are not subject to payroll taxes. This could save you about 7.65% of fees paid to them. However, be careful you are not running afoul of IRS laws on what constitutes an employee.
What revenue and cash-flow issues do owners need to be aware of?
Paying more taxes than necessary cuts directly into your working capital, makes it more difficult to manage cash flow and can affect the future of your business. In personal finance, financial planners recommend that individuals have three to six months of monthly expenses saved for emergency reserves. I highly support this idea for businesses as well. An emergency fund is a great backup for times when you run short on cash and bills and other expenses are due. If your sales cycle is long, you may need to work on creating a larger cushion. For instance, suppose that just as your business has an opportunity to expand, your main “rainmaker” gets sick and can’t bring in business. Not having adequate cash flow or emergency reserves can hurt your business.
Any other tax tips for small businesses?
Invest in good tax-accounting software in the cloud (such as QuickBooks online or FreshBooks) to make sure you get a clear picture of how the company books look at any given time and on any device. I also like the idea of establishing a very close relationship with a certified public accountant who understands the type of business you’re running and who can provide valuable advice. I recommend not doing your own bookkeeping, unless you are a trained bookkeeping professional. Your focus should be on growing your business.
I passionately believe that in order to live a life of fulfillment and joy, we must genuinely serve each other in any way possible. I found my mission in life to serve others via financial planning. Anna regularly writes about personal finance. Her work appears on Business Insider, Nasdaq, Nerdwallet, among others. Anna is the creator of Money Flow system.