Essential tax strategies for business owners

Tax planning is crucial for business owners. By implementing effective tax strategies, businesses can maximize savings while ensuring compliance with ever-changing tax regulations. But the world of tax is notoriously complex. Navigating it without expert help can be challenging at best, and detrimental at worst. 

That’s why we put together this article. With the help of experienced CPA and firm owner Victoria Thayer
, we’ll outline some effective tax strategies for small and medium-sized businesses. As the founder of Novii CPA, Victoria helps entrepreneurs achieve their goals through effective tax planning and accounting services.

So, if you’re looking for ways to meet your tax obligations while optimizing your financial outcomes, read on! 

Tax planning strategies for small and medium-sized businesses

By following the strategies and advice below, you’ll be well-positioned to optimize your tax obligations, maximize income, and ensure compliance with tax regulations. 

• Choose the right business structure
• Maximize deductions and credits
• Effective expense management
• Retirement savings plans
• Inventory management
• Cash flow management
• Home office deductions
• Health insurance premiums
• State and local tax optimization
• Reducing capital gains liabilities

1. Choose the right business structure

Different business structures have different tax obligations. The structure you choose will directly impact who is responsible for reporting tax and how it is calculated and paid. Let’s look at some examples below: 

• Sole proprietorship. This structure isn’t a separate business entity, so any profits or losses are reported on an individual income tax return.
• Partnership. As so-called pass-through entities, any profits or losses are passed through to the partners, who then report them on their personal income tax returns. 
• Limited liability company (LLC).
  – Single-member LLCs are taxed like sole proprietorships by default.
  – Multi-member LLCs are taxed like partnerships by default.
  – LLCs can also elect to be taxed as a corporation instead of a pass-through entity.
• C Corporation (C-Corp). As a separate entity, the business itself is responsible for reporting profits and losses via a corporate income tax return. If a portion of its profits is distributed to shareholders in the form of dividends, those shareholders must report them on their individual income tax return. This is a form of double taxation.
• S Corp (S-Corp). This structure avoids the issue of double taxation by passing profits and losses through to shareholders, who must then report them on their income tax returns. 

Which structure is the best for tax-planning purposes? Well, it depends on the size of your business, ownership structure, and preferences. While sole proprietorships and partnerships offer simplicity, corporations provide greater tax planning opportunities. LLCs and S-Corps offer a balance of flexibility and tax efficiency. 

According to CPA Victoria Thayer, the ideal structure often depends on the industry you operate in. If you run a professional services firm, she explains, you may benefit from an S-Corp structure, allowing you to split income between salary and distributions. This potentially reduces self-employment taxes. Victoria highlights plenty of other examples, too: 

Biotech and life sciences often rely on a C-Corp structure to attract venture capital and reinvest earnings without immediate tax consequences. Manufacturing companies might benefit from using multi-entity structures to separate operations and asset ownership, which can protect assets and optimize tax outcomes. For real estate development, forming LLCs or partnerships can offer flexibility, as they allow for profit sharing and debt structuring that is tax efficient.

2. Maximizing deductions and credits

By taking advantage of all the available tax deductions and credits, you can significantly reduce your tax liability. The Internal Revenue Service (IRS) states that businesses can report any expense that is “ordinary and necessary” to the running of a business in its given industry, such as: 

• Office expenses, supplies, and utilities 
• Marketing expenses
• Professional services, licenses, and compliance costs 
• Maintenance and repair costs
• Fees paid to contractors

Businesses can also claim deductions for research and development (R&D) costs, as well as capital expenditures (CapEx) under Section 179 of the Internal Revenue Code. 

At the same time, businesses can claim tax credits if they choose to engage in certain activities that are encouraged by the government. “For biotech and life sciences companies, R&D tax credits are invaluable, as they offset a portion of research expenses,” Victoria explains. 

3. Effective expense management

Effective expense management is crucial for a well-run business. In addition to streamlining your workflows and providing a clearer picture of your financial position, there are tax benefits to consider as well. 

By maintaining detailed records of business expenses, you can claim all allowable deductions. The opportunities for expense-related deductions vary from industry to industry, as Victoria explains. Manufacturing companies, for example, can leverage deductions for energy-efficient equipment upgrades, reducing taxable income while supporting sustainability efforts. 

4. Retirement savings plans

Saving for retirement isn’t just sound financial planning. It can also provide tax benefits to help secure your future. Contributing to employee retirement plans such as a SEP IRA, SIMPLE IRA, or Solo 401(k) brings immediate benefits by reducing taxable income. 

As Victoria explains, this strategy also encourages employees to stick around for the long term. “Across all industries, contributions to retirement and health plans provide valuable deductions while supporting employee retention.”  When you consider that replacing an employee can cost three to four times their salary, any strategy that encourages employees to stick around while boosting tax savings is a winner.

5. Inventory management

Effective inventory management impacts your cost of goods sold (COGS). It can also directly influence taxable income. By optimizing your inventory practices, you can help maintain accuracy in reporting and maximize tax savings. 

Businesses should use inventory management software to track inventory levels in real time. This helps avoid discrepancies between physical stock and the inventory levels you have recorded in digital systems. 

There are several inventory management strategies you can use to reduce your tax burden, including choosing the right valuation method. For example: 

• FIFO (First In, First Out) increases COGS when prices are decreasing, which can reduce taxable income. 
• LIFO (Last In, First Out) increases COGS when prices are increasing, which can also reduce taxable income.

When you purchase inventory can also impact your tax liability. For example, if you buy inventory at the end of the fiscal year, you may be able to defer tax liability to the following year.

6. Cash flow management

Effective cash flow management enables small business owners to meet tax obligations without hindering growth. One key strategy is timing purchases to take advantage of tax deductions. As Victoria points out, “For industries like manufacturing and tech, managing cash flow involves timing equipment purchases to maximize Section 179 deductions.” 

Tracking R&D expenditures closely is also important. “I advise biotech and life sciences companies to track R&D expenditures carefully to ensure quarterly tax payments reflect these credits,” Victoria explains. In the real estate industry, timing asset acquisitions and strategically managing depreciation can also help manage cash flow effectively. 

Another factor that impacts cash flow is whether to lease or purchase equipment or property. Both options bring different financial benefits that can impact your overall tax liability and cash flow strategy. For example:

• Leasing can provide your business with periodic tax deductions for lease payments. These are typically categorized as operating expenses (OpEx). This also avoids the upfront costs associated with purchasing, helping to maintain liquidity. Leasing is also beneficial if your business needs flexibility. It futureproofs your decisions against technological advancements that may render equipment obsolete.
• Purchasing allows your business to capitalize on potential depreciation benefits. Assets purchased outright can often qualify for tax deductions under depreciation schedules. This enables you to reduce your taxable income over time.

7. Home office deductions

If you run your operations from home, home office deductions can be an effective way to reduce your taxable income. According to the IRS, the home office deduction allows qualified taxpayers to deduct certain home expenses when they file taxes. These expenses may include: 

• Mortgage interest
• Insurance costs
• Utility costs
• Repairs and maintenance
• Depreciation and rent

To qualify for a home office deduction, you must meet the following two criteria: 

• Exclusive and regular use. A specific part of your home must be used exclusively and regularly for business purposes. 
• Principal place of business. Your home must be your primary business location. Alternatively, you can qualify if your home is where you handle key administrative or management tasks, and there is no other location to perform those duties. 

8. Health insurance premiums

Health insurance premiums aren’t just a necessary expense. They are also an effective tax-saving strategy for small business owners. Deducting health insurance premiums reduces your taxable income while providing a valuable perk for employees.

If you’re self-employed, you can generally deduct health insurance premiums for yourself, your spouse, and any children or dependents. That said, these deductions cannot exceed the amount of income you collect from your business. 

If you are the owner of a business that employs people, you can fully deduct any health insurance premiums you pay to your employees as a business expense. 

9. State and local tax optimization

State and local tax (SALT) deductions can provide significant opportunities for businesses looking to reduce their tax burdens. SALT deductions enable taxpayers who itemize to deduct certain state and local taxes from their federal income tax return.

In addition to SALT deductions, businesses can take advantage of local tax credits and incentives. These are designed to stimulate economic growth, encourage sustainable practices, and reward businesses for contributing to their local communities. 

10. Reducing capital gains liabilities

If you run a business in an industry where significant investments are commonplace, reducing capital gains liabilities is crucial. 

One such example is real estate. According to Victoria, utilizing like-kind exchanges is a powerful strategy for real estate developers. “Like-kind exchanges are a key tool to defer capital gains taxes when reinvesting in similar properties,” she explains. 

In some industries, holding onto assets for over a year can be a beneficial strategy. “In biotech and tech, holding assets for more than a year often yields lower long-term capital gains rates,” says Victoria, highlighting the importance of strategic asset management to reduce tax liabilities.

Another powerful strategy that Victoria recommends is to invest in properties in economically distressed communities, known as Qualified Opportunity Zones (QOZ). “When relevant, I suggest Qualified Opportunity Zone investments, especially for clients with substantial capital gains, as it allows them to defer and reduce tax obligations while supporting economically distressed communities,” she adds. 

Common mistakes to avoid in business tax planning

Tax planning is an arcane and complex area. Unsurprisingly, many businesses make mistakes that lead to missed opportunities. In this section, we’ll highlight some of the most common errors to watch out for.

Poor record-keeping 

Proper record-keeping is essential for effective tax planning. Without the right documentation, you can miss out on valuable deductions or credits. By keeping organized and up-to-date records, businesses can ensure they capture all eligible deductions, from operating expenses to investments in R&D.

Moreover, accurate record-keeping improves the auditability of your business. In the event of an IRS audit, having detailed records of your expenses and other relevant financial information is crucial.

Overlooking industry-specific tax deductions

Many businesses fail to seize the opportunity presented by industry-specific tax deductions. Here are some key examples that Victoria singled out:

In the biotech and life sciences industries, the Orphan Drug Credit is often overlooked — it can significantly reduce taxes for companies developing treatments for rare diseases. Manufacturing businesses may miss out on the Domestic Production Activities Deduction (DPAD) or energy-efficient equipment credits. Real estate developers can take advantage of credits for low-income housing or historic rehabilitation.

Missing out on SALT incentives

Another common mistake is overlooking state and local tax incentives. These can provide significant savings if properly utilized — especially in certain industries. “I advise businesses in tech and professional services to ensure they’re taking advantage of available state and local tax incentives, as these are often underutilized,” says Victoria. 

Not seeking professional advice

Most business tax planning mistakes stem from a lack of expertise. That’s understandable — the average small business owner isn’t a tax expert. This is why it’s so important to seek professional guidance. “Regular tax planning sessions help avoid these pitfalls and ensure clients maximize all available benefits,” explains Victoria. 

But that’s not all. Working with a tax professional ensures that your business stays compliant with tax regulations. In turn, this helps you avoid costly and stressful IRS audits. 

Choosing the right CPA or tax advisor for your business

Working with an experienced CPA or tax advisor is crucial to effective tax planning. With the right professional, you can optimize your year-end tax strategies and navigate ever-changing tax laws. 

When choosing a tax advisor, it’s a good idea to check out reviews on websites such as Google or Facebook to see what clients think of their service. We also recommend choosing tax professionals who are committed to providing an excellent service using the best technology — like TaxDome.

As a leading practice management platform, TaxDome helps tax professionals streamline their practices. It offers powerful tools spanning workflow automation, document management, team collaboration, and more. 

TaxDome also offers a suite of client-facing tools that transform the client experience. For example, our secure client portal and top-rated client mobile app enable clients to upload and e-sign documents, communicate with their tax advisor, schedule calls, and pay bills.

To see why more than 10,000 firms worldwide choose TaxDome to power their practices, request a demo today.