Our Top 4 Tax Deferral Strategies for Small Business Owners
As a financial advisor with more than 30 years of experience, I’ve seen firsthand how effective tax deferral strategies can significantly benefit small business owners – I’m one myself!
Tax deferral allows you to postpone paying taxes on certain income until a later date, which can help you manage cash flow and potentially reduce your overall tax burden. Here are some of the best strategies to consider:
Retirement Plans
One of the most effective ways to defer taxes is by contributing to retirement plans. Options like a 401(k) or a SEP-IRA allow you to defer taxes on contributions and earnings until you withdraw the funds in retirement. For example, small business owners can contribute up to $23,000 or $30,500 (if age 50 or older) of their salary to a tax-deferred plan like a 401(k) or up to 25% of earnings or $68,000 (whichever is less) into a SEP- IRA. The maximum contributions for a SOLO 401(K) are even more substantial for those that qualify. The total contribution limit (employee + employer contributions) is $69,000 (or $76,500 for those age 50 or older). These contribution limits make Solo 401(k)s especially appealing for self-employed individuals or small business owners with no full-time employees, as they allow for substantial tax-deferred retirement savings. Have someone in your household that works with you? Those same benefits may apply!
Profit Sharing Plans for Employees
Contributions made to a profit-sharing plan are tax-deductible for the business and can reduce the overall taxable income of the business. Contributions to a profit-sharing plan are not subject to payroll taxes, such as Social Security and Medicare, which can result in significant savings for the business and may help you qualify for a tax credit for the costs associated in setting up the plan. Not to mention the happy employees, better retention, and potentially reduced turnover costs!
Deferring Income and Accelerating Expenses
This strategy involves delaying the receipt of income until the next tax year while accelerating deductible expenses into the current year. By doing so, you can reduce your taxable income for the current year. Deferring income and accelerating expenses is a short-term tax planning strategy aimed at reducing taxable income in the current year by managing when you recognize income and deductions. In contrast, retirement plans like 401(k)s, IRAs, or SEP IRAs are long-term savings tools designed to build wealth for the future while providing tax advantages.
Summary of Key Differences
Tax Deferral vs Tax Deduction
Deferring Income and Accelerating Expenses: This focuses on delaying when income is taxed and accelerating when deductions are recognized. You still pay taxes on the income eventually, but the strategy gives you control over when you incur the tax burden.
Retirement Plans: These provide tax-deferred growth on the contributions and earnings (traditional retirement plans), meaning taxes are delayed until you withdraw the money. In Roth plans, you pay taxes upfront but benefit from tax-free growth.
In summary, deferring income and accelerating expenses is a tactical, short-term tax strategy, while retirement plans are structured, long-term savings vehicles designed to help you grow wealth for your future while providing tax advantages over time. Both can be powerful tools for managing your finances, but they serve different purposes and timeframes.
Implementing tax deferral strategies can provide significant financial benefits for small business owners. By strategically deferring taxes you can improve your cash flow and invest more in your business.
It’s essential to consult with a qualified tax professional to tailor these strategies to your specific situation and ensure compliance with current tax laws and your fiduciary to sync with your portfolio planning and investment goals. Feel free to reach out if you have any questions or need personalized advice on implementing these strategies in your business.