4 Ways to save money on taxes
New entrepreneurs often get surprised by their tax bill at the end of the year. What can you do now to reduce your next tax bill? This article will discuss 4 simple tips to save you money in taxes.
1. Get Organized
2. Use the Home Office Deduction
3. Track Your Mileage
4. Elect S-Corp Status
Get Organized
This may not sound fun or exciting but it’s actually the most important of all the options. Business expenses reduce the amount of tax you will owe, but only if you include them on your tax return. As a new entrepreneur, it can be so easy to pay for business expenses from whatever card or account that has the money. The problem with that is several of those expenses are likely to be overlooked or forgotten at the end of the year. Keeping your business income and expenses organized will save you a lot of money when it’s time to file taxes.
Tip: Get a separate business account and make sure everything relating to your business is paid from that account.
Pro Tip: Set up QuickBooks or a spreadsheet to track all business activity
Use the Home Office Deduction
If you are a new entrepreneur then most likely your home is your office. If you use a portion of your home exclusively for business the IRS allows you to deduct a portion of your home expenses. The home expenses include rent (or mortgage interest if you’re a homeowner), insurance, utilities, repairs, etc. That means you can deduct a portion of the expenses that you have to pay anyway. And remember deductions = pay less tax.
This tip also includes step 1, organization. Knowing exactly how much your home expenses are will save you money.
Track Your Mileage
The IRS offers a business mileage deduction rate each year. For 2020, the rate is 57.5 cents per mile. So for every business mile you drive, that’s a 57.5 cent deduction. Let’s see how that works out. Say you have a business meeting or event that’s 30 minutes away. So you drive a total of 1 hour which we will estimate is 60 miles. 60 miles x .575 = $34.50. You will get a $34.50 deduction for that one meeting.
Let’s think about that, the average car may take about $30 to fill up, and driving one hour did not cost you a full tank of gas. Using the mileage deduction saves a lot of money. This is because of the mileage rate set by the IRS factors in other aspects such as general wear and tear on the car.
We end up back at organization. It’s not possible to deduct mileage if we don’t know what it is. So keeping a record of mileage and business travel equals more deductions and deductions = pay less tax. 😊
Elect S Corp Status
Let me start by saying, if you scrolled here first because it sounds way more interesting than organization, please scroll right back up to the top lol 😄. The first 3 are more important as a new business owner, and establish good practices for your business. But if you have read from the top let me say, great job!
Now that we’re ready, let’s talk S-Corporations. You may have heard that term before but what does it mean?
S-Corp is a tax election that saves business owners 15.3% in tax. How does it do that? By eliminating the social security tax.
As employees we all see FICA and Medicare deducted from our paycheck. Those two combined are called the social security tax. The employee pays half (7.65%) and the employer pays half (7.65%). When you are self-employed you are both the employer and the employee so any profit that you have is taxed at 15.3% self-employment tax in addition to your normal income tax.
That’s where the big shock comes in for most new entrepreneurs.
Less see an example:
Irene works a full-time job and normally gets a small refund. This year she starts a side hustle and makes $5,000. She’s not ready to quit her job but she’s excited. Come tax time, however, instead of getting her small refund, she owes $1,265. What?! She wasn’t ready! How did this happen?
Self-employment tax ($5,000 x .153) + Income Tax on the $5,000.
If Irene had read this blog post she would have been ready. Because she would have
5. Deducted all her business expenses to go against the money she made
6. Used the home office deduction
7. Deducted her mileage
By then most new entrepreneurs show a loss for tax purposes and pay zero tax. If more is needed, that’s where the S-Corp election comes in and would reduce or eliminate the 15.3 percent tax. In a future article, we’ll talk more about business types from LLC to S Corp and more. For now what steps can you take to save money on taxes? Get organized. You got this!