Small Business Tax Loopholes

by | Jul 22, 2021 | Taxes

Small Business Tax Loopholes

A small business often struggles to run a business, make profits, and pay taxes. This is always an uphill battle, so when you get to the April 15 deadline business owners end up losing sleep over their tax returns and amount due. Fortunately, the Internal Revenue Service (IRS) provides certain rebates and credits you can use for some tax relaxation, but most people don’t know about these, so this article is here to help; but let’s get one thing clear, we hate the the term loophole because everything you can do is totally legal! So we think you should be taking advantage of these great opportunities.

For the sake of this article, by definition, a “loophole” is any provision of the tax code that helps a taxpayer save a little more in tax returns. Having optimum knowledge of these can help you file your returns.  

Go over the checklist below for all the best small business tax loopholes and tax breaks you may or may not know to help build your small business. 

Capital vs. Business Expenses 

First, let’s look at the difference in capital and business expenses, both of which can have benefits for corporations , LLCs, and sole proprietors running small businesses. 

Capital Expense 

A small business invests money in different types of assets; these are called capital assets. A business owns these high-value properties (assets) and includes items such as real estate, land, buildings, vehicles, and different types of equipment. Payment or expenditures incurred for maintaining these capital assets for a long-time is referred to as capital expenses.  

Buying a capital asset can increase the value of a business if you were to sell the company;  however, capital assets are often items that “lose” their value with time. This decrease in value is called depreciation, and is reflected in a reduction of your tax liability when you file your taxes. 

A business can take tax deductions on capital expenses over many years, except as it applies in Section 179. This deduction helps small businesses reduce their taxes due each year the depreciation applies, while providing your employees better tools or equipment and increasing the value of assets on the balance sheet. 

Generally, there are three types of expenses you can count as capital expenses in order to further optimize your business:

  • Business Assets
  • Improvements
  • Business start-up costs 

So consider how these can help your business reduce your taxes, or increase your business’ value in order to help you build your net worth and grow your wealth. If you decide to buy business assets remember, you get the depreciation over a period of time, and if you sell the asset it can result in capital gains or losses that apply to your taxes and tax liability under a separate “capital gains” tax rate that is tied to income levels, and is often more difficult to calculate as a small business owner.

Business Expense 

All the ordinary and necessary costs incurred by a business to run it smoothly comes under Business expenses. According to the IRS, business expenses are “helpful and appropriate” for a business. 

In general, not all business expenses are tax-deductible. And a few can be partially deducted. Nevertheless, some common deductible expenses include rent, insurance, company car, bank fees, payroll (freelance and employee), software, furniture, membership dues (including professional affiliations), meals, employee retirement plans, employee benefit programs, etc..  

Additionally, if you are operating your small business from home or using your car, you can partially deduct the expenses. You can refer to Publication 535 for more details.

Note: Capital asset costs are not deducted as business expenses. 

Section 179 Explained

Section 179 was earlier called “SUV Tax Loophole” as it allowed businesses to write off the cost of certain qualifying vehicles, among other items. While some of these benefits have been adjusted it is still very advantageous for helping reduce small business taxes.  

What is Section 179?

Section 179 is a section of the U.S tax code that allows businesses to make eligible deductions. In other words, Section 179 of the IRS allows small businesses to deduct the cost of the qualifying equipment financed or purchased during the tax year. 

The businesses can take a depreciation deduction on certain assets such as equipment, vehicle, machinery and real estate. Writing off the expense or depreciation of an asset allows spreading the cost over the time it is used by accepting a tax deduction for only a part of the cost every year. 

For instance, you can receive tax deductions for using and buying the assets for business purposes when purchasing machinery or vehicles. The deductions can help save money in tax returns, especially the small business. A key to ensure you maximize the use of the Section 179 is to work with a CPA when filing your taxes, and to engage them when making decisions on purchasing your assets. A quick question to your CPA could end up saving you thousands of dollars for multiple years in a row, so be sure to engage with a CPA to get the best outcome.

What is a Qualifying purchase?

“Qualifying purchase” refers to anything that you spend money on that is tangible personal property, and counts as depreciable because it is bought for business use. 

Deductions in 2020 

Limits change year to year and are indexed against inflation. If a small business spends more, then the allowable deduction, the deduction is then reduced on a dollar-dollar basis. However, In case you miss a tax deduction because you did not earn enough, you can carry it to the next year and take the deduction then, assuming your next year’s income allows it then.  

Bonus Depreciation  

Bonus depreciation is an accelerated depreciation method that permits a business to take an additional 100% deduction on certain qualifying property’s cost. This benefit applies to when the property is placed into service. It can be taken after you take any 179 deductions.  

It is an incentive provided by Congress to allow small businesses to invest in capital assets. According to the Tax Cuts and Jobs Act (TCJA), a few changes were made to enhance bonus depreciation options, and for this specific benefit, check out the instructions for Form 4652.

Keep in mind that the deduction only applies to items purchased for use post-September 17, 2017, and the bonus depreciation is increased to 100% and will remain 100% till January 1, 2023. Again, be sure to review the instructions and latest rules from the IRS to ensure you are doing this correctly, and if you have any questions, as always, we recommend contacting a CPA to ensure you optimize you tax filings for any given year.

What does this mean for a business and the asset purchase? 

All the provisions mentioned above imply that there is no need to buy a new property to get a bonus deduction provided you have added this first time under service.  

Electric Vehicle Incentives

If you own an electric vehicle, you are eligible for Electric Vehicle Incentives (EVI). All new electric and plug-in hybrid cars bought after 2010 can avail of the federal income tax credit. This can go up to $7500.  

The incentive can vary based on the capacity of the battery measured in kilowatt-hours. But this applies only to someone whose income meets the current requirement. Also, it depends on the incentive you qualify for and the Electric Vehicle (“EV”) or Plug-In Hybrid Electric Vehicle (“PHEV”) you decide to buy.  

Electric Vehicle Incentive is not a rebate but an actual tax credit. This means that it reduces tax liability on your income dollar for dollar. Some of the limitations on Electric vehicle tax credits include:

  • The vehicle must have a battery pack with a capacity of 4-kilowatt hours or above.
  • The vehicle should be a 100% battery-run electric car.
  • Vehicles with internal battery chargers do not qualify for Electric Vehicle Incentives.
  • There are only a certain number of credits for each brand of car manufacturer, and you have to ensure the manufacturer hasn’t given out all of the available credits for that vehicle make yet. 

Note that General Motors and Tesla do not qualify anymore. Their tax credits are already phased out due to the number of cars the have sold over the years. 

How does it impact your business and taxes? 

A business has a tax liability on an electric car in the purchase year to claim the electric vehicle tax credit. The liability should be equal to or more than the credit amount you request. For instance, your vehicle is eligible for a full $7500 tax credit, but if you have $5000 in federal taxes, you can claim $5000 only. This is mainly due to the income tax liability you owe from the previous years. 

Apart from the income tax concessions and credits, a few states offer small business buyers of EV and Plug-in vehicles rebates on registration, sales tax, and title fees. Some states provide discounted or free parking and access to carpool lanes as well.

Charitable Donations 

Contributions made to a tax-exempt organization, for instance, a charity, are tax-deductible donations. These donations are capable of lowering your taxable income. To claim this deduction, you can file Schedule A of IRS Form 1040 or 1040-SR. 

  • Sole proprietors of pass-through business entities can report tax deductions on their tax returns. It should qualify for the regulations set for individual taxpayers and can be a useful way to offset your taxable income if you are already making tax deductible donations.. 
  • Cash donations for C corporations have increased from 10% to 25% with some adjustments. 
  • Special rules are set for food inventory contributions, and should be carefully considered if this is your preferred method of donations.

Note that the maximum limit on charitable contributions is raised from 15% of C corporations’ taxable income and 15% of net income for pass-through businesses to 25% each.   

Bottom Line  

A business can use creative tax deductions if it knows the best small business tax loopholes and how they work in the business’s favor, which is why it is common to front-load expenses at the end of a year and to invest in property to give out to employees to help attract and retain talent.. As said earlier, the filing process is not easy, and a minor mistake can make you regret it later, so always consult a CPA to ensure that you use these tax code benefits as early and as optimally as possible. 

 

References

About the Author

Aaron is a financial planner who is passionate about helping small business owners create wealth in an efficient way. Helping you define your vision for a wealthy life in both money and lifestyle, Gig Wealthy helps you reduce taxes, manage cash flow, and optimize retirement savings with strategies advised by world class financial panning firms.