The annual tax filing deadline is only a month away, but franchise owners still have time to make sure they’re taking advantage of everything available to them as small business owners. What follows is a guide that offers straightforward advice (with hypothetical examples) on key tax-saving tips, deductions you may not have considered, and how the appropriate business structure can save you money in the future.
Organization is the Key to Maximizing Your Deductions
There are several often-overlooked deductions that can substantially lower your tax liability. For instance, the franchise fee you paid to launch your business – often a hefty sum – can be amortized if paid from your personal account. Likewise, loan interest is a critical deduction, especially if the funding is directly tied to business operations. Contributions to retirement plans, like a SEP IRA or solo 401(k), not only secure your future but also offer deductions. And buying a vehicle for business use or paying your children for legitimate work can also lower your tax liability. Organization is the key to leveraging these deductions, because without proper documentation, tracking, and a knowledgeable bookkeeper, it’s easy to overlook these strategies.
Leverage the Qualified Business Income Deduction (QBI)
The QBI deduction allows eligible business owners to deduct up to 20% of their qualified business income.
Example: If your franchise generated $100,000 in qualified business income, you might be eligible to deduct $20,000 before income tax is applied, significantly lowering your tax liability. It’s essential to calculate this deduction correctly to maximize your tax savings.
Review Your Entity Structure and Consider an S-Corp
Evaluating whether an S corporation structure could benefit your franchise could lead to substantial savings, especially a reduction in self-employment taxes. S-Corp status allows profits to be distributed without being subject to self-employment taxes.
Example: Sarah, who runs a successful bakery franchise, strategically converted her business from a sole proprietorship to an S-Corp. Initially, her business income was $120,000, fully subject to self-employment taxes at approximately 15.3%. By transitioning to an S-Corp, she set her salary at $60,000, with the remaining $60,000 paid out as dividends – which are not subject to self-employment taxes. This change meant that only her salary was subject to the 15.3% tax, resulting in a savings of $9,180 (15.3% of $60,000) in self-employment taxes.
Benefits of Switching to an S-Corp:
- Reduction in Self-Employment Taxes: salaries paid to shareholding employees are subject to employment taxes, but not the entire business profit
- Flexibility in Tax Planning: offers strategic advantages in income and loss allocation among owners
- How to Make the Switch: File IRS Form 2553 by March 15 to elect S-Corp status for the current tax year, ensuring your business meets the IRS’ criteria for S-Corp designation
Purchase a Business Vehicle
For franchise owners, buying a business vehicle can unlock significant tax benefits, utilizing either 1) the standard mileage rate, or 2) actual expenses method for deductions. Consider the two scenarios below for a business vehicle driven 10,000 miles in a year:
Scenario 1 – Using the Standard Mileage Rate: if the IRS standard mileage rate is 58.5 cents per mile, driving 10,000 miles for business purposes allows a deduction of $5,850.
Scenario 2 – Purchasing a Vehicle for $50,000: If you buy a vehicle exclusively for business use at $50,000 and use it for 10,000 business miles, Section 179 deduction comes into play. This provision lets you deduct 60% of the full purchase price of the vehicle in the year it’s put to use – subject to limits and a business-use percentage calculation. For 100% business use, you could potentially deduct 60% of the entire cost of the vehicle.
Key Takeaways:
- Diligent record-keeping of business mileage and expenses is essential
- Deciding between the standard mileage rate and actual expense method requires analysis of your specific situation
- The Section 179 deduction offers an opportunity for substantial tax savings on new vehicle purchases for business use in 2024
Employ Your Children
Hiring your children can save you money on taxes. When you pay them for real work, it lowers your business’s taxable income because their salaries are business expenses. If your child earns less than the standard deduction amount for a single person ($12,950 in 2023), they won’t have to pay federal income taxes on what they earn. This means you get a tax break, and your child keeps their earnings.
Example: If your child handles social media for your franchise and earns $12,000 in a year, this amount is fully deductible. Since $12,000 is less than the standard deduction, your child won’t owe any federal income tax.
Also, if your child is under 18 and you’re the sole owner or own the business with your spouse, you might not have to pay Social Security, Medicare, or federal unemployment taxes on their wages – a smart way to keep more money in the family.
Invest in a Retirement Plan
Investing in a retirement plan is essential for securing your financial future and enjoying tax benefits now. By contributing to retirement plans such as SEP IRAs, solo 401(k)s, or SIMPLE IRAs, you can lower your current taxable income.
Example: Alex owns a franchise and chooses to put $40,000 into a SEP IRA this tax year. Because the $40,000 contribution counts as a business expense, it directly decreases the amount of income Alex is taxed. If Alex’s income falls into the 24% tax bracket, this contribution can lead to tax savings of around $9,600. This example highlights how retirement contributions offer an effective tax reduction strategy for the present.
Closing Thoughts
Tax season is a critical time to ensure you’re leveraging every opportunity to minimize your tax burden and set your franchise up for future success. By taking these strategic steps, you can navigate through tax obligations efficiently, positioning your franchise for a prosperous year ahead.
Ryland Beard is the founder and CEO of Ledge Accounting, a turnkey provider of bookkeeping and tax services operating exclusively in the franchising industry. Since founding Ledge Accounting as a startup in 2019, he’s experienced astonishing growth – now handling the books for over 500+ individual franchise owners across the U.S. Ryland is a regular contributor to franchise industry publications and a frequent guest on several podcasts, where he discusses the value and benefits of living an entrepreneurial life.