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Self-employed professionals have a million things on their plate. While taxes might be top of mind, implementing a strategy usually falls to the bottom of the to-do list.
It’s unfortunate because most independent workers are paying more than their fair share of taxes and have become so focused on figuring out how to make more when they could simply shift their focus to keeping more.
So, with that in mind and 2023 coming to a close, here are seven advanced tax strategies to help you keep more of what you make.
1. Establish the right entity and tax election for your business
Choosing the right business structure is crucial. It will significantly influence taxation, personal liability, and business management. In most cases, when you’re making more than $80,000 a year, opting for an S-Corp will yield significant tax savings, as owners can pay Social Security and Medicare taxes solely on their salaries rather than the entire business profit. If you need help finding the right structure, contact a tax professional, check your state’s website, or use online resources.
2. Leverage itemized deductions vs standard deductions
Itemized deductions are crucial as they enable taxpayers to maximize savings by accounting for a broader range of eligible expenses compared to the standard deduction, such as mortgage interest and property taxes, out-of-pocket medical costs, state and local taxes, and charitable contributions both cash and non-cash. This tailored approach ensures a more precise reflection that can lead to substantial tax savings.
Imagine you’re a homeowner, and your annual mortgage interest, property taxes, and charitable donations total $22,000. You can subtract the full $22,000 from your taxable income if you itemize your deductions. However, if you opt for the standard deduction (e.g., $14,600 for single filers in 2024), you’d miss out on deducting the extra $7,400 you’re eligible for by itemizing. So, in this case, itemizing would result in lower taxable income and potentially lower taxes.
3. Maximize retirement accounts
Retirement contributions are a great tax-saving strategy, offering a twofold benefit of securing financial stability in the future while reducing current tax liabilities. By contributing to retirement plans such as a Simplified Employee Pension (SEP) IRA, a Solo 401(k), or a Cash Balance Plan, entrepreneurs can deduct their contributions from their taxable income, dramatically lowering their overall tax burden.
For example, John is a 55-year-old real estate agent making $285,000 per year after expenses (including payroll of $125,000 for himself since he runs an S-Corp). With a 401(k) by itself, he could contribute $30,500 from his wages as the employee and $31,250 as the employer for the year, to a total of $61,750.
In adding a Cash Balance plan to go with his 401(k), he could add a $168,126 contribution as an employer to the retirement savings of the 401(k), bringing the total contributed to retirement to $229,876 per year. And that limit only goes up: as John gets older and his business potentially continues to get more profitable, he could have the ability to pay himself a higher salary and increase the amount contributed to the plan.
4. Pay your children and spouse
As an S-Corp owner, employing family members comes with various advantages. Adding your spouse to the payroll can increase fringe benefits, with contributions to Social Security boosting retirement benefits. Setting up a 401(k) plan for your spouse can further enhance the family’s retirement fund. Additionally, employing your children can decrease family taxes, increase deductible business expenses, and facilitate the initiation of a retirement plan for them.
5. Constructive receipt
Constructive receipt is a tax concept that provides flexibility in managing taxable income. Income is considered received when it’s under your control, even if not yet physically collected. This allows self-employed individuals to optimize their tax planning by strategically timing income recognition. For example, they can delay collecting payments to shift income into a lower-tax year, helping to minimize their overall tax liability. However, it’s crucial to maintain accurate records and adhere to tax regulations to use this flexibility effectively.
6. Invest in real estate and rentals
Real estate rental properties can be an integral component of a comprehensive tax strategy for individuals, providing various avenues for tax benefits and savings. Property owners can benefit from depreciation deductions, allowing them to deduct a portion of the property’s cost each year. This deduction can significantly reduce taxable income, thereby lowering overall tax liability.
7. Health premiums HSA and FSA
Entrepreneurs can deduct health insurance premiums from their total income on their tax return. Alternatively, S-Corp owners can set up a group health insurance plan, enabling the S-Corp to pay premiums through the payroll, leading to substantial tax savings. Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) further help entrepreneurs reduce taxable income and benefit from tax-free contributions, growth, and withdrawals for qualified medical expenses.
How to get started
With many available options, the best approach will be comprehensive and proactive, but you can’t do it alone. You’ll need to enlist the guidance of a knowledgeable tax professional and put together a dream team to advise you along the way.
Don’t let another year go by with this at the bottom of your list!