How Pandemic-Stricken Small Businesses Can Lower Their Taxes

President/CEO of Joseph’s Premier Real Estate; professor of finance, business, real estate at IRSC; author of Madness, Miracles, Millions.

As the 2020 election heats up, small businesses are eager to see the candidates’ plans for small business tax relief. This is especially important during the Covid-19 pandemic, which has shuttered more than 1 million small businesses and still threatens millions more. Many small-business owners are cash-strapped and desperate for any semblance of tax relief. If they save more in taxes, America’s most dedicated job creators will surely invest in business expansion. I believe that with enough cash on hand, employers will invest in their workers — and their workers’ families.

In the meantime, there are ways for small businesses to lower their effective tax rates. Here are just three of them:

Create a 401(k) retirement plan with profit sharing.

Employees appreciate small-business owners who invest in their retirement. Such investment signals that employers genuinely do care about their workforce — beyond a base salary and vacation time. Indeed, nearly 60% of working Americans participate in a workplace retirement plan.

However, a retirement plan can also benefit employers. By introducing a 401(k) plan with profit sharing, whereby employers make pretax contributions to the 401(k) plan on a quarterly or annual basis, small businesses can deduct those contributions from their taxes (for the previous tax year). Not only does 401(k) profit sharing boost employees’ retirement savings without increasing their taxable income, but it is also exempt from Social Security and Medicare withholding for employers.

Small-business owners can be flexible with profit sharing. Because it applies to the previous tax year, an employer can make a contribution in January 2021 and deduct it on a 2020 tax return. This allows employers to map out their finances in both the short and long terms with greater efficacy. 

Invest in a 412(e) plan with guaranteed annuities and life insurance.

Private investment is not always easy. For certain small businesses, even one subpar month can be a death sentence. During a pandemic, that risk is only amplified.

That’s why 412(i) plans were developed in the first place. Now known as 412(e) plans, they are defined benefit pension plans that allow small-business owners to ramp up private investment while covering other costs — from payroll to retirement plan contributions. Since 412(e) plans are tax-qualified benefit plans, the entire amount contributed immediately becomes tax deductible for small businesses. However, employers who are considering this tax deduction must contribute to the plan with guaranteed annuities or a combination of annuities and life insurance.

Set up a section 125 cafeteria plan.

Helping your employees pay their medical bills is always a good thing. But healthcare-related contributions can also be used to cut taxes. Small-business owners may create a Section 125 cafeteria plan, which is a part of the Internal Revenue Service code that enables employers to use taxable benefits — say, a base salary — and convert them into nontaxable benefits. So-called cafeteria plans, which cover expenses related to medical care (including child care), are deducted from an employee’s paycheck before taxes are ever paid.

Small businesses with cafeteria plans can save on the Federal Insurance Contributions Act (FICA) tax, Federal Unemployment Tax Act tax and State Unemployment Tax Act tax. On average, employers save $115 per plan participant on the FICA tax alone.

Remember: Every dollar counts. These are just three ways to save on taxes, and there are many more available. It pays to consult an accountant or tax attorney, especially one who specializes in small businesses. Often, an expert can introduce employers to tax savings once thought unimaginable.

Ask around, and get a second, third and fourth opinion. When it comes to cutting taxes, it’s impossible to ask too many experts for advice. Do your due diligence now, and the savings will come.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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