Using Your Books to Calculate Business Taxes and Using Basic Strategies to Reduce Them
“With great power comes great responsibility” – Spider Man
I’m not going to come at you with any fluff or fiddle dust. Unlike many “tax gurus” that come and go like tumble weeds, I’ve been in this space for more than a decade, because I do what works, and I stand behind my work. I use tax strategies that help you legally save money, and help you sleep better at night.
I have no interest in selling you an expensive “hit-it-and-quit-it” tax strategy that I wouldn’t defend, or driving you through tax court with the fuel of retainer fees.
My objective in this post is simple: Help you use your books to calculate taxes, and identify the opportunities available to you to avoid tax traps and overpayments.
This is a combination of basic math and basic tax law. Let’s not overcomplicate this. We’re just calculating our taxes, and then looking for ways to lower them.
So if that sounds like cake to you, then let’s get cooking!
Overview
There are two ways to calculate taxes:
Calculate them yourself
Have other people calculate them for you
Some taxes, like property taxes or buyer’s side sales taxes, will be calculated for you, and if they exist you will generally pay them at that amount unless you find a reason to the contrary.
For example, if you buy medical marijuana from a dispensary, you don’t have to go through the pain of calculating sales taxes, excise taxes, etc. The dispensary will do that for you. However, you do have to pay for it at the register.
Since the majority of people reading this are small business owners and accountants, I'll focus on the taxes that are your responsibility to calculate and pay, the ones that your business will incur, and that will be captured in your financial statements + tax returns in one way or another:
Income taxes
Employment taxes
Sales taxes
Income Tax – Tax Brackets
When you read the headlines about tax brackets, this is usually what they’re talking about. When you make more income, you usually pay more income tax.
There are different types of income that receive different tax treatment:
Earned income
Ordinary income
Investment income
Gift or inheritance income
Passive income
If you know your taxable income, and just want to see how much money you owe in taxes, then you can either do this on your tax return and find the end amount, or go to IRS.gov for an estimate.
The rest of this post is not on how to necessarily manipulate the numbers, identifying the things you can do to leverage the tax law to avoid overpaying, or underpaying tax.
Earned Income – Wages + Profits
If you’re an employee, self-employed, a business owner, or a mix, then you’ll likely have earned income. This includes things like W2 and self-employment income.
This income generally has high income tax rates and high employment tax rate – like FICA taxes. But if your earned income is within a certain range, you could qualify for the earned income tax credit which gives you money back in the form of a refundable credit from the IRS. This is basically the IRS’s way of saying “you’re a low-income earner, but since you’re actually part of the labor force, we’re going to help you grow with a tax break.”
Earned income is generally the income that is taxed the highest, however, and so when we have high amounts of it, we want to find ways to shift that from earned income to ordinary income in order to minimize our employment taxes.
Ordinary Income – s-corporation and certain partnership profits
For the purpose of reducing taxes, it’s sometimes good to shift earned income to ordinary income.
One technique that is commonly used by self-employed individuals is changing the tax treatment of profit generating entities.
Example, if we’re operating a single member LLC being taxed as a sole proprietorship, then we might consider electing s-corp status by filing form 2553 to treat the entity as an s-corporation for income tax purposes.
This lets us pay ourselves a reasonable wage from our profits and take the remaining amount as distributions, which do not incur employment taxes.
We can also use s corporations to reclass partnership income.
Let's look at a partnership distributing income to each of 2 partner's LLCs.
This income incurs 15.3% employment tax on the two partner's personal tax returns. Those two partners decide instead to elect S-Corporation status for their LLCs, and the S-Corporation pays the owners a reasonable salary.
What happens is that the S-Corporations will earn income from the partnership, and will distribute it to the owners in the form of wages + profits.
Those profits will save 15.3 cents on the dollar since that income shifts from earned income to ordinary income.
And there’s more ways that we could find to reduce these taxes, but this is just one way to get you thinking about it in a creative way.
Employment Taxes – Social Security + Medicare
So payroll taxes, or otherwise known as employment taxes, are the combination for federal purposes of FICA taxes which are made up of Social Security and Medicare taxes and are assessed at 6.2% for both employee and the employer and 1.45% for both employee and the employer on all earned income up to a certain threshold.
Beyond that threshold the Social Security tax is completely faxed out and the Medicare tax at a certain point increases.
When we have self-employment income then at least up to about $175,000 of this incur that 15.3% tax on Social Security and Medicare.
This is an addition to the to the income tax. What this means is that if you’re at a 30% income tax rate and you’re earning self-employment income then you’ll be in an effective 45.3% tax rate generally speaking because you will have that 15.3% additional tax.
Who incurs Employment Taxes?
Two kinds of people that pay employment taxes:
Employers
Employees
Each pays half of this tax. This tax is 15.3%. If you are self-employed, you pay the full 15.3%.
General partners in partnerships are also considered to be self-employed for payroll tax purposes, which means that their profits get taxed at an additional 15.3% in FICA taxes.
Sales Taxes
Sales taxes are assessed at the state and local level. They are paid by the buyer and collected and remitted to the taxing agency by the seller. Therefore, it’s considered an expense to the buyer, and a liability to the seller.
This is, however, the tax that, if mismanaged, can put you out of business faster than any other tax, because they can be extremely high, and the seller must pay it, even if they fail to collect it from the consumer.
For example, if you are selling widgets, then you might owe 8% in sales taxes. Customers are used to this tax and willing to pay it, but if you forget to charge them for this tax, then the liability will transfer to you or your business, and you won’t be able to go after the buyers to collect back taxes for what they should’ve and would’ve paid originally.
Who Pays Sales Tax
Sales taxes are on sales or purchases of certain items. These are generally physical inventory or equipment, but it’s circumstantial and varies depending on what you’re buying/selling and where. Be sure to consult with your tax advisor to be sure that you’re not overpaying, or underpaying these taxes.
When are Sales Taxes Paid
Sales taxes are generally due at the end of the month or quarter on sales taxable sales for the period. For income tax purposes, it’s worth nothing that these items will generally not be reported directly.
Buyers, paying this tax generally on inventory that they’re reselling or processing or for fixed assets, will capitalize this expense, and then write it off through cost of goods sold or depreciation.
Sellers do not pay this tax, but rather remit it on behalf of the buyer. So it will be recorded as a liability on the balance sheet not an expense on the profit and loss statement.
So these taxes should only be a burden when purchasing goods, or remitting the taxes to the state or locality, but rarely for the purposes of an income tax return.
Can you Reduce Taxes after Calculating Them
If you are calculating a tax based on things that already happened, then you won’t have many ways to reduce it, other than changing accounting methods or doing deeper research to find benefits that you are eligible to take, like missed deductions or credits.
If your tax is based upon an estimate of the future, then you will be able to have more control as to how much it will be, and you can choose if and how you want to reduce it, if possible.
For taxes in the past, i.e. 2024 and prior, you’re going to want to find out your taxable income now, and find ways to reduce it if possible.
This is something I’d have a tax advisor do, as they know what to look for: i.e. prepaid invoices, unpaid invoices, missed deductions, credit opportunities, tax elections, etc.
After that, you will want to do some planning if you can, so you can minimize surprise taxes and control your tax outcome. Your two main opportunities to get ahead of taxes for 2025 and beyond will be:
A tax projection in beginning of Q3 for the rest of the year, and
Make a Tax Plan in Q4 for 2026 taxes
Reducing income Taxes
Your income taxes are not directly affected by your choice of s corp or disregarded entity for federal tax purposes. But most businesses will want to look for more deductions to reduce these taxes.
Common hiding places for these tax benefits are: auto deductions, home office deductions, and payroll taxes, since accounting software still cannot automate this calculation correctly in most cases.
Reducing Employment Taxes
To reduce payroll taxes as a single member LLC, you’d need to find more deductions, and write them off against your business income. However, given a fixed net income, you cannot reduce this tax without switching your entity type from a disregarded entity to an S corp for tax purposes.
Using Retirement Plans
With disregarded entities on sch C and s corps you might want to invest money into a 401k whether Roth or traditional in order to reduce your income taxes.
Traditional plans are pretax contributions so you only pay tax on the withdrawals while roths are post tax and therefore tax exempt
Roth dollars are more valuable since they are tax free but more expensive since they are generally tax diluted when initially invested.
Sometimes it’s best to pay yourself a higher salary to allow yourself to put more into a 401k which lets you possibly write off income taxes in exchange for paying more self employment taxes. Highly dependent on your strategy.
Using Real Estate
Real estate is one of the higher tax incentivized investment vehicles due to depreciation, which opens the possibility of recording a tax loss while having positive cash flow on an appreciating asset.
Under passive activity loss limitations (PAL limits) you may be eligible to write up to $25K of losses against earned income. And if you’re a real estate professional, then the PAL limits don’t apply, although others do.
There are many rules and complexities to this, so if you are looking use real estate for your tax plan then be sure to consult with a tax advisor who can steer you in the right direction.
Rounding it Out
When you’ve arrived at your final taxable income amount for all the taxes you’ve owed you can be more certain about what your liabilities and rights are. Sometimes you’ll owe more than you thought, sometimes less, and often it’ll not be a surprising number.
If you owe penalties or interest for late payments or filings, be aware that you can often apply for it to be forgiven, but it’s circumstantial and not a guarantee.
The best way to minimize taxes owed is to pay them on time. Then the best way to minimize taxes accrued is to tax planning and make a good plan for you, your business, and your goals.
Motivation, Philosophy, and a Helping Hand
Taxes inspire the most creative fears in us, but in the words of Mark Twain –I’ve have know many worries and suffered many misfortunes in my life, most of which have never happened.
If you stare fear down, it usually backs down, and the same goes for taxes.
Once you know what you’re looking at, what the truth of the numbers is, then you can take action to control it.
In this case, you need to know your taxable income, the taxes you have to pay, and what those taxes come out to. Then, it’s your chance to find ways to reduce the numbers.
And sometimes the best short cut is to simply stop looking for shortcuts and just take the long way.
There are many tools that you can use to figure your taxes, from online calculators to even filling out the tax return itself, but in the end, the most important step you can take is the first one.
And savings are nice. Personally, I’d rather save 1 dollar than make 1 dollar. I hate losing money much more than I like making money. But taxes are the biggest expense in your life. So you’ll want to find somebody who can help you chip away at the taxes due, whether that’s you or a professional.
What gets measured gets improved, and when you have an expert tracking the numbers for you, then you’ll be sure that your results are in good hands.
If you are looking for help in managing your taxable income, then book a complimentary CPA call and I’d love to discuss it with you.
Until next time.
Happy Hunting,
Jonathan Sussman CPA
