As a business owner, one of the least favorite pastimes you have is paying taxes. Whether it’s last year’s income taxes, this year’s taxes, or future taxes –the best tax income tax bill is a small one.
But most business owners spend time allocated to income taxes dealing with past tax years or in the present tax year. There may be some tactical tax items you can adjust, but you simply can’t change too much of the past or the present.
Instead, what if you allocate your time thinking on future tax strategies to minimize future taxes. Makes sense, right?
In the intricate world of business ownership, the pursuit of tax efficiency is a critical component of your financial success. This article explores three powerful ways business owners can lower their income taxes, with a special focus on the implications of temporary tax law changes available through 2025, the strategic benefits of cash balance plans, and the role of cash values in life insurance, as well as the opportunities presented by commercial real estate.
family to stay in control, how do I transfer the business to them?
- Will I have enough assets once I sell my business and pay taxes to retire on my terms?
How you answer these questions really impacts how much time it takes to sell your business. In this article, we’ll walk you through the necessary steps and considerations when selling your business. With the above questions in mind, you’ll be taking the first step in adequately preparing for selling your business…on your own terms.
Two Laws That Likely Expire in 2025
The two laws below were passed into law in 2017 but are set to expire at the end of 2025. While they are not part of our strategic solutions for future planning, they’re worth knowing about.
#1 The 20% Qualified Business Income (QBI) deduction
This was a pivotal change for entities like sole proprietorships, LLCs and S-Corporations. If this is you, this deduction allows eligible business owners to deduct up to 20% of their qualified business income, subject to certain limitations.
A 20% reduction in business income is meaningful.
Combining the ‘20% deduction of QBI’ with ‘Cash Balance Plans’, which is another tax strategy that we’ll discuss below, can create a powerful set of deductions for the next few years.
Navigating the complexities of QBI requires a thorough understanding of the rules, and it’s advisable to consult with tax professionals to optimize its utilization.
#2 Increased Bonus Depreciation Strategies
These were also part of prior tax law changes that are set to sunset in 2025. By taking advantage of increased bonus depreciation percentages, businesses may write off a more substantial portion of the cost of property in the year it is placed in service. This might be trucks, machines, and other fixed assets needed for the future of your business.
If you’re a service-based business owner, like a consultant or financial services provider, you probably don’t have much use for enhanced depreciation as a strategy. For other business owners, this bonus depreciation may allow for significant capital investments as taxable income is reduced.
3 Strategic Approaches to Lower Future Income Taxes
Now that the short term tax planning items are out of the way, let’s look at three ways to significantly lower a business owner’s tax burden for future years.
1. Unlocking Future Tax Deductions with Cash Balance Plans
While retirement planning is an ever-evolving consideration, recent tax law changes have rekindled interest in sophisticated retirement strategies, notably cash balance plans. These plans offer business owners a unique blend of tax advantages and wealth accumulation potential, but they don’t fit for every owner.
Understanding Cash Balance Plans
Cash balance plans are a form of defined benefit pension plan with characteristics that resemble both traditional pensions (like employers might have done in prior decades) and 401(k) plans. Jumping right in, why would business owners prefer a cash balance plan, anyways?
Cash Balance Plans typically provide a much larger tax deduction to the business, than just a typical 401k alone. And the more of the retirement benefit may favor the owner, than just a typical 401k would.
It’s no wonder that cash balance plan usage is on the rise.
- To determine if this fits for you and your business, your business needs the right mix of employee headcount, income for each employee, and the tenure for each employee. And, the details matter. Contributions made by the business to the plan are tax-deductible, effectively reducing the business owner’s taxable income. Furthermore, the assets in the plan grow tax-deferred, allowing for compound growth over time. This tax efficiency can result in significant wealth accumulation, especially for business owners in higher tax brackets.
- When this is combined with the 20% Qualified Business Income deduction mentioned above, taxable income can really reduce for future years.
- Beyond the personal benefits for the business owner, cash balance plans can serve as a powerful tool for attracting great employees. By offering an additional, tax-advantaged retirement benefit, businesses can enhance their competitive edge in attracting top talent.
Reviewing your employee census with a financial advisor experienced in these types of plans is often your first step.
2. Cash Values in Life Insurance: A Triple-Purpose Strategy
Life insurance, traditionally viewed as a risk management tool, can also play a strategic role in tax planning for business owners. Cash value life insurance, such as whole life or universal life, provides a unique avenue for tax-efficient wealth accumulation:
Cash Values Often Grow Without Taxation
We find that many types of investment accounts you choose as an owner, including CDs, stocks, or bonds, produce extra taxable income along the way. This taxable income is on top of the other income you have, creating a compounding of taxes over time. As the account compounds in value, so does the tax.
While not right for every owner, cash values often accumulate tax-deferred over time. These cash values are often liquid, and amounts may be distributed as withdrawals, often tax-free up to the amount of premiums paid. For business owners in high income brackets, these tax reductions matter, especially when compared to the taxable income generated from other types of investments.
Tax-Free Retirement Income
Business owners can strategically leverage cash value life insurance as a source of tax-free retirement income. By withdrawing cash values business owners can supplement their retirement income, often without triggering taxable events, providing a valuable layer of flexibility in retirement planning.
Income Tax Free Death Benefit
The death benefit paid to beneficiaries is typically income-tax-free, and if structured appropriately, it can also be estate-tax-free. This makes life insurance an efficient tool for replacing some of the business value if a key-owner dies unexpectedly.
Business owners, even when they successfully exit from their business, have future income tax, estate tax, and other liquidity needs. While these future taxation items are hard to plan for with precision, possessing cash values and death benefits that are tax advantaged makes planning much easier.
MUCH easier.
3. Real Estate for Tax Advantages & Wealth Building
Investing in commercial real estate is another avenue for business owners to optimize their tax position while building long-term wealth, especially when you can be your own landlord. Several tax advantages and strategies are associated with commercial real estate, including:
- Depreciation Deductions: Commercial real estate owners can benefit from depreciation deductions, allowing them to recover the cost of the property over time. This can significantly reduce taxable income over time.
- Tax Credits and Incentives: Depending on the location and nature of the property, business owners may be eligible for various tax credits and incentives, such as historic rehabilitation tax credits, energy efficiency incentives, or opportunity zone treatment. Exploring and taking advantage of these opportunities can enhance the overall tax efficiency of commercial real estate investments.
Lower Your Income Taxes
Strategies to lower income taxes are not only worth exploring as a business owner but necessary in maximizing your business’ value.
The best part about these three strategies is they may be used in combination with one another or stand-alone.
By adopting a proactive, informed, and strategic approach to tax planning, business owners can not only lower their income taxes but also lay the foundation for sustained financial success and wealth accumulation.
To start planning the right course of action to accumulate wealth in your business, chat with an experienced advisor at Consolidated Planning.
2023-165437 Exp. 11/2025
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
