So, today, I will take you back to a fundamental principle: tax efficiency. Your business needs to evolve to become more tax-efficient over time, which we do through strategic tax planning. For small business owners, tax efficiency in their business means personal tax efficiency, which connects to this week’s titular question: “How do business owners pay less taxes now and in retirement?”
Here’s where we start:
- Tax-efficient entity structure
- Review retirement options and savings accounts
- Utilize health savings accounts (HSAs)
- Review Measures for Asset Protection
- Get an exit strategy
More on how each of the five work in a bit.
Not enough small business owners save for retirement
37% of small business owners don’t think they make enough profit to save for retirement.¹
That number is far too small. Saving for retirement shouldn’t be something you do only when your business has a particularly good year or when you’re thinking about stepping away from work — it needs to be part of a comprehensive tax strategy.
Start strategizing now
In this article, I’ll go in-depth on a few strategies that can help business owners pay less taxes right now and after they’ve retired.
By optimizing your tax strategy right away, you can ensure long-term financial stability and enjoy a comfortable retirement.
It’s a lifelong process, but you can get started now. Here’s how.
1. Adopt new, tax-efficient legal entity structures as your business grows
The choice of entity can have a major impact in terms of how small business owners pay less taxes.
Many business owners start as sole proprietors or multi-member LLCs. The question is, when does it make sense to restructure to an S-corp or C-corp? (LLCs can elect to be taxed as S-corps. Ask me about that when we talk.)
Each business structure has its own tax implications, affecting things like self-employment tax, pass-through taxation, and corporate tax rates.
I can tell you what kind of entity structure I would choose in your position, but as a CPA, I cannot directly advise you on the specifics. However, I can refer clients to a capable tax lawyer to formalize changes and draw up the appropriate documents.
2. Review retirement options and savings accounts
Retirement savings accounts are powerful tools that can reduce your current tax bill while helping you toward a comfortable retirement.
The retirement accounts available to you are
- Traditional 401(k)
- Safe harbor 401(k)
- Solo 401(k)
- SIMPLE IRA
- SEP IRA
- Traditional IRA
- Roth IRA
- Defined Benefit Plans
- 412e3 Plans
Contributing to a tax-advantaged account allows you to deduct contributions from your taxable income, which may push you into a lower tax bracket.
Plus, the funds in these accounts can grow tax-deferred until retirement when you withdraw them.
Meet with a CPA to find the account that’s right for you
Which method is best for you depends on your specific circumstances. If you don’t have any employees or are self-employed, the Solo 401(k) is probably ideal. If you want the simplest option and have 20 or fewer employees, you’ll likely want the SEP-IRA, which is funded solely by the employer.
Keep making regular contributions to your retirement account
The power of compound interest relies on time. Regular contributions allow your retirement savings to grow steadily over the long term.
The longer your money remains invested, the more time it has to compound, leading to significant growth.
3. Utilize health savings accounts (HSAs)
The average retired couple age 65 will need around $315,000 saved after tax to cover health care expenses in retirement.²
To get there, you need to put away money throughout your business’s lifecycle. Fortunately, there’s a way to do that while lowering your tax liability: It’s called a Health Savings Account (HSA).
An HSA lets you set aside pre-tax money to pay for certain medical expenses. If you have a high-deductible health insurance plan, you can contribute to an HSA and enjoy triple tax advantages: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses.
HSAs aren’t only for medical costs
Even better, once you turn 65, you can withdraw money from your HSA and use it for any reason. You’ll just need to pay income taxes on withdrawals not used for medical expenses.
It’s like having an additional retirement account. That’s why, according to the Wall Street Journal, using an HSA to save for retirement medical expenses “is a better strategy than using retirement accounts.”³
Even better — use both.
4. Review Measures for Asset Protection
You can protect your assets with IRAs and Roth IRAs as discussed earlier, but as part of your strategic tax plan, you need to look into life insurance—cash-value or proceeds.
And we don’t want to forget annuity cash value. Life insurance cash value generates annuity under certain conditions. We want to take advantage of that in your strategic tax plan.
5. Get an exit strategy
It’s important to have the right plan for your exit from your business, whether it’s through selling, passing it on to a family member, or another exit strategy.
A well-structured business ensures a smooth transition and enables you to benefit from your business’s value when you retire.
Certain tax provisions may allow for lower capital gains taxes or other tax benefits, depending on how the sale is structured. This area’s complicated, so I definitely recommend consulting a CPA to solidify your exit strategy.
Use the gift tax exclusion to pass a business to children
The gift tax exclusion is the amount you can give someone without having to report it to the IRS. Right now you can give up to $17,000 to someone in a year without having to report.⁴
Gifting shares of your business to family members is a good way to ensure smooth succession. This method allows you to pass the business’s value to your heirs while minimizing taxes.
Business owners need to think long-term
Remember, reducing your tax burden is not only about saving money in the short term. It’s also about securing a prosperous retirement.
If you incorporate deliberate strategy into your accounting processes and consult with an expert, you can reduce your tax bill now and in the years to come.
Let’s get you on a tax plan that works
I’m a Fort Worth-based CPA who knows how to help business owners pay less taxes while planning for a secure future.
I can work with you long-term — to help you make the right decisions now and in retirement.
Schedule a discovery call today.
Talk soon,
Jeremy A. Johnson, CPA
References
- Small business retirement – investing in your future. SCORE. 2019. Available from: https://www.score.org/resource/infographic/infographic-small-business-retirement-investing-your-future
- 5 ways HSAs can help with your retirement. Fidelity.com. 2022. Available from: https://www.fidelity.com/viewpoints/wealth-management/hsas-and-your-retirement
- Tergesen A. HSAs Offer Tax Benefits Beyond 401(k)s. The Wall Street Journal. 2016. Available from: https://www.wsj.com/articles/hsas-offer-tax-benefits-beyond-401-k-s-1454063400
- Frequently asked questions on gift taxes. Irs.gov. Available from: https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes