So you’ve finally turned a profit: Now’s your chance to invest that money back into your business while lowering your tax liability. Yes, you can invest in your business and pay less taxes. Today, I’ll be outlining four major tax strategies for small business owners who want to know how to invest business profits to avoid taxes.
Lower taxes matter, but so does growth
Reduced tax liability is excellent for your business, but that alone should not be the sole driver behind your reinvestment decisions.
Fortunately, you have viable strategies at your disposal to pay less in taxes while growing your business.
- Invest in marketing
- Set up a retirement plan
- Purchase depreciable assets
- Explore R&D tax credits
In this article, we’ll explore a few reinvestment strategies that can help you make the most of your business profits while reducing what you pay in taxes.
Consult your business plan
Remember that business plan you drew up when you started your business? Dust it off and give it a read. You probably mapped out some of your business goals and the expenditures necessary to fulfill them.
As you consider your options, ask yourself what investment opportunity will have the most significant ROI. Once you know how you want to reinvest, you can start thinking about how to utilize profits effectively. A CPA will be able to help you implement your ideas.
Here are a few suggestions I recommend to my clients, depending on their situation.
1. Invest in marketing
Many small business owners don’t realize that marketing costs are often tax deductible. Marketing provides the highest return on investment, and it’s what I advise business owners to do if they’re struggling to find out how to invest business profits to avoid taxes.
The IRS has regulations that incentivize advertising and marketing activities. Here are the rules about what constitutes an ordinary and necessary expense (meaning one that’s deductible):
- An ordinary expense is typical and accepted in the industry.
- A necessary expense is helpful and appropriate for the trade or business. An expense does not have to be indispensable to be considered necessary.¹
As long as your marketing plans aren’t too off-the-wall, there’s a good chance they’ll be tax deductible. You can even deduct the cost of attending a trade show or conference.
2. Set up a retirement plan
Another effective way to minimize taxes on profits is by starting a retirement plan for you and your employees.
With the SECURE Act 2.0, the tax credit available to small employers who initiate a new retirement plan has increased. The tax credit now ranges up to $5,000 annually for the initial three years. To qualify, you must
- have no more than 100 employees who received a minimum of $5,000 in the previous year;
- at least one non-highly compensated employee must be eligible to participate in the plan; and
- the plan must be genuinely new and not a replacement for an existing plan.²
Also, keep in mind that for employees to be eligible, they must not have a qualified plan offered by the company within the last three years.
Now, we’re talking about how to invest business profits to avoid taxes and offer additional benefits that retain workers and attract new talent.
Or invest in a tax-advantaged retirement account
If you’re not ready to set up a plan for your employees, you can also contribute to your retirement.
These accounts allow you to defer taxes on contributions and earnings until retirement, enabling your investment to grow tax-free in the meantime.
3. Purchase a depreciable asset
You can deduct the full cost of assets like
- machinery; and
Section 179 of the Internal Revenue Code lays it all out.³ In short, by factoring in the decrease in your assets’ value, you can significantly reduce the amount of taxes your business will pay. There are a few rules.
The asset must
- be owned by the business;
- be used by the business or be income-producing activity;
- have a determinable useful life; and
- be expected to last more than one year.
There’s also bonus depreciation, which allows for accelerated depreciation, enabling you to deduct a significant portion of the asset’s cost in the first year.
So if there’s a truck, let’s say, that you’ve needed for your business but have been waiting to buy, now could be the time to make that investment.
4. Explore R&D Tax Credits
You can invest in improving your product and developing new products, while also reducing tax burden. These activities may be eligible for one of several R&D tax credits. This one is huge. It’s a fantastic way to scale and a great answer to the question of how to invest business profits to avoid taxes.
These credits reward businesses that invest in innovation by offsetting some of the expenses associated with research and development.
- developing new software;
- creating innovative prototypes;
- improving manufacturing processes; and
- conducting research.
These are tax credits. Unlike deductions, tax credits directly reduce what you owe the IRS.
Many business owners I meet with think the R&D tax credit is limited to businesses in the medical or science fields. That couldn’t be further from the truth.
No matter your sphere, if you perform research to improve product quality, performance, or manufacturing processes, you could be eligible.
Let’s lower your tax liability
I’m a Fort Worth-based accountant with over a decade of experience in strategic tax planning services.
To schedule an appointment, click here.
Jeremy A. Johnson, CPA
- Small business advertising and marketing costs may be tax deductible. Irs.gov. Available from: https://www.irs.gov/newsroom/small-business-advertising-and-marketing-costs-may-be-tax-deductible
- SECURE 2.0 Act of 2022. Senate.gov. 2022. Available from: https://www.finance.senate.gov/imo/media/doc/Secure%202.0_Section%20by%20Section%20Summary%2012-19-22%20FINAL.pdf
- Publication 946 (2022), how to depreciate property. Irs.gov. Available from: https://www.irs.gov/publications/p9466