Financial Planning Tips for Small Business Owners
Being self-employed and owning a business provide many benefits but it can pose challenges for your personal finances. Here are some financial planning tips for small business owners to consider.
Be tax-wise
Is your business operating as the most tax-efficient entity it possibly could?
As a business owner, you have different options to structure your business. If you operate your business as a sole-proprietorship, partnership, or S corporation, these are considered pass-through entities where the company’s net income is passed through to the owner’s individual tax return. Under these entities, you are qualified for a Qualified Business Income deduction (QBI) of up to 20% of your business income.
However, if you operate as a C corporation, you cannot take the QBI deduction of 20%. But the same law (Tax Cuts and Jobs Act of 2017) that created QBI also lowered the corporate rate from 35% to 21%. Be aware that there’s discussions in Congress to increase the corporate tax rate to 26.5%; so, you may need to proactively plan out these tax scenarios with your financial advisor, CPA, or tax professional.
Be aware that if your business is of type Specified Service Trades or Businesses (SSTBs), you lose out on the QBI deduction if your income is too high. SSTBs generally refer to service-based businesses. The deduction starts to phase out if your personal taxable income exceeds $164,900 (single) or $329,800 (married and filing as joint return).
If your business isn’t an SSTB, but your total taxable income is above those limits, you may still be subject to certain limitations. Planning ahead is the key strategy.
Leverage any potential COVID tax relief
Employee retention credit: businesses that kept idle workers on payroll during the pandemic can qualify for tax credit of $7,000 per employee for tax year 2021. This may be claimed retroactively in years subsequent to 2021. You have to prove that your business suspended operations or experienced a 20% decline in gross receipts. You can use this credit to reduce payroll tax deposits, or even request an advance from IRS.
Sick & Family leave credits: employees who are sick and quarantined due to COVID, are caring for someone who’s sick from COVID, or caring for a child whose school or daycare is closed can receive up to two weeks of paid leave benefits and or 2/3 of their normal pay. You, as the employer, can receive a fully refundable tax credit equal to the benefit payments paid through September 2021.
Shifting income to family members: is it possible to hire your teenage child to help in your business and, by doing so, shift some income to them at lower tax bracket? It may enable your children to contribute to Roth IRA accounts, help them establish a better credit limit, and potentially may qualify them for more financial aid for college.
Pay yourself first: saving for retirement
If you are a self-employed business who only employs yourself and maybe your spouse, then consider setting up a solo 401(k) retirement plan for yourself and your spouse. Solo 401(k)s allow you to contribute up to $19,500 plus $6,500 of catch-up for people who are age 50 or older. In addition, as the employer, you can make an additional profit-sharing contribution up to 25% of your net profit for a total of $57,000 annually. This is a very powerful way of saving for retirement as you build up your businesses and to also defer taxable income during your peak earning years.
Small businesses with 5 or more employees: California has a mandate for small businesses to offer a retirement plan to their employees. The plan must have been set up by June 30, 2022 or the consequence is a fine of $250 per employee. One option is to enroll in CalSavers, which is a state-sponsored individual retirement account (IRA). As an owner, understand that CalSavers is low cost and easy to use but there are income limits for eligibility and lower contribution limitations compared to other types of retirement accounts.
Choosing the right type of retirement plan to fit into your goal is important. You may want to put emphasis on talent retention or you may want to be more tax efficient and save more for retirement. Certain types of retirement plans work better for different purposes. We encourage you to discuss the best type of retirement plan options with your advisor.
Create contingency plans
Protect your business as well as your personal finances by making sure you carry enough insurance such as professional liability insurance, errors and omissions, employment practices liability insurance overhead expense insurance, and cybersecurity insurance.
Have an emergency plan in place to minimize disruption of your day-to-day operations; preventing any potential loss is important. One way is to make sure you set up a clear business contingency plan in case of emergencies such as fire on site, earthquakes, etc.
Capture the value of your hard work by creating a business succession plan before you think you’ll need it. It may take years to find suitable partner or solution but it’s always good to set up a road map.
Connect with a Financial Advisor
It is a daunting task to manage your business and align your business financial goals with your personal financial goals. We encourage you to establish a good financial team to help you strategize and implement your financial plans.
If you have questions on this topic or others, we encourage you to please reach out.
Contributor
Ellen Li is a partner at Financial Alternatives and a lead advisor for many of the firm’s clients and has a special focus on financial planning. Ellen has an MSBA degree in Financial and Tax Planning from San Diego State University and she holds the CERTIFIED FINANCIAL PLANNER™ designation. She is a member of the Financial Planning Association (FPA).
