The 3 Best Ways to Save on Taxes When You Have Multiple Business Ventures
In today's work world, it's not uncommon for entrepreneurs to earn income from several places -- but the onus is on them to manage and optimize their tax strategies.
Despite the difficulties stemming from the current crisis — or perhaps because of them — 2020 saw a significant increase in the number of new business applications. In 2020, nearly 4.5 million businesses applied to open their doors for the first time. That represents a 24.3 percent increase from the prior year, according to NerdWallet.
Why the explosion? Although entrepreneurs often do see opportunities in challenging environments, the wealth manager in me is guessing they were also going after something else during the trying times of the pandemic: multiple income streams.
It’s common to have multiple income streams these days. The National Bureau of Economic Research found that 19 percent of entrepreneurs studied between 2001 and 2013 were considered serial entrepreneurs — and it’s safe to assume that number has grown over the years. Another study covered on CNBC found that 29 percent of self-made millionaires had at least five different sources of income. So how do you make the most of your multiple business ventures and join the ranks of millionaires? By optimizing your tax strategy for each of your businesses.
How to manage multiple streams of income to make the most of your taxes
When you have money coming in from multiple places, it creates opportunities to take advantage of tax deferrals and tax minimization strategies. With a coordinated approach and a cohesive plan — and taking all of your income sources into account — it’s possible to find ways to save on tax expenses that might otherwise be missed with only one stream of income.
So what are some ways you as a business owner can minimize the taxes of your income streams?
1. Get your tax forms in order
If you have multiple business ventures but are also employed elsewhere — perhaps as a part-time employee — you’ll receive a W-2 tax form that will impact your overall income tax. The 6.2 percent Social Security tax will be withheld by the employer automatically, but it’s only applied on the first $142,800 of income. If you happen to have two W-2 jobs and make that amount at both of them, then you could expect to get 6.2 percent refunded after you file your taxes (because one of the Social Security taxes was redundant).
The Medicare tax, on the other hand, is 1.45 percent on the first $200,000 of income for single filers plus another 0.9 percent surcharge for income above that amount. Going off of the example mentioned earlier: If your employers didn’t withhold the extra surcharge tax, you could owe tax on the $85,600 in income that exceeded the $200,000 threshold.
If you are one of the 36 percent of workers in the U.S. who participates in the gig economy, then you are considered self-employed and will receive a 1099 tax form.
It’s up to you to calculate your Social Security and Medicare tax burdens and make any quarterly estimated tax payments so you don’t have any penalties. Those who are self-employed don’t have federal and state taxes withheld from their income, which is why making quarterly estimated tax payments — due April 15, June 15, September 15 and January 15 (of the following year) — is critical. Taxes can be more complicated for self-employed individuals. Working with an accountant is a good idea to maximize these deductions and utilize all the tax minimization strategies that are available.
2. Make the most of business deductions
For serial entrepreneurs looking to open a new business, first consider the performance of your other businesses. If an existing business is doing well, then you can offset the income with the losses that often accompany starting a new venture. Because it can take startups a few years to become profitable, the IRS permits you to write off losses on your personal tax return — so long as the new business isn’t considered a hobby.
In the eyes of the IRS, a business that doesn’t produce profit in at least three out of the last five years is considered a hobby, and you therefore wouldn’t be able to make any business deductions on it. To ensure you can offset the losses of your new business, create a plan for profitability. There are other opportunities to deduct startup costs. For example, up to $5,000 for startup activities and $5,000 for organizational costs can be deducted in your first year of business. However, this amount decreases once those two categories of expenses exceed $50,000, and if they reach $55,000, then you can’t make any deductions.
There are many other opportunities for deductions as long as the expenses are “ordinary and necessary.” Think equipment purchases, auto expenses, travel expenses (not commuting) or anything else that is critical to operating your business (think internet, utilities and office supplies). If you can prove that your home is the principal place you conduct business, for example, then you can make home office tax deductions. Be sure to only deduct expenses you’re entitled to in order to avoid unnecessary and potentially serious tax problems.
3. Prioritize your retirement account contributions
One of the best tax minimization strategies for serial entrepreneurs is simply to use a variety of retirement accounts to leverage the advantages of each. There are two main ways to save or defer taxes if you have self-employed income: a SEP IRA or a Solo 401(k).
In 2021, you can contribute up to $58,000 in a Solo 401(k), which is the same as a SEP IRA. If you’re 50 or over, however, you get an additional $6,500 in catch-up contributions — which a SEP IRA doesn’t offer. In addition, a Solo 401(k) also doesn’t impact your back-door Roth IRA contributions, which can’t be said for SEP IRAs. However, Solo 401(k)s do have more complex filing requirements once an account hits $250,000 or more.
If you make a lot of money from your multiple business ventures, then a cash balance pension plan is another option to defer taxes. This plan allows a tax deferral of potentially $100,000 or more per year, but your money will be taxed as it’s withdrawn from the account. For relatively stable income that’s expected to last several years, such as a board seat, a cash balance pension plan is a solid option that can also be rolled into an IRA down the road.
A complicated tax situation involving multiple retirement income streams can be a pain, but it’s also a great problem to have. If you’re wondering how to manage multiple streams of income in a way that makes the most sense from a tax standpoint, note that there are generally two options: Pay taxes now or pay taxes later. You can save for retirement in many ways, but when it comes to withdrawing those funds as income streams once you hit retirement age, some are taxable and some are not. Taxable streams reduce your overall income tax burden today in favor of paying at the time of withdrawal. Tax-free income streams, on the other hand, have already been taxed at the time of contribution, so withdrawals aren’t taxed. If you expect to be in a higher tax bracket down the road, it’s worth paying taxes now and letting funds grow tax-free in a Roth IRA or Roth 401(k).
You might want to defer taxes as a high earner, because you’ll most likely be in a lower tax bracket by the time you withdraw money from an IRA or 401(k). However, you can hedge your bets by paying some taxes now and deferring payments in other accounts. No matter what route you take, it’s probably worth hiring an accountant to help organize your income streams and create a cohesive strategy around your specific financial goals.
Disclosure: This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.
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