When setting up a business, a very important first step is choosing what type of business you wish to establish. Your choice will affect how you pay your taxes (income, self-employment, payroll), and also what types of tax reduction strategies apply to you. In fact, business entity selection is an essential part of the tax reduction planning process.
Sole Proprietorships, single member LLCs, Partnerships and LLCs taxed as S Corporations (S Corps) do not pay their own income taxes (though both S Corporations and Partnerships file their own income tax returns). Rather, any profits or losses “pass through” to the owners or partners, which is why these entities are referred to as “pass through entities”. This is in contrast to C Corporations which we will exclude here, but will discuss in an upcoming blog post.
When looking to reduce income tax liability (tax reduction planning) for a Sole Proprietorship, LLC, Partnership or S Corp, we must look at two sides of the equation: the business side, and the individual side, i.e. the owner or partner’s personal income tax liability.
Accountants, CPAs and other tax professionals very often focus on the business and overlook the business owner as an individual – and this oversight may cost thousands, or hundreds of thousands, in taxes that could have been avoided.
A few examples of Unreimbursed Partner Expenses that may become deductible to partners are:
This method is often referred to as tax loss harvesting, where you sell shares at a loss on purpose, to balance any gains on profitable sales.
Losses give you the chance to offset gains and balance your portfolio while paying a lighter tax bill.
Selling ‘down’ investments at a loss and reporting the loss on your tax return could help you offset taxes from the sale of better-performing stocks.
Tackling Income Tax liability on the Business Side
What are Tax Deductions?
Costs of doing business, such as rent, utilities, vehicle use, IT and accounting, are deducted from revenue generated by a business, and lower tax liability. A good accountant, CPA or tax reduction adviser should analyze the types of deductions being taken by a business and offer insights into whether or not the deductions are allowed, and if any are being overlooked.Hiring Children as a Tax Reduction Strategy
Parents can hire children under the age of 18 to perform age-appropriate tasks for their business. Why is this a good idea? As long as you pay your child a fair-market salary at or under the standard deduction rate for single taxpayers (this is $15,000 in 2025), the child does not incur federal income tax (assuming they have no income from other sources), social security, or Medicare taxes. Your business can deduct your child’s salary. As a parent or legal guardian, you can administer your child’s salary and use their income for any child-related expenses you are already incurring (school tuition, college fund, school trips, or an allowance).The money can also be used to fund a Roth IRA for your child!
Your child’s federal tax rate will be 0% – yours may be 37% (or more in the near future!). This strategy comes with several caveats – so it is a good idea to consult a CPA before implementation.Retirement and Taxes
For business owners focused on their future, there are a myriad of solutions for deferring tax liability through the use of retirement accounts. It is important to note that accounts such as 401(k)s or SEP IRAs are not a tax reduction measure – but rather a tax deferment measure. Those contributing to these retirement accounts are deferring today’s tax liability in the hope that their tax liability upon retirement will be lower (as their income will be lower), thus leading to tax savings in the long run. This may or may not be the case. As of writing this article, the highest federal tax bracket is 37%. Though it may not seem to be the case, historically, a 37% federal tax rate is actually on the low side. Many tax and financial professionals believe that tax rates will increase, sooner rather than later. This may mean that your tax bracket upon retirement, dozens of years into the future, will be higher than it is today. As a result, deferring tax liability today may not be profitable in the long run. This is not to say that contributing to retirement accounts is a bad idea – only that business owners should be wary of using retirement as their only or main tax reduction strategy. There are many types of retirement accounts, each with their own caps, rules and regulations, the most popular of which are:- Simple IRA
- SEP IRA
- 401(k)
- Cash balance plan
- Profit sharing plan
- A Roth IRA (or a backdoor Roth IRA)
- A private deferred compensation fund
Tax Deduction for Home Office Use
Owners of a single member LLC have it easy – they can simply deduct various expenses, including taking a home office deduction (if applicable!), on their Schedule C. In the case of S Corporations, this is not the case. Because the owners of S Corporations are considered employees of their S Corps, they need to take an additional step in order to deduct home office use; they can do so through an Accountable Reimbursement Plan. An Accountable Reimbursement Plan or Accountable Plan allows S Corp owners to deduct part of permissible personal expenses, if these have a business use dimension. As an example, most people own their home personally (not through their business). Establishing an administrative home office and drafting an accountable reimbursement plan will allow your business to reimburse you (tax fee!) for home office use, as well as other expenses, such as the use of a car owned by you personally (when used for business purposes), or internet/cell phone use if the contract is in your personal name.Unreimbursed Partnership Expenses
Partnerships usually reimburse partners for various business-related expenses, but in certain cases not all expenses are reimbursed. If you receive a K-1 and are required to cover ordinary and necessary partnership-related costs out of pocket, you may be able to deduct these costs on your individual income tax return. Deductible unreimbursed partnership expenses will reduce your income and self-employment taxes.
- Partner home office expenses
- Partner automobile expenses
- Travel expenses, including parking fees and tolls
- Business meals
- Cell phone and internet use
- Office supplies
- Software subscriptions
- Seminars and professional services
Advanced Tax Strategies
Certain business owners have access to advanced tax reduction strategies, depending on the type of business they are running. These include strategies such as:- Research and Development tax credits
- 831(b) reinsurance companies
- Becoming a real estate professional in order to deduct rental property losses against active income
Tackling Income Tax Liability on the Individual Side
HSA Tax Benefits
A Health Savings Account, or HSA, is a tax-advantaged account available to individuals with high-deductible health insurance plans that qualify for HSAs. Unlike an FSA (Flexible Savings Account), an HSA does not need to be set up by an employer, and funds carryover to following years. HSA funds can be invested, or used for qualified healthcare expenses (ambulance services, co-pays, medications, dental expenses, contact lenses and glasses, etc.). As long as funds are used for qualified healthcare expenses, your money becomes double tax exempt, with possible tax savings of $3,000+ annually, depending on your tax bracket.529 Plan for Education
A 529 plan is a tax-advantaged savings account intended to fund education costs. These plans are also known as “qualified tuition plans”, and are usually state-sponsored. Here are the main pros of a 529 plan:- Funds within the plan can grow federal-tax free
- Funds used for eligible purchases (such as college tuition) are also not taxed
- Your state might offer state benefits, such as full or partial tax deduction or tax credit
Tax Loss Harvesting for Reducing Capital Gains
If part of your investment portfolio has done extremely well this year, but a portion of your stocks have netted you a loss, you can use the former to your advantage. One strategy for reducing capital gains is to sell your underperforming investments at a loss and use those capital losses to balance the gains for tax purposes. If we make a capital gain of $10, and a capital loss of $10, the net effect is zero – and no taxes are owed.
Advanced Tax Planning Strategies
High income earners may qualify for advanced tax reduction strategies, and a notable one is commercial solar purchases. You can leverage a commercial solar purchase for mitigating high income tax liability on your individual tax return – no matter your source of income. This tax strategy is becoming increasingly more popular among high-income W-2 wage earners, including medical and IT professionals. In contrast to purchasing a residential solar project for your own residence (and receiving a small 30% tax credit), participating in a commercial solar project allows buyers to fund a solar project for a third party (a non-profit or business). In exchange, purchasers receive:- A one-time federal investment tax credit, between 30% and 70%
- A federal and (possibly) state depreciation deduction, including a Year 1 Bonus Depreciation deduction
- Possible cash flow from the sale of electricity.