3 Practical Tax Strategies for Your Education Business

For early education business owners in particular, filing taxes can be a nerve-wracking experience. After all, in an industry where margins are already razor thin, you want to make sure you have taken advantage of every opportunity to keep as much of your hard-earned money as possible — and reduce your chances of a costly audit.

Fortunately, there are practical strategies that can help you do just that. To provide insight on these strategic tax moves, we recently partnered with early education tax expert Laura Johns to host a webinar, “Tax Strategies for Your Early Education Business.” Johns, a Certified Public Accountant and owner of Tax & Beyond, shared a few concrete takeaways that early education business owners can use to save money this tax season and beyond.

Strategy #1: Take Advantage of the PTE Tax Credit

The Pass-Through Entity (PTE) tax credit was first introduced in response to the Tax Cuts and Jobs Act, which went into effect in 2018. The act limited individual taxpayer deductions for state and local tax (SALT) payments to $10,000 a year. Previously, there was no cap on these deductions. Unfortunately, the act has had a detrimental impact on businesses that are designated as PTEs (primarily S-corporations and multi-member LLCs) as their business tax is determined through the owner’s personal tax returns. As a result, 36 states now offer a PTE tax credit option, which allows you to pay your state income tax through your business.

“The PTE tax credit allows business owners to continue to deduct state income taxes, even with the SALT tax limit, by paying state income taxes through their business. This makes the amount that comes through to their personal return smaller,” Johns explains.

If you want to start taking advantage of PTE tax credits, Johns recommends talking with your tax advisor. Confirm that your state offers the credit and ensure your tax advisor is familiar with state laws on when and how these taxes must be paid. “As a CPA, every year I am surprised by the number of clients I see who haven’t been taking advantage of PTE tax payments,” says Johns. “For those that have the option in their state, it’s really a no-brainer.”

Strategy #2: Get Familiar with Your Basis — and How to Maximize It

Are you familiar with the term “basis” in the tax world? Basis is the amount of your investment in your business. For example, purchasing a building for your school or paying a security deposit to rent out a facility contributes to your basis. Your basis increases when your business makes a profit and can decrease with losses, or when you take a distribution. “Your basis basically represents how much skin you have in the game,” says Johns. “When you own a business, there are dozens of things that can impact your basis.”

So why should early education business owners care about their basis? Until recently, basis was not tracked by the IRS. However, the IRS now requires that S-corporations report their basis annually. This requirement will extend to multi-member LLC owners soon. And, when you decide to sell your business, basis will determine your capital gains, based on how much you have invested into the business and how much you stand to gain when you sell.

Basis becomes important to your taxes when it comes to your losses. If you have a loss for which you do not have basis, you cannot deduct the loss against other income. For early education business owners, this can happen if, for example, you have multiple entities, such as an LLC that owns your building and a center that rents from the LLC but operates as an S-corporation. In this case, if you are transferring money from one entity to another, there is no paper trail allowing you to create your basis. For this reason, Johns strongly recommends that all financial transfers move through your personal bank account, so that you can get credit toward your basis for any money you are putting in or taking out of your business.

If you have an S-corporation, Johns recommends reviewing your basis on Form 7203 and making sure that you are aligned with your tax professional on how it was calculated. If you need to make any corrections, you should do so as soon as possible so your basis can be accurately tracked in the years to come.

Strategy #3: Ensure You are Paying Yourself “Reasonable Compensation”

One of the most stressful parts of filing taxes is the fear of being audited, which can be costly and time-consuming. In fact, the IRS recently indicated that it will be launching an audit program for S-corporations specifically. To ease any concerns, it can be helpful to understand the areas of your return that the IRS will be most interested in.

Your officer compensation is one area that the IRS is likely to look at very closely. They want to make sure that you are paying yourself “reasonable compensation,” because wages are subject to payroll taxes, but distributions of profit are not. Failure to demonstrate that you are paying yourself reasonable compensation can have major consequences, including steep penalties and interest.

So, how do you determine reasonable compensation? “It is a bit subjective, but the best way to think about it is to consider how much you would have to pay your replacement if you had to extract yourself from your business,” says Johns. “You should have an understanding of what roles like yours are earning in the marketplace.”

Johns says that too often tax preparers are not taking the time to break out officer compensation from other employee wages in their filings, which will raise an immediate red flag with the IRS. She recommends checking line 7 on Form 1120S, which should clearly list your officer compensation. If you are receiving a W-2 from your company and the amount is not reflected on your Form 1120S, line 7, have your tax preparer break out the amount before finalizing the return.

“My advice is to make sure you are paying yourself reasonable compensation, and make sure you show that in your return,” says Johns. “Overall, my goal is to help you feel informed so you know what to look for when you are presented with a draft of your tax return from your tax advisor.”

Interested in learning more about how to set yourself and your early education business up for success? Join us for our free Door-to-Door Webinar Series or contact us at info@hingeadvisors.com at any time!