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- January 22, 2025
Tax Planning Strategies for IT Firms: Minimizing Liability and Maximizing Deductions
IT firms have to deal with clients and workforce from across the globe. So, their tax liabilities and compliance are a bit complex. But what if we tell you there are certain strategies that can help IT firms?
It would be a great relief, right? So, we decided to come up with a quick blog that can help IT industries with this issue. In this blog, we will take a look at some simple strategies that can help IT firms minimize their tax burden.
Let’s begin.
How can IT firms minimize their Tax Burden?
#1: Right Business Structure
This is very important. As you know, each business structure is taxed differently. For IT firms, S Corporation or LLC (Limited Liability Company) could be a great choice. These business structures offer multiple benefits, like pass-through taxation. So owners can avoid corporate tax.
On top of that, section 199A allows them to claim a Qualified Business Income (QBI) deduction. This deduction can be 20% of their QBI. 20% deduction can make a big difference for IT firms with big revenues. That’s the reason why we recommend that our clients opt for either an S corporation or an LLC business structure.
#2: Use R&D Tax Credits
Let’s say your IT firm spends a lot of money on research & development projects like software development or tech research. If so, you can claim a Research & Development (R&D) tax credit. The best part? You can use this credit to offset payroll tax liability.
This is an excellent option for startups and smaller IT firms. A 10-15% deduction on R&D expenses is no small thing. Given the thousands of dollars IT firms pour into their R&D, the deduction can be significant. The only thing to keep in mind? You will need accurate documentation of your R&D activities to justify your claim.
Example: R&D Tax Credit Calculation
An IT firm invests in developing new software and qualifies for the Research & Development (R&D) tax credit. In 2023, the company incurs $300,000 in eligible R&D expenses.
Calculation:
The company can claim a credit of approximately 10-15% of these expenses. Using a conservative rate of 12%, the R&D tax credit would be:
R&D Credit = $300,000 x 12% = $36,000
The IT firm can reduce its tax liability by $36,000 directly from the R&D tax credit.
#3: Deductions Under Section 179 and Bonus Depreciation
One more option for IT firms is to take the benefit of Section 179 and Bonus Depreciation. IT firms can deduct the cost of equipment and software purchases right away. They won’t have to wait several years to claim it. As of now, IT firms can claim up to $1,160,000 for these qualifying assets. If your IT firm relies heavily on software purchases, you can reduce your tax liability a lot with this deduction. But remember, you’ll have to claim this deduction in the purchase year only.
Example: Section 179 Deduction
Scenario:
Let’s say an IT firm purchases $150,000 worth of new equipment and servers in the year 2024. This purchase qualifies for the Section 179 Deduction. The firm can deduct the entire equipment cost in the current tax year itself.
Calculation:
The firm can deduct the entire $150,000 immediately from their taxable income. This reduces their taxable income for 2024 by $150,000.
Tax Savings:
Assuming the company is in the 21% corporate tax bracket, the tax savings from this deduction would be:
Tax Savings=$150,000×21%=$31,500
#4: Accounting Methods
IT firms can benefit a lot if they pick the cash method of accounting. If an IT firm uses the cash method of accounting, it has to record the revenue only when the cash is received. Result? They can defer their income to the next year. This can bring down the current year’s tax liability. But to pick an accounting method, the IT firm has to meet certain criteria. For example, their gross annual revenue should be below $23 million in a year. On the top, if the IT firm holds inventory for sales, they cannot opt for this method. Another option is to delay client billing at year-end. This will help shift income and expenses to the next year.
#5: Utilize State and Local Tax Incentives
Some states offer tax credits and incentives to certain business verticals. So if your IT firm is based in one of such states, you can claim these deductions. The core idea behind these deductions and incentives is to promote businesses in certain verticals. You can claim credits like relocation incentives or job creation credits. For example, New York offers Empire State Development incentives to IT firms that relocate to New York. But you’ll need an accounting expert like CROWNGLOBE to help you identify the state-wise deductions.
#6: Work Opportunity Tax Credit (WOTC)
Hiring from specific target groups, such as veterans or individuals receiving government assistance, can qualify firms for the Work Opportunity Tax Credit (WOTC). You can use this credit to reduce tax liability by up to $9,600 per new hire. This might be a small amount, but if you have a big workforce, the final savings could be a lot more.
#7: Employee Benefits and Retirement Contributions
If you provide tax-advantaged retirement plans like 401(k) or SEP IRAs, you can deduct contributions made to employee retirement accounts. If you offer benefits such as health insurance premiums and Health Savings Accounts (HSAs) improves employee satisfaction. Even better, you can claim a deduction for that amount.
#8: Charitable Contributions
Donating to eligible charities provides a direct deduction on taxable income. IT firms engaged in community programs or educational initiatives can lower their tax liability. The add-on benefit? You can improve your CSR (Corporate Social Responsibility.) But IT firms have to maintain all the donation records to justify these deduction claims. If they can’t, they should expect legal troubles.
Work with IT Tax Experts
Look, tax planning is not a one-off thing. IT firms have to deal with multiple tax laws and regulations. So you’ll need an IT taxation expert who understands these legalities. At CROWNGLOBE, we’ve been offering full-service IT tax services. We have IT tax experts with extensive experience who can help your IT firm minimize their tax liabilities.
So if you have any doubts, we are here to help. Just reach out to us and our experts will help you out.
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