Small Business Tax Planning FAQ

The optimal business entity depends on your specific circumstances including income level, growth plans, liability concerns, and administrative preferences. Each structure has distinct tax implications:

Sole Proprietorship: Simplest structure with no separate entity. All business income flows directly to your personal return (Schedule C) and is subject to self-employment tax (15.3%) plus income tax. Best for low-risk businesses with modest income and no employees.

Limited Liability Company (LLC): Provides liability protection with flexible taxation. Single-member LLCs default to sole proprietorship treatment; multi-member LLCs default to partnership taxation. Can elect S corporation or C corporation treatment if beneficial. LLCs can qualify for the 20% QBI deduction under Section 199A.

S Corporation: Pass-through taxation like partnerships, but with potential self-employment tax savings. Only wages paid to shareholder-employees are subject to FICA; distributions are not. Requires reasonable compensation to owner-employees. Excellent for businesses generating significant profits above reasonable salary level. Subject to QBI deduction limitations based on W-2 wages paid.

C Corporation: Taxed at flat 21% federal rate. Distributions to shareholders are taxed again as dividends (qualified dividends at 0-20%). This "double taxation" can be mitigated through salary payments, retirement contributions, and other deductible expenses. May be advantageous for retained earnings and certain fringe benefits unavailable to >2% S corp shareholders.

Under IRC Section 162, you can deduct all "ordinary and necessary" expenses paid or incurred in carrying on a trade or business. "Ordinary" means common and accepted in your industry; "necessary" means helpful and appropriate for the business. Major deductible expense categories include:

• Office Expenses: Supplies, equipment, software, furniture, computers, phones
• Travel: Transportation, lodging, and incidental expenses for business trips. Standard mileage rate is 67 cents per mile for 2024, or actual vehicle expenses
• Meals: Business meals are 50% deductible; must document business purpose and attendees
• Professional Services: Legal fees, accounting, consulting, bookkeeping
• Marketing: Advertising, website costs, promotional materials, sponsorships
• Insurance: Business liability, professional liability, property insurance, health insurance premiums (for self-employed)
• Rent and Utilities: Office rent, utilities, internet, phone service
• Employee Costs: Wages, salaries, benefits, payroll taxes, retirement contributions
• Interest: Business loan interest, credit card interest for business purchases
• Education: Training, courses, conferences, and publications that maintain or improve existing skills
• Home Office: Deduction for regular and exclusive business use of home space

Non-Deductible Items: Personal expenses, fines and penalties, political contributions, capital expenditures (must be depreciated), and start-up costs over $5,000 (excess amortized over 180 months).

Business owners who don't have adequate tax withholding from other sources must pay estimated taxes quarterly to avoid underpayment penalties under IRC Section 6654. This applies to self-employed individuals, partners, S corporation shareholders, and others with significant non-wage income.

Due Dates:

• Q1: April 15 (for income January-March)
• Q2: June 15 (for income April-May)
• Q3: September 15 (for income June-August)
• Q4: January 15 of following year (for income September-December)

Safe Harbor Rules: To avoid underpayment penalties, pay at least:

• 90% of current year's total tax liability, OR
• 100% of prior year's tax liability (110% if prior year AGI exceeded $150,000 / $75,000 if married filing separately)

Calculation Steps:

1. Project annual business income
2. Subtract business deductions to get net profit
3. Add self-employment tax: 15.3% on net earnings (12.4% Social Security on first $168,600 in 2024, plus 2.9% Medicare on all earnings)
4. Calculate income tax on total taxable income (business + other income - deductions)
5. Subtract any withholding from W-2 jobs or other sources
6. Divide remaining tax due by four for quarterly payments

Small business owners have access to powerful tax-advantaged retirement plans that can significantly reduce current taxes while building retirement wealth:

SEP-IRA (Simplified Employee Pension):

• Contribution limit: 25% of net self-employment income (20% effective rate after SE tax adjustment), up to $69,000 for 2024
• Employer-only contributions; no employee deferrals
• Minimal paperwork and easy administration
• Must contribute same percentage for eligible employees
• Deadline: Tax filing date plus extensions

Solo 401(k) / Individual 401(k):

• Contribute as both employer AND employee
• Employee deferrals: $23,000 for 2024 ($30,500 if age 50+)
• Employer contributions: Up to 25% of compensation
• Total limit: $69,000 ($76,500 if 50+) for 2024
• Roth option available for employee deferrals
• Can borrow from plan (up to 50% of vested balance, max $50,000)
• Only available for businesses with no employees (other than owner and spouse)

SIMPLE IRA:

• Employee deferrals: $16,000 for 2024 ($19,500 if 50+)
• Employer must match up to 3% or contribute 2% non-elective for all eligible employees
• Good for small businesses with employees
• Lower contribution limits than SEP or Solo 401(k)

Defined Benefit Plan: Can shelter $200,000+ annually depending on age and income. Complex administration but maximum tax deferral for high earners.

The home office deduction under IRC Section 280A allows self-employed individuals to deduct expenses for the business use of their home. To qualify, the space must be used:

• Regularly and Exclusively for business (a dedicated space used only for work)
• As your Principal Place of Business, OR
• As a place where you Meet Clients or Customers in the normal course of business, OR
• As a Separate Structure used in connection with your business

Simplified Method:

• Deduct $5 per square foot of home office space
• Maximum 300 square feet ($1,500 maximum deduction)
• No depreciation recapture on home sale
• Minimal recordkeeping requirements

Regular (Actual Expense) Method:

• Calculate percentage of home used for business (square footage of office divided by total home square footage)
• Apply percentage to deductible expenses: mortgage interest, rent, property taxes, utilities, insurance, repairs, depreciation
• Direct expenses (painting the office only) are 100% deductible
• Often produces larger deductions than simplified method
• Depreciation may trigger recapture on home sale

Important: W-2 employees generally cannot claim the home office deduction (eliminated for employees by TCJA through 2025). The deduction is primarily for self-employed individuals and business owners.

Section 179 expensing and bonus depreciation allow businesses to immediately deduct the cost of qualifying assets instead of spreading deductions over the asset's useful life through regular depreciation.

Section 179 Expensing (IRC Section 179):

• Deduction limit: $1,220,000 for 2024
• Phase-out: Begins when total property placed in service exceeds $3,050,000
• Limited to taxable business income (cannot create or increase a loss)
• Qualifying property: Equipment, machinery, vehicles (with limitations), office furniture, computers, software, and certain building improvements (HVAC, roofing, fire protection, security)
• Allows you to choose which assets to expense

Bonus Depreciation (IRC Section 168(k)):

• 2024: 60% of asset cost (declining 20% per year - was 100% through 2022)
• 2025: 40%; 2026: 20%; 2027: 0% (unless extended by Congress)
• No income limitation - can create or increase business losses
• Applies to new AND used property (if new to the taxpayer)
• All-or-nothing election per asset class

Strategy: Use Section 179 first (if income supports it) for maximum current-year deduction, then apply bonus depreciation to remaining basis. This accelerates deductions but eliminates future depreciation on the same assets.

Vehicle Limitations: Section 179 for SUVs over 6,000 lbs is limited to $30,500. Passenger vehicles have annual depreciation caps regardless of Section 179/bonus depreciation.

The method of paying yourself from your business significantly impacts your tax liability. Optimal strategy depends on your entity type:

Sole Proprietorship / Single-Member LLC:

• Take "draws" (withdrawals) from the business account as needed
• All net profit is subject to self-employment tax (15.3%) plus income tax
• No distinction between salary and profit distribution
• Draws are not deductible to the business

Partnership / Multi-Member LLC:

• Guaranteed payments: Fixed payments for services regardless of profit (subject to self-employment tax)
• Profit distributions: Share of net income based on ownership percentage (generally not subject to SE tax for limited partners)
• Strategy varies based on partner role (general vs. limited) and participation level

S Corporation:

• Must pay "reasonable compensation" as salary (subject to FICA - 15.3% total between employer and employee portions)
• Remaining profits taken as distributions (NOT subject to FICA)
• Strategy: Set salary to cover Social Security wage base ($168,600 for 2024), take additional profits as distributions
• IRS scrutinizes S corp salaries - must be reasonable for work performed

C Corporation:

• Salary: Deductible to corporation, taxable to you (plus FICA)
• Dividends: Not deductible to corporation, taxed to you at qualified dividend rates (0-20%)
• Accumulated earnings above reasonable business needs may trigger accumulated earnings tax

Under IRC Section 6001, every person liable for tax must keep records sufficient to establish the amounts of gross income, deductions, credits, and other matters required on any return. Good recordkeeping is essential for maximizing deductions and surviving an audit.

Essential Business Records:

• Income Documentation: All invoices issued, 1099 forms received, sales records, bank deposit records, payment receipts
• Expense Records: Receipts, invoices, canceled checks, credit card statements with itemized descriptions
• Bank Statements: All business account statements, reconciliation records
• Mileage Logs: Date, destination, business purpose, and miles for each business trip (required for vehicle deductions)
• Travel Records: Receipts plus documentation of business purpose, dates, locations, and business contacts
• Meal Records: Amount, date, place, business purpose, and names/business relationships of attendees
• Payroll Records: W-2s, 1099s, time records, payroll tax deposits
• Asset Records: Purchase invoices, depreciation schedules, disposal records establishing basis
• Home Office: Square footage calculations, photos of dedicated workspace, utility bills
• Entity Documents: Articles of incorporation/organization, operating agreements, meeting minutes, stock registers

Retention Periods:

• General records: 3 years from filing date
• If income underreported by >25%: 6 years
• Employment tax records: 4 years
• Property/asset records: Keep until 3 years after disposing of asset
• Business formation documents: Permanently