How businesses can maximize their tax savings
The business environment continues to present challenges, from supply chain and staffing shortages to rising prices and higher interest rates. Yet many businesses are thriving. Whatever your business's situation, taking full advantage of available tax breaks is critical. And changes under the TCJA still demand attention, too.
If you own the business, it’s likely your biggest investment, so thinking about long-term considerations, such as your exit strategy, is critical as well. And if you’re an executive, you likely have to think about not only the company’s taxes, but also tax considerations related to compensation you receive beyond salary and bonuses, such as stock options. Planning for executive comp involves not only a variety of special rules but also several types of taxes — including ordinary income taxes, capital gains taxes, the NIIT and employment taxes.
Income taxation and owner liability are the main factors that differentiate one business structure from another. Many owners choose entities that combine pass-through taxation with limited liability, namely limited liability companies (LLCs) and S corporations. But the TCJA significantly changed the tax consequences of business structure.
The now-flat corporate rate (21%) is significantly lower than the top individual rate (37%), providing significant tax benefits to C corporations and helping to mitigate the impact of double taxation for their owners. (The new 15% corporate alternative minimum tax imposed by the Inflation Reduction Act effective for tax years beginning after Dec. 31, 2022, applies only to the very largest C corporations.) But, the TCJA also introduced the powerful Section 199A deduction for owners of pass-through entities.
Depending on your situation, a structure change may sound like a good idea. But keep in mind that increases to both the corporate and the top individual rate have been proposed. Even if there are no tax increases, a change could have unwelcome tax consequences. Consult your tax advisor if you'd like to explore whether a structure change could benefit you.
Through 2025, the TCJA provides the Section 199A deduction for sole proprietorships and owners of pass-through business entities, such as partnerships, S corporations, and LLCs that are treated as sole proprietorships, partnerships or S corporations for tax purposes. The 199A deduction isn’t allowed in calculating the owner’s adjusted gross income, but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction (though you don’t have to itemize to claim it).
The deduction generally equals 20% of qualified business income (QBI), not to exceed 20% of taxable income. QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business, or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.
Additional limits can begin to apply if taxable income for the year exceeds the applicable threshold.
One such limit is that the 199A deduction generally can’t exceed the greater of the owner’s share of:
- 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
- The sum of 25% of W-2 wages plus 2.5% of the cost (not reduced by depreciation taken)
of qualified property.
Qualified property is the depreciable tangible property (including real estate) owned by a qualified business as of year end and used by the business at any point during the tax year to produce qualified business income. Additional rules apply.
Another limitation for taxpayers subject to the income-based limit is that the 199A deduction generally isn’t available for income from “specified service businesses.” Examples include businesses that involve investment-type services and most professional practices (other than engineering and architecture).
The W-2 wage and property limitations and the service business limitation don’t apply if your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% deduction.
Projecting your business’s income for this year and next can allow you to time income and deductions to your advantage. It’s generally — but not always — better to defer tax, so consider:
Deferring income to next year. If your business uses the cash method of accounting, you can defer billing for products or services at year end. If you use the accrual method, you can delay shipping products or delivering services.
Accelerating deductible expenses into the current year. If you’re a cash-basis taxpayer, you may pay business expenses by Dec. 31, so you can deduct them this year rather than next. Both cash and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid.
Warning: Don’t let tax considerations get in the way of sound business decisions. For example, the negative impact of these strategies on your cash flow or customers may not be worth the potential tax benefit.
Taking the opposite approach. If your business is a flow-through entity and it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax over the two-year period.
For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases the Modified Accelerated Cost Recovery System (MACRS) will be preferable to the straight-line method because you’ll get a larger deduction in the early years of an asset’s life.
But if you make more than 40% of the year’s asset purchases in the last quarter, you could be subject to the typically less favorable midquarter convention. When it comes to repairs and maintenance of tangible property, however, different rules may apply. Careful planning during the year can help you maximize depreciation deductions in the year of purchase.
Other depreciation-related breaks and strategies also are available, and in many cases have been enhanced by the TCJA:
Section 179 expensing election. This allows you to deduct (rather than depreciate over a number of years) the cost of purchasing eligible new or used assets, such as equipment, furniture, off-the-shelf computer software, and qualified improvement property. An annual expensing limit applies, which begins to phase out dollar for dollar when asset acquisitions for the year exceed the applicable threshold. You can claim the election only to offset net income, not to reduce it below zero to create a net operating loss.
Bonus depreciation.This additional first-year depreciation is available for qualified assets, which include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software and water utility property.
Under the TCJA, through 2026, the definition has been expanded to include used property and qualified film, television and live theatrical productions. In addition, qualified improvement property is now eligible for bonus depreciation.
Unfortunately, the 100% bonus depreciation that has been available in recent years generally expired Dec. 31, 2022. Unless legislation is signed into law extending the 100% amount (check with your tax advisor for the latest information), bonus depreciation is scheduled to drop 20 percentage points annually until it's eliminated in 2027.
Warning: Under the TCJA, in some cases a business may not be eligible for bonus depreciation. Examples include real estate businesses that elect to deduct 100% of their business interest expense and dealerships with floor-plan financing, if they have average annual gross receipts exceeding the applicable threshold for the previous three tax years.
Tangible property repair safe harbors. A business that has made repairs to tangible property, such as buildings, machinery, equipment and vehicles, can expense those costs and take an immediate deduction. But costs incurred to acquire, produce or improve tangible property must be depreciated. Distinguishing between repairs and improvements can be difficult. Fortunately, some IRS safe harbors can help: 1) the routine maintenance safe harbor, 2) the small business safe harbor, or 3) the de minimis safe harbor. The rules are complex, so contact your tax advisor for details.
Cost segregation study. If you’ve recently purchased or built a building or are remodeling existing space, consider a cost segregation study. It identifies property components and related costs that can be depreciated much faster and dramatically increase your current deductions. Typical assets that qualify include decorative fixtures, security equipment, parking lots, landscaping and architectural fees allocated to qualifying property. See the Case Study "Cost segregation study can accelerate depreciation."
The benefit of a cost segregation study may be limited in certain circumstances — for example, if the business is located in a state that doesn’t follow federal depreciation rules.
Business-related vehicle expenses can be deducted using the mileage-rate method or the actual-cost method (total out-of-pocket expenses for fuel, insurance and repairs, plus depreciation).
Purchases of new or used vehicles may be eligible for Sec. 179 expensing. However, many rules and limits apply. For example, the normal Sec. 179 expensing limit generally applies to vehicles with a gross vehicle weight rating of more than 14,000 pounds. A reduced limit applies to vehicles (typically SUVs) rated at more than 6,000 pounds but no more than 14,000 pounds.
Vehicles rated at 6,000 pounds or less don’t satisfy the SUV definition and thus are subject to the passenger vehicle limits.
Also keep in mind that, if a vehicle is used for business and personal purposes, the associated expenses, including depreciation, must be allocated between deductible business use and nondeductible personal use. The depreciation limit is reduced if the business use is less than 100%. If business use is 50% or less, you can’t use Sec. 179 expensing or the accelerated regular MACRS; you must use the straightline method.
Before the TCJA, businesses regularly claimed deductions for meal, entertainment, vehicle and travel expenses, as well as employee reimbursements of such expenses. But the TCJA eliminated some of these deductions. Here’s a look at what's deductible and what's not:
Entertainment. Under the TCJA, these expenses are no longer deductible.
Meals. Under the TCJA, business-related meal expenses, including those incurred while traveling on business, have remained 50% deductible. But, the TCJA expanded the 50% disallowance rule to meals provided via an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer. (Such meals used to be 100% deductible.)
Also, some temporary relief that generally increased the deduction to 100% for food and beverages provided by a restaurant in 2021 or 2022 has not been extended. So, unless an extension is signed into law, such meals will be only 50% deductible for 2023 and beyond. (Check with your tax advisor for the latest information.)
Transportation. Employer deductions for the cost of providing commuting transportation to an employee (such as hiring a car service) aren’t allowed under the TCJA, unless the transportation is necessary for the employee’s safety. The TCJA also eliminated employer deductions for the cost of providing qualified employee transportation fringe benefits (for example, parking allowances, mass transit passes and van pooling). However, those benefits are still tax-free to recipient employees, up to applicable limits. Transportation expenses for business travel are still 100% deductible, provided they meet the applicable rules.
Including a variety of benefits in your compensation package can help you not only attract and retain the best employees, but also save tax because you generally can deduct your contributions:
Qualified deferred compensation plans. These include pension, profit-sharing, SEP and 401(k) plans, as well as SIMPLEs. You can enjoy a tax deduction for your contributions to employees’ accounts, and the plans offer tax-deferred savings benefits for employees. Certain small employers may also be eligible for a tax credit when setting up a plan.
HSAs and FSAs. If you provide employees with a qualified high-deductible health plan (HDHP), you can also offer them Health Savings Accounts. Regardless of the type of health insurance you provide, you also can offer Flexible Spending Accounts for health care. If you have employees who incur day care expenses, consider offering FSAs for child and dependent care.
HRAs. A Health Reimbursement Account reimburses an employee for medical expenses up to a maximum dollar amount. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion can be carried forward to the next year. But only the employer can contribute to an HRA.
Fringe benefits. Certain fringe benefits aren’t included in employee income, yet the employer can still deduct the portion, if any, that it pays and typically also avoid payroll taxes. Examples are employee discounts, group term-life insurance (up to $50,000 per person) and health insurance.
Warning: You might be be penalized for not offering health insurance. The play-or-pay provision of the Affordable Care Act (ACA) can in some cases impose a penalty on “large” employers if they don’t offer full-time employees “minimum essential coverage” or if the coverage offered is “unaffordable” or doesn’t provide “minimum value.”
The IRS has issued detailed guidance on what these terms mean and how employers can determine whether they’re a “large” employer and, if so, whether they’re offering sufficient coverage to avoid the risk of penalties.
Generally, under the TCJA, interest paid or accrued by a business is deductible up to 30% of adjusted taxable income (ATI). Taxpayers (other than tax shelters) with average annual gross receipts that don't exceed the applicable threshold for the three previous tax years are exempt from the interest deduction limitation.
Some other taxpayers are also exempt. For example, real property businesses can elect to fully deduct their interest, but then would be required to use the alternative depreciation system for real property used in the business.
A loss occurs when a business’s expenses and other deductions for the year exceed its revenue:
Net operating losses (NOLs). The TCJA generally reduces the maximum amount of taxable income that can be offset with NOL deductions from 100% to 80%. In addition, the TCJA generally prohibits NOLs from being carried back to an earlier tax year — but it allows them to be carried forward indefinitely (as opposed to the 20-year limit under pre-TCJA law), So if your business is headed for a loss this year due to temporary business conditions, consider accelerating income if possible to reduce the amount of the loss.
Pass-through entity “excess” business losses. Through 2025, the TCJA limits deductions for current-year business losses incurred by noncorporate taxpayers: Such losses generally can offset income from other sources, such as salary, self-employment income, interest, dividends and capital gains, only up to the annual limit. “Excess” losses are carried forward to later tax years and can then be deducted under the NOL rules.
The CARES Act temporarily lifted the limit, allowing taxpayers to deduct 100% of business losses arising in 2018, 2019 and 2020. But the limit returned in 2021, and the Inflation Reduction Act of 2022 extends it through 2028.
Tax credits can reduce tax liability dollar for dollar, making them particularly beneficial:
Research credit. The research credit (often called the “research and development” credit) gives businesses an incentive to step up their investments in research.
Certain start-ups (in general, those with less than $5 million in gross receipts) that haven’t yet incurred any income tax liability can, alternatively, use the credit against their payroll tax.
While the credit is complicated to compute, the tax savings can prove significant.
Work Opportunity credit. This credit is designed to encourage hiring from certain disadvantaged groups, such as certain veterans, ex-felons, individuals who’ve been unemployed for 27 weeks or more and food stamp recipients. This credit is scheduled to expire Dec. 31, 2025.
The size of the tax credit depends on the hired person’s target group, the wages paid to that person and the number of hours that person worked during the first year of employment. The maximum tax credit that can be earned for each member of a target group is generally $2,400 per adult employee. But the credit can be higher for members of certain target groups, up to as much as $9,600 for certain veterans.
Employers aren’t subject to a limit on the number of eligible individuals they can hire. That is, if there are 10 individuals that qualify, the credit can be 10 times the listed amount.
Warning: You must obtain certification that an employee is a target group member from the appropriate State Workforce Agency before you can claim the credit. The certification generally must be requested within 28 days after the employee begins work.
New Markets credit. This credit gives investors who make “qualified equity investments” in certain low-income communities a 39% tax credit over a seven-year period. Certified Community Development Entities (CDEs) determine which projects get funded — often construction or rehabilitation real estate projects in “distressed” communities, using data from the 2006–2010 American Community Survey. Flexible financing is provided to the developers and business owners. This credit is scheduled to expire Dec. 31, 2025.
Retirement plan credit. Small employers (generally those with 100 or fewer employees) that create a retirement plan may be eligible for a $500 credit per year for three years. The credit is limited to 50% of qualified startup costs.
Small-business health care credit. The maximum credit is 50% of group health coverage premiums paid by the employer, provided it contributes at least 50% of the total premium or of a benchmark premium. Only employers with fewer that 25 full-time equivalent employees (FTEs) and average annual wages below certain thresholds are eligible. And the credit is reduced for employers with more than 10 FTEs or average wages exceeding certain amounts. Contact your tax advisor for details. Warning: To qualify for the credit, online enrollment in the Small Business Health Options Program (SHOP) generally is required. In addition, the credit can be taken for only two years, and they must be consecutive. (Credits taken before 2014 don’t count, however.)
Family and medical leave credit. The TCJA created a tax credit for qualifying employers that begin providing paid family and medical leave to their employees. It is equal to a minimum of 12.5% of the employee’s wages paid during that leave (up to 12 weeks per year) and can be as much as 25% of wages paid. Ordinary paid leave that employees are already entitled to doesn’t qualify. This credit is scheduled to expire Dec. 31, 2025.
An exit strategy is a plan for passing on responsibility for running the company, transferring ownership and extracting your money from the business. This requires planning well in advance of the transition. Here are the most common exit options:
Buy-sell agreements. When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death. Among other benefits, a well-drafted agreement:
- Provides a ready market for the departing owner’s shares,
- Sets a price for the shares, and
- Allows business continuity by preventing disagreements caused by
A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax and nontax issues and opportunities.
One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income. There are exceptions, however, so be sure to consult your tax advisor.
Succession within the family. You can pass your business on to family members by giving them interests, selling them interests or doing some of each. Be sure to consider your income needs, how family members will feel about your choice, and the gift and estate tax consequences. With the higher gift tax exemption in effect under the TCJA for the next few years, now may be a particularly good time to transfer ownership interests in your business. Valuation discounts may further reduce the taxable value of the gift.
Management buyout. If family members aren’t interested in or capable of taking over your business, one option is a management buyout. This may provide for a smooth transition because there may be little learning curve for the new owners. Plus you avoid the time and expense of finding an outside buyer.
Employee stock ownership plan (ESOP). An ESOP is a qualified retirement plan created primarily to own your company’s stock. Whether you’re planning for liquidity, looking for a tax-favored loan or wanting to supplement an employee benefit program, an ESOP can offer many advantages.
Sale to an outsider. If you can find the right buyer, you may be able to sell the business at a premium. Putting your business into a sale-ready state can help you get the best price. This generally means transparent operations, assets in good working condition and minimal reliance on key people.
Whether you’re selling your business as part of your exit strategy or acquiring another company to help grow it, the tax consequences can have a major impact on the transaction’s success or failure. Here are a few key tax considerations:
Asset vs. stock sale. With a corporation, sellers typically prefer a stock sale for the capital gains treatment and to avoid double taxation. Buyers generally want an asset sale to maximize future depreciation write-offs.
Taxable sale vs. tax-deferred transfer. A transfer of ownership of a corporation can be tax-deferred if made solely in exchange for stock or securities of the recipient corporation in a qualifying reorganization. But the transaction must comply with strict rules. Although it’s generally better to postpone tax, there are some advantages to a taxable sale:
- The seller doesn’t have to worry about the quality of buyer stock or other business
risks that might come with a tax-deferred transfer.
- The buyer benefits by receiving a stepped-up basis in its acquisition’s assets.
- The parties don’t have to meet the technical requirements of a tax-deferred transfer.
Installment sale. A taxable sale might be structured as an installment sale if the buyer lacks sufficient cash or pays a contingent amount based on the business’s performance. An installment sale also may make sense if the seller wishes to spread the gain over a number of years — which could be especially beneficial if it would allow the seller to stay under the thresholds for triggering the 3.8% NIIT or the 20% long-term capital gains rate.
But an installment sale can backfire on the seller. For example, depreciation recapture must be reported as gain in the year of sale, no matter how much cash the seller receives. And, if tax rates increase, the overall tax could wind up being more. Of course, tax consequences are only one of many important considerations when planning a merger or acquisition.
If you’re an executive or other key employee with a larger company, you may receive incentive stock options (ISOs). ISOs receive tax-favored treatment but must comply with many rules. ISOs allow you to buy company stock in the future (but before a set expiration date) at a fixed price equal to or greater than the stock’s fair market value (FMV) at the date of the grant.
Therefore, ISOs don’t provide a benefit until the stock appreciates in value. If it does, you can buy shares at a price below what they’re then trading for, provided you’re eligible to exercise
the options. Here are the key tax consequences:
- You owe no tax when the ISOs are granted.
- You owe no regular tax when you exercise the ISOs.
- If you sell the stock after holding the options for at least one year and then holding the shares for at least one year from the exercise date, you pay tax on the sale at your long-term capital gains rate. You also may owe the NIIT.
- If you sell the stock before long-term capital gains treatment applies, a “disqualifying disposition” occurs and any gain is taxed as compensation at ordinary-income rates. (Disqualified dispositions aren’t, however, subject to FICA and Medicare tax, including the additional 0.9% Medicare tax.)
Warning: If you don’t sell the stock in the year of exercise, a tax “preference” item is created for the difference between the stock’s FMV and the exercise price (the “bargain element”) that can trigger the AMT. A future AMT credit, however, should mitigate this AMT hit. Plus, you may now be at lower AMT risk because of the higher AMT exemption and exemption phaseout range under the TCJA. Consult your tax advisor because the rules are complex.
If you’ve received ISOs, plan carefully when to exercise them and whether to immediately sell shares received from an exercise or hold them. Waiting to exercise ISOs until just before the expiration date (when the stock value may be the highest, assuming the stock is appreciating) and holding on to the stock long enough to garner long-term capital gains treatment often is beneficial. But there’s also market risk to consider.
Plus, in several situations, acting earlier can be advantageous:
- Exercise early to start your holding period so you can sell and receive long-term capital gains treatment sooner.
- Exercise when the bargain element is small or when the market price is close to bottoming out to reduce or eliminate AMT liability.
- Exercise annually so you can buy only the number of shares that will achieve a breakeven point between the AMT and regular tax and thereby incur no additional tax.
- Sell in a disqualifying disposition and pay the higher ordinary-income rate to avoid the AMT on potentially disappearing appreciation.
On the negative side, exercising early accelerates the need for funds to buy the stock, exposes you to a loss if the shares’ value drops below your exercise cost, and may create a tax cost if the preference item from the exercise generates an AMT liability.
The timing of ISO exercises could also positively or negatively affect your liability for the higher tax rates and the NIIT. See the Case Study "The TCJA provides tax deferral opportunity in certain circumstances" for additional information and, with your tax advisor, evaluate the risks and crunch the numbers using various assumptions to determine the best strategy for you.
The tax treatment of nonqualified stock options (NQSOs) is different from that of ISOs: NQSOs create compensation income (taxed at ordinary-income rates) on the bargain element when exercised (regardless of whether the stock is held or sold immediately), but they don’t create an AMT preference item.
You may need to make estimated tax payments or increase withholding to fully cover the tax on the exercise. Keep in mind that an exercise could trigger or increase exposure to top tax rates, the additional 0.9% Medicare tax and the NIIT.
Restricted stock is stock your employer grants to you subject to a substantial risk of forfeiture. Income recognition is normally deferred until the stock is no longer subject to that risk (that is, it’s vested) or you sell it. You then pay taxes based on the stock’s fair market value when the restriction lapses and at your ordinary-income rate. (The FMV will be considered FICA income, so it could trigger or increase your exposure to the additional 0.9% Medicare tax.)
But, under Section 83(b), you can elect to instead recognize ordinary income when you receive the stock. This election, which you must make within 30 days after receiving the stock, allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.
The election can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly before income would otherwise be recognized. And with ordinary-income rates now especially low under the TCJA, it might be a good time to recognize income.
There are some disadvantages of a Sec. 83(b) election: First, you must prepay tax in the current year — which also could push you into a higher income tax bracket and trigger or increase your exposure to the additional 0.9% Medicare tax. But if a company is in the earlier stages of development, the income recognized may be small. Second, any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or you sell it at a decreased value. But you’d have a capital loss when you forfeited or sold the stock. Third, when you sell the shares, any gain will be included in net investment income and could trigger or increase your liability for the 3.8% NIIT.
See the Case Study "The TCJA provides tax deferral opportunity in certain circumstances" for additional information, and work with your tax advisor to map out whether the Sec. 83(b) election is appropriate for your particular situation.
RSUs are contractual rights to receive stock (or its cash value) after the award has vested. Unlike restricted stock, RSUs aren’t eligible for the Sec. 83(b) election. So there’s no opportunity to convert ordinary income into capital gains.
But they do offer a limited ability to defer income taxes: Unlike restricted stock, which becomes taxable immediately upon vesting, RSUs aren’t taxable until the employee actually receives the stock. So rather than having the stock delivered immediately upon vesting, you may be able to arrange with your employer to delay delivery. Also see the Case Study "The TCJA provides tax deferral opportunity in certain circumstances".
Such a delay will defer income tax and may allow you to reduce or avoid exposure to the additional 0.9% Medicare tax (because the RSUs are treated as FICA income). However, any income deferral must satisfy the strict requirements of Internal Revenue Code (IRC) Section 409A. Also keep in mind that it might be better to recognize income now because of the currently low tax rates.
Nonqualified deferred compensation plans pay executives in the future for services to be currently performed. They differ from qualified plans, such as 401(k)s, in several ways. For example, unlike 401(k) plans, NQDC plans can favor highly compensated employees, but any NQDC plan funding isn’t protected from the employer’s creditors.
One important NQDC tax issue is that employment taxes are generally due once services have been performed and there’s no longer a substantial risk of forfeiture — even though compensation may not be paid or recognized for income tax purposes until much later. So your employer may withhold your portion of the payroll taxes from your salary or ask you to write a check for the liability. Or it may pay your portion, in which case you’ll have additional taxable income. Warning: The additional 0.9% Medicare tax could also apply.
Keep in mind that the rules for NQDC plans are tighter than they once were, and the penalties for noncompliance can be severe: You could be taxed on plan benefits at the time of vesting, and a 20% penalty and potential interest charges also could apply. So check with your employer to make sure it’s addressing any compliance issues.