Top Ten Tax Planning Strategies for Small Business Owners
As a small business owner, taxes are likely your largest expense, which means that lowering them can make a significant difference to your bottom line.
Here are 10 tax planning strategies that every small business owner should consider.
1. Review Entity Structure
The tax structure of your business—whether it’s a sole proprietorship, partnership, S-corporation, or C-corporation—has a significant impact on your total tax liability.
Sole proprietorships are reported on your individual return and taxed as ordinary income.
Both partnerships and S-corporations are pass-through entities. While they each file their own respective tax returns, income and losses flow through to the owner and are taxed at the individual level.
S-corporations allow business owners to avoid paying self-employment taxes on business distributions, unlike sole proprietorships or partnerships, although they require that the owner is paid a reasonable salary.
C-corporations are subject to double taxation, including a corporate tax of 21% on all income, plus dividends that are taxed at the shareholder level. While double taxation sounds unappealing, it is often advantageous because both corporate and dividend tax rates are significantly lower than individual tax rates on ordinary income.
The right entity structure can offer potential savings on self-employment taxes, corporate taxes, and eligibility for certain deductions. It is the starting point for all effective business tax planning.
2. Maximize the Qualified Business Income (QBI) Deduction
The Qualified Business Income (QBI) deduction, available to sole proprietors and pass-through entities like partnerships and S-corporations, allows business owners to deduct up to 20% of their qualified business income. This deduction can provide massive tax savings, so it is important that it plays a central role in the tax planning process for small business owners.
The trick in maximizing the QBI deduction is understanding its various limitations and planning ahead to avoid them if possible. The limitations are complicated and can depend on the following factors:
Income level of the taxpayer
Type of business
Wages paid by the business
Cost of property purchased by the business
And if it isn’t already complicated enough, there are scenarios where the entity type can have a significant impact on the amount of QBI deduction as well.
Optimizing your QBI deduction should be one of the first topics you discuss with your tax advisor, and it should be a regular part of your annual tax planning process.
3. Optimize Owner’s Compensation and Business Distributions
When you receive cash from your business, it is not always taxed the same way.
In fact, there are many different ways it could be viewed by the tax code.
Here are some examples:
Wages
Distributions
Dividends
Return of capital
Loans
Each of these are treated differently from a tax standpoint, some more advantageous than others. For example, wages are taxed as ordinary income, dividends are often taxed at long-term capital gains rates, and loans are tax-free.
However, it’s not as simple as walking up to the counter and picking your “tax treatment” from the tax code’s menu of options. There are rules and strings attached with each choice. Loans, for example, must be legitimate and paid back with interest. For S-corporations, it’s crucial to pay yourself a reasonable salary for the work you perform. And while dividends are generally taxed at a lower rate, they require you to be a C-corporation and only apply after the business itself has already paid corporate tax.
But as long as you operate within the framework of the tax code, there can be significant opportunities to reduce your taxes by being thoughtful about the form in which you are paid by your business.
4. Maximize State Income Tax Deduction with the Pass-Through Entity Tax
The state income tax deduction is limited to $10,000 on personal returns.
Business owners, however, may have access to a valuable loophole that allows them to deduct the full amount of their state tax payments.
It is called the Pass-Through Entity Tax, and it was enacted by many states following the Tax Cuts and Jobs Act in 2017.
If your state allows for this strategy and your business is a pass-through entity, such as a partnership or S-corporation, you might be able to pay state taxes through your business. These state tax payments are, in turn, reported on your business tax return and deducted against income.
Voilà! You have now effectively deducted the full amount of your state taxes, even if they exceed $10,000, which can provide significant federal tax savings.
5. Manage Timing of Income and Expenses
Tax planning is not just about minimizing your taxes this year.
It’s about minimizing taxes over your lifetime.
When we view your tax situation from this multi-year perspective, one of our most valuable tools is shifting income and deductions between years. As a business owner, this is particularly valuable because you often have a unique level of control over the timing of your income and deductions.
For example, if your business is having a particularly profitable year, it may be beneficial to delay invoicing or push back income recognition to the following tax year. Similarly, if you have planned business expenses, consider prepaying them in the current year to reduce your taxable income for that year.
If it is going to be a lower income year, on the other hand, the opposite tactics may be appropriate.
As a general rule, we want to use this strategy to minimize income during high-income years and maximize income during low-income years. If your business income is stable and growing, the priority may always be minimizing taxable income.
One final – and very important – comment on this strategy: You should never spend money in your business solely for tax deduction purposes. All spending should, first and foremost, be viewed through the lens of maximizing your long-term profits and business value.
6. Maximize Retirement Plan Contributions
Retirement plans are one of the most valuable – and flexible – tax planning tools for business owners. There are a wide variety of plan types, including the following:
401(k) plans
SEP IRAs
SIMPLE IRAs
SIMPLE 401(k) plans
Individual 401(k) plans
Cash balance plans
Each of these plan types come with their own particular benefits, contribution limits, and tax advantages. The administrative burden also varies. The key is to find the plan that strikes the right balance between tax savings, cost, and administrative burden that makes sense for you and your business. The rules can be complicated, so working with a skilled advisor is critical.
In addition to retirement plans, there are also deferred compensation plans. While these technically are not retirement plans, they function very similar to them and can be another valuable tool for tax-deferred savings.
7. Plan for Capital Expenditures
If your business regularly invests in real estate, machinery, or equipment, pay attention!
Because these investments have a useful life greater than one year, they generally need to be capitalized and depreciated over the life of the asset. This can be painful as a business owner.
Hypothetically, you could buy a $100,000 piece of equipment but only be able to deduct a small fraction of that in the year of purchase.
Fortunately, there are several strategies to maximize deductions in the year the asset is purchased. Here are some examples:
Section 179
The Section 179 deduction allows small businesses to immediately deduct the full cost of qualifying business equipment purchased during the year, rather than depreciating the asset over several years. For 2025, the maximum deduction limit is $1.25 million, with a phase-out threshold of $3.13 million.
Bonus Depreciation
Bonus depreciation allows businesses to depreciate a large percentage of qualifying property in the first year it’s placed in service. Under the current rules, the bonus depreciation rate is 40% for 2025, 20% for 2026, and 0% for 2027 and beyond. However, this rate tends to be changed frequently by Congress. Since it is a frequent political bargaining chip, there is a reasonable possibility that it will increase again in the future. It was 100% for several years prior to 2025.
Properly Categorize Useful Life
Ensure that you categorize assets correctly according to their useful life for depreciation purposes. The IRS has guidelines for the useful life of various assets, and using these correctly can help you optimize your depreciation strategy.
Cost Segregation Studies
A cost segregation study involves identifying and reclassifying certain components of a property to accelerate depreciation deductions. For businesses that own real estate, this strategy can lead to substantial tax savings in the early years of ownership.
Repairs and Maintenance
Routine repairs and maintenance costs related to property are allowed to be deducted immediately rather than capitalized and depreciated over time. Properly capturing these repair costs and separating them from larger capital expenditures is an easy way to maximize current year deductions and lower your taxes. While this may seem obvious, it requires attention to detail that is often overlooked by small businesses, especially if they are working with a tax preparer that is not intimately involved in their accounting and bookkeeping.
De Minimis Threshold
The safe harbor de minimis rule allows businesses to immediately expense capital expenditures below $2,500, rather than capitalizing and depreciating these costs over time. When tax time comes around, it is worth combing through your invoices to make sure that smaller items below this threshold are deducted immediately.
8. Use Tax-Favored Fringe Benefits
Fringe benefits can provide valuable tax savings for both business owners and employees.
Certain fringe benefits, such as health insurance, term life insurance, retirement plan contributions, and transportation benefits, are tax-deductible for the business while being tax-free for the employee.
In addition to providing valuable benefits to employees, offering tax-favored fringe benefits can help reduce your taxable income. Consider offering health savings accounts (HSAs), flexible spending accounts (FSAs), or even educational assistance programs to your employees, as these can offer tax advantages for both your business and your workforce.
9. Implement an Accountable Plan for Employee Reimbursements
Under an accountable plan, businesses can reimburse employees for business-related expenses without the reimbursements being treated as taxable income. This includes expenses such as travel, meals, and office supplies. By setting up an accountable plan, you can ensure that these expenses are tax-free for your employees and deducted as legitimate business expenses.
To implement an accountable plan, employees must submit receipts and account for the expenses, and any unsubstantiated reimbursements must be returned. This reduces your tax liability while also simplifying your employee reimbursement process.
10. Make Estimated Payments
Whereas most Americans pay their taxes through payroll withholding, small business owners face the unique privilege of writing checks to the IRS for their tax liability each year. This is both inconvenient and painful – you actually feel the pain from writing those checks.
It also means you need to plan ahead for two very important reasons. First, you want to avoid underpayment penalties. Second, you need to make sure you set aside the cash needed to cover your tax liability.
To avoid underpayment penalties, you will need to pay quarterly estimated payments that equal at least 90% of your current year tax liability or 100% of your prior year tax liability (110% if your income exceeds $150k). These payments are due April 15th, June 15th, September 15th, and January 15th .
At Trailhead, we generally recommend that our clients pay safe harbor amounts based on the previous year’s income for the first two quarters. Then once we have a clearer picture of the current year’s income and expenses, it often makes sense to run a detailed tax projection prior to the third and fourth quarter payment deadlines. This helps ensure that you avoid underpayment penalties, while also giving you the opportunity to fine tune your payment amounts more closely with your actual tax liability later in the year.
So What Should You Do?
If you are serious about tax planning for your business, there are two very important things to do. First, keep detailed records. It’s not possible to do good tax planning without them. Second, find a great accountant that focuses on proactive tax planning. If you don’t know where to find one, start by asking other business owners in your industry. And never go with the cheapest option. With tax planning, you tend to get what you pay for.
Taxes are complicated. But if you plan ahead and work with the right professionals, you have more control than you think.