4 More Strategies to Help Cut Taxes for Business Owners

Editor’s note: This is the second in a two-part series examining how you may help small business owners save on their taxes.

Following our most recent article outlining possible deductions for business owner clients, we are reviewing four more tax-saving strategies that business owners should consider using.

These four strategies benefit from the fact that, unlike the recommended tax deductions that require an additional outlay of cash to realize the deduction, many of these strategies can be put in motion with a simple change of entity status or shift in the realization of income.

With the additional tax savings, business owners can reinvest back into their business, support growth initiatives, and enhance the profitability of the business.

1. Deferring expenses (or accelerating income), depending on profit expectations

If profit is projected to be lower each year, consider deferring expenses and accelerating income, when possible. This strategy is possible as the end of the business year approaches (normally December 31), when income can either be accelerated and realized in the current year (perhaps by seeking payment for outstanding invoices) or by deferring expenses into the following year (for instance, paying a utility bill on the due date in the future rather than immediately when the bill is issued.)

The inverse of this strategy is also a viable option. In years when profit is expected to be higher than normal, consider deferring revenue into the following business year. Perhaps a new client engagement can be pushed out to the following year, or encouraging clients to not pre-pay outstanding invoices. Large, annual expenses can be accelerated, or paid as soon as possible.

Pro tip: Early insights into a business’s profit can allow for business owners to reduce their tax liabilities. However, shifting income and expenses into the present or future should never compromise the liquidity of the business or its cash flows. Having said that, if the business is particularly profitable this year, consider other ways to time the income, or offset the income with other tax-saving strategies such as large equipment purchases or sizable retirement plan contributions.

2. Determine if the business can take the Qualified Business Income (QBI) deduction

Courtesy of the Tax Cuts and Jobs Act of 2017, many small business owners can deduct 20% of Qualified Business Income (QBI) in calculating their federal taxes.

However, owners of specified service trades or businesses (SSTBs) lose out on the deduction if their income is too high. A business is generally considered to be an SSTB when the principal asset of the firm is the skill or reputation of one or more of the employees. Common examples are doctors or health care providers, law practices, tax and consulting firms, consultants and financial service providers.

For businesses that are considered SSTBs, the QBI deduction starts to phase out once total taxable income exceeds certain thresholds. For the 2024 tax year, a Married Filing Joint taxpayer can take full advantage of the deduction up to $383,900 of taxable income. The deduction is then phased out as income increases, before being fully phased out when taxable income exceeds $483,900.

Consider the owner and operator of an art gallery. She has Schedule C income of $350,000 and expenses of $100,000, and files a Married Filing Jointly return with her spouse. She is the primary earner, and the bulk of their savings is in retirement accounts, so their overall income is $250,000. After subtracting half of self-employment taxes, and their standard deduction, the QBI deduction is for 20% of taxable income

Take a look at the calculation below to see an example of how meaningful this deduction can be.

The QBI deduction leads to tax savings of $9,227, and also brings their taxable income down into the 22% bracket. Take advantage of tools available to advisors (such as Holistiplan) to show clients just how much they could be saving in taxes.

Pro tip: When appropriate, combine the QBI deduction with the deferral of income (either through retirement plan contributions or some other method) to maximize the QBI deduction.

3. Determine whether pass-through entity (PTE) status could help maximize the state and local tax deduction

In 2024, 36 states and New York City have enacted pass-through entity (PTE) status as an approved workaround to the $10,000 limitation imposed on state and local tax deductions as part of the TCJA. Generally, a qualified PTE, such as an S corporation, partnership, or an LLC taxed as either of the two, can make an election to pay a PTE tax at the entity level on behalf of the owners’/partners’ share of their qualified net income from the entity.

Here’s an example of how it can work: If an S corporation has $1 million worth of income and the ultimate state tax is $60,000, that amount is considered an expense, so that the S corporation’s income for federal tax purposes becomes $940,000. The business owner, who previously would have passed through the full $1 million of income to their personal return, now only passes through $940,000. Because they were able to fully deduct the $60,000, their tax savings is $22,200. Had they not paid the state tax at the entity level, they would have been capped at the $10,000 deduction limit, for a total tax savings of $3,700. Paying the state taxes at the entity level provided additional tax savings of $18,500.

Pro tip: Be sure to check if the resident state has any limitations on using these PTE credits before taking steps to pay these taxes at the entity level. If not, consider taking steps to reclassify a small business to take full advantage of this strategy.

4. Excluding capital gains of $10 million—or more—from taxes with Qualified Small Business Stock

The Qualified Small Business Stock (QSBS) capital gains exclusion is an often overlooked, but highly valuable tax planning opportunity for investors in certain small businesses.

The QSBS provision allows investors to potentially exclude up to $10 million (or more if certain conditions are met) of capital gains from federal taxes when selling qualified small business stock that was held for more than five years.

To be eligible, the company must:

• Be a C corporation,
• Have gross assets under $50 million when the stock was issued, and
• Use at least 80% of assets in a qualified active trade or business.

Pro tip: It’s common for small businesses to issue grants in the form of Incentive Stock Options (ISOs), Non-Qualified Stock Options (NSOs), Restricted Stock Units (RSUs), Performance Stock Units (PSUs), splits, warrants, or convertible debt, to name a few of the more common types. These grants generally represent an agreement by the company to compensate the recipient with company shares after a certain amount of time has passed. This is known as the vesting period, after which the recipient has the discretion to exercise the options or warrants and receive the actual shares. Remember that these grants are only QSBS-eligible after they vest, and an exercise and conversion takes place.

For small business owners and entrepreneurs, every tax dollar paid is one less dollar saved or invested back into the business. Many of the strategies outlined above can be used together to maximize company and personal profit.

Be proactive in your delivery of these ideas, since your clients may not be aware of these opportunities for 2024.