It’s probably no great revelation to learn that taxes are complicated. As a consequence, most small business owners rely on tax professionals, at least for preparing income tax returns. I’ve been working with federal taxes for many years, and it never surprises me that there are surprises. Here are some tax rules that aren’t obvious, and small business owners should know about them, even if they work with a tax pro.
1. Not all business-related costs are business deductions
Certain expenses you incur because you’re in business may be deductible, but not as a business expense. In some cases, this doesn’t matter because a personal deduction might have the same tax-saving effect as a business deduction. But there are other cases where it does matter.
If you’re self-employed, you can’t take a business deduction for:
- State income taxes related to your business income. The state income taxes related to your profits on Schedule C, for example, can only be deducted as a personal expense. To get a benefit from this, you must itemize. Even so, the $10,000 cap on state and local taxes (SALT cap) may prevent any tax benefit from this write-off. But check to see if your state has a pass-through entity tax (PTET). A PTET allows owners of pass-through entities to pay state income and local taxes at the entity level. The PTET rules vary by location, so check in your location. As of June 2024, 36 states and New York City had a PTET in place. Annual elections may be required. For example, in New York, a business must opt in each year if the PTET is used.
- Contributions to your retirement savings account. For instance, if you have a solo 401(k), contributions are deductible only as a personal write-off.
- One–half of self-employment tax. The so-called “employer” share of self-employment tax is not really treated as an employer-like deduction; you can’t reduce your net earnings by this write-off.
- Health insurance. If you’re a self-employed individual or a more-than-2% shareholder in an S corporation, premiums for your personal coverage are only deductible as a personal write-off; no business deduction is allowed.
Because you don’t deduct these items as business expenses, if you’re self-employed, net earnings from self-employment are not reduced; your self-employment tax is increased even though you’ve made business expenditures.
2. You can be personally liable for taxes despite incorporating
One of the motivating factors of incorporating your business or forming a limited liability company is to obtain personal liability protection. If the business has debts, creditors can look only to an owner’s personal assets for satisfaction. But when it comes to federal employment taxes, personal liability protection under state law does not control. Owners can be 100% personally liable for federal trust fund taxes.
This penalty applies when a “responsible person” (typically a small business owner) “willfully” (intentionally although not maliciously) fails to withhold and deposit trust fund taxes (income tax withholding and the employees’ share of FICA). This failure is subject to a trust fund recovery penalty, regardless of whether the business is incorporated or is an LLC.
3. Quarterly estimated taxes aren’t due each quarter
Self-employed owners usually must pay their taxes through 4 estimated taxes. C corporations also have estimated tax obligations. Often estimated taxes are referred to as quarterly payments. But if you look at a calendar, they don’t fall quarterly.
- For individuals, payments are due on the 15th day of April, June, September, and January of the following year.
- For calendar year C corporations, payments are due on the 15th day of April, June, September, and December.
Note: The Tax Administration Simplification Act (H.R. 8964) would change estimated tax due dates. Instead of the 3-month, 2-month, 3-month, and 4-month intervals that currently are used for individuals, the deadline for federal estimated tax payments would be changed to true quarters…a payment due every 3 months. The measure has bipartisan support.
4. After the year is over, you can’t take action to save taxes
You may hear a lot about year-end tax planning…moves to make before the end of the year to optimize your tax position for the year. But the end of the year does not end opportunities for taking actions that can favorably influence your tax bill. Examples:
- Make savvy elections with respect to equipment purchases. When you file your return, you can elect to write off the cost of equipment and machinery bought during the year up to a set dollar limit ($1,220,000 in 2024). You can also opt out of using bonus depreciation (60% of cost in 2024). You can even decide not to add purchases to your balance sheet and instead use a de minimis rule to deduct the cost of equipment purchases. These tax options are explained in IRS Publication 946.
- Set up a qualified retirement plan. You have until your extended due date of your return for the year to do this and fund it with tax-deductible contributions. For instance, you can set up a SEP for your business and claim a deduction for 2024 if you do this by October 15, 2025 (assuming you timely request a filing extension),
5. Federal rules may not control state taxes
Most states that have an income tax base it largely on federal tax rules. This is referred to as “conformity.” But many of these states have their own peculiarities when it comes to taxes. Some examples:
- S corporations. Making an election to be taxed as an S corporation for federal income tax purposes does not automatically apply at the state/local level. For example, Tennessee and New York City don’t recognize an S election; they tax the corporation.
- Depreciation rules. Some states, including Illinois, New Jersey, New York, and Pennsylvania have decoupled from federal law, which means that the state the rules for bonus depreciation (mentioned earlier) don’t necessarily follow federal law; separate legislation is required to set the same limits.
Final thought
“The hardest thing in the world to understand is the Income Tax.” ~ Albert Einstein
Not everything makes sense when it comes to taxes, yet we’re suppose to follow the rules to avoid penalties. It’s a challenge, to say the least!
Find more information about business tax rules in this list of blogs.
