Business Tax Planning and Preparation: A How-To

Business tax planning involves organizing financial affairs to manage tax obligations, while tax preparation is the process of filing returns. Proactive planning throughout the year simplifies the preparation process. By making informed decisions and maintaining diligent records, a business can meet its legal requirements and take advantage of available tax benefits. This ongoing process of evaluation and adjustment is fundamental to sound financial management.

Foundational Planning Decisions

Choosing a Business Entity

A significant financial decision a business owner makes is the choice of legal structure, as it dictates how the business is taxed. A sole proprietorship is the simplest structure, as the business is not legally separate from its owner. Business income and losses are reported on the owner’s personal tax return using Schedule C (Form 1040), and the net income is subject to both income tax and self-employment taxes.

A partnership files an informational return on Form 1065, but the business itself does not pay income tax. Profits, losses, deductions, and credits are passed through to the partners. Partners report their respective shares on their personal tax returns via a Schedule K-1 and pay tax at their individual rates.

A C Corporation is a distinct legal entity that provides shareholders with liability protection. The corporation files Form 1120 and pays tax on its profits at the corporate rate. If profits are distributed to shareholders as dividends, the shareholders also pay tax on them, resulting in “double taxation.”

A business can file Form 2553 to be an S Corporation, which avoids double taxation. An S Corporation files Form 1120-S and is a pass-through entity, where income and losses are passed to shareholders’ personal returns. A Limited Liability Company (LLC) is a state-level legal structure, not a federal tax classification. An LLC can choose its tax status; a single-member LLC is taxed as a sole proprietorship and a multi-member LLC as a partnership, unless it elects corporate taxation.

Selecting an Accounting Method

A business’s accounting method determines when income and expenses are recognized for tax purposes. The two primary methods are cash basis and accrual basis.

Under the cash basis, income is recorded when received, and expenses are deducted when paid. This method is simpler and provides a clear picture of cash flow, making it a common choice for small businesses.

The accrual basis recognizes income when earned and expenses when incurred, regardless of when payment changes hands. This method provides a more accurate picture of financial health by matching revenues with their associated expenses. The IRS requires businesses with average annual gross receipts over $31 million for 2025 or those with inventory to use the accrual method. A business must file Form 3115 to change its accounting method.

Key Strategies for Tax Reduction

Maximizing Business Deductions

Claiming all permissible business deductions is a primary method for reducing taxable income. A business can deduct up to $5,000 in startup costs and another $5,000 in organizational costs in its first year. This deduction is reduced for costs exceeding $50,000, and any remaining amounts are amortized over 180 months.

A business can deduct a wide range of operating expenses, including employee salaries, rent, utilities, and office supplies. These expenses must be both “ordinary,” meaning common in the industry, and “necessary,” meaning helpful for the business.

Depreciation allows a business to recover the cost of tangible property over its useful life. Section 179 expensing allows a business to deduct the full purchase price of qualifying equipment in the year it is placed in service. For 2025, the maximum deduction is $1,250,000, with a phase-out threshold of $3,130,000. Bonus depreciation also allows an accelerated deduction, with the bonus percentage at 40% for 2025.

Vehicle expenses can be deducted using one of two methods. The standard mileage rate for 2025 is 70 cents per mile. The actual expense method involves tracking all vehicle-related costs, such as gas, repairs, insurance, and depreciation, proportioned by business use. If the actual expense method is chosen first, the business cannot switch to the standard mileage rate for that vehicle in later years.

Utilizing Tax Credits

Unlike deductions, which lower taxable income, tax credits provide a dollar-for-dollar reduction of tax liability. The Work Opportunity Tax Credit (WOTC) is available to employers who hire individuals from targeted groups, such as veterans or ex-felons. The WOTC is authorized through December 31, 2025.

To claim the WOTC, an employer must submit IRS Form 8850 to a state workforce agency within 28 days of the employee’s start date. For most targeted groups, the credit is 40% of the first $6,000 in wages for an employee who works at least 400 hours. This results in a maximum credit of $2,400.

The Credit for Increasing Research Activities, or R&D tax credit, incentivizes innovation. It is calculated based on the increase in research spending over a base amount and can offset income tax. Some small businesses may apply a portion of the credit against their payroll tax liability.

Retirement Plan Contributions

Contributing to a business retirement plan provides a current-year tax deduction while building future savings. A Simplified Employee Pension (SEP) IRA is a simple option for the self-employed and small businesses. An employer can contribute up to 25% of an employee’s compensation, with a 2025 maximum of $70,000, and these contributions are tax-deductible.

A SIMPLE IRA (Savings Incentive Match Plan for Employees) allows both employee and employer contributions. Employers are required to make either matching or non-elective contributions. These plans are a good fit for small businesses whose employees want to save for retirement.

A Solo 401(k) is advantageous for sole proprietors with no employees other than a spouse. This plan allows the owner to contribute as both the “employee” and the “employer.” This structure can result in higher contribution amounts compared to a SEP IRA, especially at lower income levels.

Required Information and Documentation for Filing

Core Financial Statements

Core financial statements are the foundation of a business tax return. A Profit & Loss (P&L) Statement, or income statement, summarizes revenues, costs, and expenses over the fiscal year to determine a net profit or loss. This provides the breakdown of income and expenses for the tax forms.

A Balance Sheet is required for corporations and partnerships with gross receipts and total assets of $250,000 or more. It presents a snapshot of the company’s financial position at year-end. The statement details the business’s assets, liabilities, and owner’s equity.

Expense Records

To claim a business deduction, you must have documentation proving the expense was for a business purpose. This requires organized records for all claimed expenses, such as receipts, canceled checks, and bank statements. Records should be categorized to align with the expense categories on the tax return. For expenses like travel and meals, keep a log detailing the amount, time, place, and business purpose. Without proper substantiation, the IRS can disallow deductions, leading to a higher tax bill and penalties.

Asset Information

For any business assets purchased or sold during the year, detailed information is required. For purchased assets, you need records showing the cost and the date placed in service to calculate depreciation or a Section 179 deduction. If an asset was sold, you must document the sale date and price to calculate any taxable gain or loss.

Payroll Data

Businesses with employees must gather all relevant payroll data. This includes the quarterly payroll tax filings on Form 941, which reports total wages and taxes withheld and paid. At year-end, the quarterly forms must be reconciled with the totals on Form W-3, Transmittal of Wage and Tax Statements. The W-3 is filed with the Social Security Administration along with each employee’s Form W-2.

Independent Contractor Information

Businesses must keep records of all payments to independent contractors. If a contractor was paid $600 or more during the year, the business must issue Form 1099-NEC to both the contractor and the IRS. To do this, the business needs the contractor’s name, address, and Taxpayer Identification Number (TIN). This information is collected using Form W-9, which should be on file for every contractor.

Previous Year’s Tax Return

A copy of the prior year’s tax return is a useful tool for preparing the current year’s return. It serves as a reference for consistent reporting and contains data that may need to be carried over. This includes any net operating loss, capital loss, or tax credit carryforwards. The previous return also provides a baseline for comparing financial activity and identifying potential errors.

The Tax Filing Process

Key Filing Deadlines

Meeting tax filing deadlines is a fundamental aspect of compliance. For businesses on a calendar year, due dates vary by entity. Partnerships and S corporations have a March 15 deadline. This allows partners and shareholders to receive their Schedule K-1s in time to file personal returns. Sole proprietorships and C corporations face an April 15 deadline. If a due date falls on a weekend or holiday, it shifts to the next business day.

Filing a Tax Extension

If a business cannot meet its filing deadline, it can request an automatic six-month extension. Partnerships and corporations file Form 7004, while sole proprietors use Form 4868. The form must be filed by the original due date of the return. An extension of time to file is not an extension of time to pay. A business must estimate its tax liability and pay any amount due by the original deadline to avoid penalties and interest.

Methods of Submission

The IRS prefers electronic filing, or e-file, for submitting tax returns. E-filing offers faster processing, immediate confirmation of receipt, and fewer errors than paper filing. Tax software or a tax professional can facilitate this process. Businesses can also mail paper returns, and using certified mail is recommended to obtain proof of timely filing.

Making Tax Payments

If a tax return shows a balance due, payment must be made by the original deadline. The IRS offers several payment options:

• Electronic Federal Tax Payment System (EFTPS) is a free online service for all federal taxes.
• IRS Direct Pay allows for direct online payments from a bank account without registration.
• Debit card, credit card, or digital wallet payments are available through third-party processors, though fees apply.
• A check or money order can be mailed with a payment voucher.

Businesses expecting to owe $1,000 or more in tax must make quarterly estimated tax payments to avoid penalties.

Post-Filing Record Keeping

After filing, a business must keep a copy of the return and all supporting documents. The standard retention period is three years from the filing date or the due date, whichever is later. This is the typical window for the IRS to initiate an audit or for a taxpayer to amend a return.

The retention period is longer in certain situations. Records for employment taxes should be kept for at least four years. The period extends to six years if a business underreports income by more than 25%. Records should be kept indefinitely in cases of fraud or failure to file.