Creative Tax Planning Strategies for Businesses and Individuals
Explore practical tax planning strategies that help businesses and individuals optimize deductions, manage gains, and choose effective entity structures.
Tax planning is an ongoing process that can significantly affect financial results for businesses and individuals. Strategic planning allows for the legal minimization of tax liabilities, improvement of cash flow, and better alignment of finances with long-term objectives. As tax laws change, proactive management becomes increasingly important.
This article examines creative tax planning approaches that extend beyond basic deductions and standard credits. Whether managing a business or optimizing personal finances, understanding these strategies can inform smarter decisions throughout the year.
Approaches to Gains and Losses
Managing the timing and nature of gains and losses from asset sales is a key part of tax planning. Selling a capital asset like stocks, bonds, or real estate results in a capital gain or loss based on the difference between the selling price and the adjusted basis. The tax treatment depends heavily on the holding period. Assets held for one year or less yield short-term gains or losses, taxed at ordinary income rates. Assets held longer generate long-term gains or losses, typically taxed at lower rates (0%, 15%, or 20% for most individuals in 2024).
A proactive strategy involves realizing losses to offset gains, often called tax-loss harvesting. This means selling investments that have decreased in value. These losses can offset realized capital gains, following specific netting rules where short-term losses first offset short-term gains, and long-term losses first offset long-term gains, before offsetting gains of the other type. This process can lower the overall tax on investment profits.
If total capital losses exceed total capital gains, the excess loss can reduce ordinary income, up to an annual limit. This limit is $3,000 per year ($1,500 for married individuals filing separately).1Internal Revenue Service. Topic No. 409 Capital Gains and Losses Any losses beyond this annual limit can be carried forward to future tax years indefinitely, retaining their short-term or long-term character, to offset future gains or ordinary income subject to the limit. Accurate record-keeping is necessary to track these carryforwards.
When harvesting losses, taxpayers must consider the wash-sale rule. This rule disallows claiming a loss on selling stock or securities if “substantially identical” ones are acquired within 30 days before or after the sale.2Internal Revenue Service. IRS News Release AT-03-29: Wash Sale Rule Explanation If the rule applies, the loss is deferred by adding it to the cost basis of the replacement securities. The holding period of the original asset also transfers to the replacement. The rule applies across all accounts, including IRAs.
For businesses, gains and losses on property used in a trade or business and held over a year (Section 1231 property) receive special treatment. Net gains from selling such property are generally treated as long-term capital gains. However, if combined losses exceed gains, the net loss is treated as an ordinary loss, which can fully offset ordinary income without the $3,000 limit. A “look-back” rule prevents timing sales for optimal treatment by recharacterizing current capital gains as ordinary income to the extent of prior ordinary losses claimed on such property within the last five years.
Types of Specialized Deductions
Several specialized deductions can lower taxable income if specific requirements are met. Businesses investing in tangible personal property like machinery or equipment may immediately expense the cost under Section 179, instead of depreciating it over time. This is subject to annual dollar limits on the amount expensed and the total amount of property purchased. For 2023, the maximum expense was $1,160,000, phasing out if total purchases exceeded $2,890,000.
Bonus depreciation also allows businesses to deduct a percentage of the cost of qualifying assets in the first year. The Tax Cuts and Jobs Act initially set this at 100%, but it decreased to 80% in 2023 and is scheduled to phase down further (60% in 2024, 40% in 2025, 20% in 2026, and 0% after), barring legislative action. Unlike Section 179, bonus depreciation isn’t limited by taxable income or total purchases but applies to specific property types, often used after the Section 179 limit is reached.
Owners of pass-through entities like sole proprietorships, partnerships, and S corporations may be eligible for the Qualified Business Income (QBI) deduction. This generally allows a deduction of up to 20% of QBI, plus certain investment income. The calculation is complex and subject to limitations based on taxable income, the type of business (with stricter limits for specified service trades or businesses), W-2 wages paid, and the basis of qualified property. Careful planning around business structure, wages, and assets can impact the QBI deduction amount.
Individuals using part of their home exclusively and regularly for business might qualify for the home office deduction. This allows prorating home-related expenses like mortgage interest, insurance, utilities, and depreciation. The space must be the principal place of business, used for meeting clients, or a separate structure. Self-employed individuals typically claim this, while employees face stricter requirements. A simplified method allows a standard deduction based on square footage ($5 per square foot, up to 300 sq ft), reducing record-keeping.
Contributions to Health Savings Accounts (HSAs) offer a deduction for individuals with high-deductible health plans (HDHPs). These contributions reduce adjusted gross income. For 2024, contribution limits are $4,150 for self-only coverage and $8,300 for family coverage, plus a $1,000 catch-up for those 55 or older. HSA funds grow tax-deferred and withdrawals for qualified medical expenses are tax-free, providing a triple tax advantage.
Businesses involved in research and development must follow specific rules for deducting these expenses. Tax law changes effective after December 31, 2021, require research or experimental (R&E) expenditures, including software development, to be capitalized and amortized over five years (for U.S. research) or 15 years (for foreign research), instead of being expensed immediately. This change affects the timing of deductions and requires careful tracking of R&E costs.
Credits That May Apply
Tax credits reduce tax liability dollar-for-dollar, making them more impactful than deductions. Understanding available credits is part of effective tax planning. Credits can be nonrefundable (reducing tax to zero, with some business credits potentially carried over) or refundable (potentially resulting in a cash refund).3Internal Revenue Service. Refundable Tax Credits
Businesses can benefit from credits incentivizing specific activities. The Credit for Increasing Research Activities (R&D tax credit) encourages investment in qualified research conducted in the U.S. It’s generally calculated as a percentage of research spending above a base amount. Qualifying research must meet specific criteria related to purpose, technology, uncertainty, and experimentation. Detailed documentation is required.
The Work Opportunity Tax Credit (WOTC) is available for hiring individuals from targeted groups facing employment barriers, like veterans or ex-felons. Employers must get certification from their state workforce agency. The credit is typically a percentage of the employee’s first-year wages, depending on hours worked.
Energy-related credits exist for businesses and individuals. Businesses may claim credits for investments in renewable energy property (like solar) or for producing electricity from renewable sources. The Inflation Reduction Act of 2022 modified or added credits for clean vehicles, advanced manufacturing, and clean hydrogen. Many business credits are part of the General Business Credit, which is nonrefundable but has carryover provisions.
Individuals can also access credits. Homeowners investing in energy efficiency may qualify for the Energy Efficient Home Improvement Credit (for insulation, efficient windows/doors, HVAC systems, subject to annual limits) or the Residential Clean Energy Credit (a percentage credit for solar, wind, geothermal, battery storage, generally without an annual dollar cap).
Families might benefit from the Child Tax Credit (CTC), providing up to $2,000 per qualifying child under 17, subject to income limits. A portion may be refundable. The nonrefundable Credit for Other Dependents applies to those not qualifying for the CTC. For higher education, taxpayers might claim either the American Opportunity Tax Credit (AOTC, partially refundable, for undergraduate expenses) or the Lifetime Learning Credit (LLC, nonrefundable, for broader course types), but not both for the same student. Both have income limits.
Considering Entity Structures
Choosing the right legal structure is a foundational business decision with significant tax implications. How a business is organized—sole proprietorship, partnership, corporation, or LLC—affects taxation, paperwork, and owner liability.
A sole proprietorship is the simplest structure for an individual owner. It’s a “disregarded entity” for tax purposes; the owner reports business income and expenses on Schedule C of their personal tax return.4Internal Revenue Service. Schedule C & Schedule SE FAQs Net profit is subject to income tax and self-employment taxes. This structure offers no liability protection, making the owner personally responsible for business debts.
A partnership involves two or more owners. It’s typically a pass-through entity; the partnership files an informational return (Form 1065), and partners report their share of income/loss on their personal returns via Schedule K-1. General partners usually pay self-employment tax on their share of earnings, while limited partners often only pay it on guaranteed payments for services. General partners remain personally liable for business debts.
A Limited Liability Company (LLC) offers liability protection, separating personal assets from business debts. By default, a single-member LLC is taxed like a sole proprietorship, and a multi-member LLC like a partnership. However, an LLC can elect to be taxed as a C corporation or an S corporation, providing flexibility to choose the most suitable tax treatment without changing the legal structure.
Electing S corporation status can offer payroll tax advantages. An S corporation is a pass-through entity, but owner-employees must receive a “reasonable salary” subject to payroll taxes. Remaining profits distributed beyond this salary are generally not subject to self-employment or payroll taxes. This potential saving is a key reason for the election, but the IRS requires the salary to be genuinely reasonable. S corporations must meet specific eligibility criteria, including limits on shareholder types and number, and having only one class of stock.
A C corporation is a separate legal and taxpaying entity. It files its own return (Form 1120) and pays corporate income tax on profits (currently a flat 21%). This can lead to “double taxation”: the corporation pays tax, and shareholders pay tax again on dividends. However, C corporations can often deduct fringe benefits like health insurance for owner-employees more favorably than S corps and may find it easier to raise capital. They must be mindful of potential penalties like the Accumulated Earnings Tax if they retain excessive earnings to help shareholders avoid dividend taxes.
Changing a business’s structure or tax classification can have complex consequences, such as potential taxes on appreciated assets when converting from a C corporation to an S corporation. The choice of entity requires ongoing evaluation based on profitability, growth, operational needs, and owner goals.