How to Maximize Profits: A Small Business Tax Strategy Guide for 2025 and 2026

What actually moves after-tax income — entity structure, retirement plans, depreciation, family payroll, credits, and timing — with every figure verified against current law.

Here is the uncomfortable truth about tax season. By the time you are sitting in front of a preparer in March or April, the year is over and almost every decision that mattered has already been made. Filing a return is bookkeeping. Reducing tax is planning, and planning happens between January and December.

The distinction matters because “maximize profits” is really a question about after-tax cash flow. Revenue is only half of it. A business that earns $400,000 and pays $118,000 in federal and California tax keeps less than a business that earns $380,000 and pays $72,000, and the gap between those two outcomes is almost entirely structural — entity choice, retirement plan design, how assets are bought, how family members are paid, and which credits get claimed.

This guide covers the levers that actually work for a small business, in rough order of how much money they usually move. Every dollar figure, code section, rate, and effective date has been verified against IRS notices, revenue procedures, form instructions, and enacted legislation as of August 2026 — not written from memory.

First, Get the Framing Right

Preparation, Planning, and Representation Are Three Different Services

Tax preparation is historical. It reports what already happened. Tax planning is prospective — it changes what happens before the year closes. Tax representation is defensive; it handles the IRS or a state agency when a position is challenged. Most business owners buy only the first one and then wonder why their tax bill never changes.

A common piece of advice says to hire a professional so you can “sit back” while they do the work. That is exactly backwards, and it produces bad outcomes. The professional needs your numbers, your plans, your hiring intentions, your equipment purchases, and your family situation — in advance. The value of the relationship is proportional to how much you tell them and how early you tell them. A preparer who receives a shoebox in March can only report what is in the shoebox.

Professional fees are themselves a deductible business expense on Schedule C, Form 1065, or Form 1120-S to the extent they relate to the business. The portion attributable to preparing your personal return is not deductible — a distinction worth having on the invoice.

Deduction Versus Credit — Where the Leverage Actually Is

A deduction reduces taxable income. A credit reduces tax. In the 24% bracket a $10,000 deduction saves $2,400; a $10,000 credit saves $10,000. Most small business owners spend all their energy on deductions and never look at credits, which is why the credit section of this guide exists.

And a warning that saves more money than anything else in this guide: never spend a dollar solely to save a tax dollar you would not otherwise have spent. A $10,000 purchase in the 24% bracket costs $7,600 after tax. That is a discount, not a windfall. Deductions are worthwhile when you needed the thing anyway. Buying equipment you do not need to “save on taxes” destroys cash.

Entity Structure and Reasonable Compensation

The Self-Employment Tax Problem

A sole proprietor or single-member LLC pays self-employment tax of 15.3% on 92.35% of net self-employment earnings — 12.4% Social Security up to the annual wage base ($184,500 for 2026, up from $176,100 for 2025) and 2.9% Medicare with no ceiling, plus the additional 0.9% Medicare tax on earnings above $200,000 single or $250,000 joint. Half of the self-employment tax is deductible in computing adjusted gross income.

That is a large number, and it is the reason S corporation elections exist. In an S corporation, the owner takes a reasonable salary subject to payroll taxes, and remaining profits pass through as distributions that are not subject to self-employment tax. On $200,000 of profit, the difference between a $70,000 salary and treating the whole amount as self-employment income can exceed $15,000 a year.

Reasonable Compensation Is Not Optional

This is where owners get into trouble. The IRS has been litigating and winning reasonable compensation cases for decades, and the pattern is always the same: an owner who performs substantially all the work takes a token salary and a large distribution, and the IRS recharacterizes the distribution as wages, with payroll taxes, penalties, and interest attached.

Reasonable compensation is a facts-and-circumstances determination based on the owner’s duties, hours, training and experience, what comparable businesses pay for similar services, and the relationship between compensation, distributions, and profits. It should be documented before the fact — a written analysis referencing actual comparable data — not reconstructed after a notice arrives. An S corporation election is a legitimate and valuable strategy. An unreasonably low salary inside one is an audit magnet.

When an S Corporation Does Not Help

• Profits are small. Payroll administration, a separate return, and reasonable compensation exposure are not worth it on $40,000 of profit.
• Income is passive or investment-driven rather than earned from services.
• You need maximum retirement contributions and the wage base actually helps — a defined benefit or cash balance plan calculation depends on W-2 compensation, and a very low salary caps the plan.
• The qualified business income deduction math runs the other way. Above the income thresholds, the deduction is limited by W-2 wages paid, so reducing salary can reduce the deduction.

The right answer requires modeling all of it together, and it changes as profit changes. An entity structure that was correct three years ago is not automatically correct now.

The Qualified Business Income Deduction (Section 199A)

For owners of sole proprietorships, partnerships, LLCs, and S corporations, this is often the single largest deduction on the return: 20% of qualified business income, capped at 20% of taxable income less net capital gain.

What Changed

• It is now permanent. The deduction was scheduled to sunset after 2025. The One, Big, Beautiful Bill Act removed the sunset. Multi-year planning around it is finally rational.
• The phase-in ranges widened for 2026. The range over which the W-2 wage limitation and the specified service business exclusion phase in grew from $50,000 to $75,000 for single filers and from $100,000 to $150,000 for joint filers.
• A minimum deduction arrived. Beginning in 2026, a taxpayer who materially participates in a qualified trade or business with at least $1,000 of QBI gets a minimum deduction of $400, even above the phase-out. It does not apply to income from specified service businesses that are fully excluded.

The Thresholds

Below the threshold, you generally get the full 20% and a specified service business is treated like any other. Inside the range, the deduction is limited proportionally. Above it, non-service businesses are limited to the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property, and specified service trades or businesses — health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, and any business whose principal asset is the reputation or skill of its employees or owners — lose the deduction entirely.

What This Means in Practice

Taxable income sits at the center of the calculation, which makes almost every other strategy in this guide a QBI strategy too. A retirement plan contribution, a §179 election, or a health savings account contribution that pulls taxable income back under the threshold can be worth far more than the deduction itself, because it restores a 20% deduction on all of your business income. Conversely, an aggressive depreciation election that drops taxable income too far can shrink the QBI deduction — the deduction is capped at 20% of taxable income less net capital gain, so there is such a thing as deducting too much in one year.

For owners near a threshold, the sequence matters: model the retirement contribution, the depreciation elections, and the QBI deduction together, in that order, before December 31. Computed on Form 8995 or Form 8995-A.

Retirement Plans: The Largest Single Lever

For a profitable small business, nothing else moves as much money. A correctly designed plan can shelter six figures a year, and unlike most deductions the money stays yours.

2026 Limits (2025 in Parentheses)

Choosing the Plan

• Solo 401(k) (one-participant plan). For an owner with no employees other than a spouse. You contribute as employee (up to $24,500 in 2026, plus catch-up) and as employer (up to 25% of compensation, or 20% of net self-employment income after the self-employment tax adjustment for an unincorporated business), with the combined total capped at $72,000 plus catch-up. Almost always produces the largest contribution at moderate income levels because the employee deferral does not depend on profit.
• SEP IRA. Simplest to administer, funded entirely by the employer at up to 25% of compensation to the same $72,000 cap. No deferral component, so at lower incomes it contributes less than a solo 401(k). Critically, a SEP generally requires the same percentage for every eligible employee, which makes it expensive once you have staff.
• SIMPLE IRA. For businesses with 100 or fewer employees. Lower limits, low administrative cost, mandatory employer match or nonelective contribution.
• Defined benefit or cash balance plan. Where the real money is for a high-income owner over about 45 with stable profits. Contributions are actuarially determined and can far exceed $72,000 — the 2026 annual benefit limit is $290,000, which supports very large annual funding. Requires an actuary, a funding commitment, and staff coverage. Frequently paired with a 401(k) profit-sharing plan.

Plan Timing Rules That Catch People

• A SEP can be established and funded up to the due date of the return including extensions — the most forgiving option if the year is already over.
• A SIMPLE IRA generally must be established by October 1 for the current year.
• Under SECURE 2.0, a sole proprietor can establish a solo 401(k) after year end and make employee deferrals for the prior year up to the return due date without extensions — but the practical execution is tight, and establishing the plan during the year remains far safer.
• Employer contributions are generally deductible for the year if made by the return due date including extensions.

The Roth Catch-up Mandate

Beginning in 2026, a participant whose prior-year wages from the sponsoring employer exceeded $150,000 must make catch-up contributions on a Roth basis. If your plan document does not permit Roth contributions, those participants cannot make catch-up contributions at all. Owners over 50 in an S corporation with meaningful W-2 wages need to confirm the plan allows Roth deferrals before the first payroll of the year.

Get Paid to Start the Plan

The SECURE 2.0 credits are covered in the credits section below, but the headline belongs here: an employer with 1–50 employees can claim 100% of qualified startup costs up to $5,000 per year for three years, plus $500 per year for three years for adding automatic enrollment, plus an employer contribution credit of up to $1,000 per employee for the first five years. Between them, the true first-three-year cost of launching a plan is frequently close to zero.

Employing Family Members — Correctly

Hiring your children or your spouse is legitimate and can be valuable. It is also one of the most commonly overstated strategies online, and one of the easiest for an examiner to unwind. Here is what the rules actually say.

The Payroll Tax Exemptions Depend Entirely on Entity Type

• A child under age 18 employed by a parent’s sole proprietorship, or by a partnership in which each partner is a parent of the child, is not subject to Social Security and Medicare taxes.
• A child under age 21 in that same structure is not subject to federal unemployment tax (FUTA).
• None of this applies if the business is a corporation — including an S corporation — or a partnership with any partner who is not the child’s parent. In those structures the child’s wages are fully subject to FICA and FUTA like any other employee. This is the single most misunderstood point in the entire strategy, and it means an S corporation election can eliminate the benefit of hiring your kids.
• A spouse employed in the business is subject to income tax withholding and FICA, but wages are not subject to FUTA.
• A parent employed by a child is subject to income tax withholding and FICA, and generally not subject to FUTA.

Why It Still Works

A child with no other income can earn up to the standard deduction amount — $15,750 for 2025 and $16,100 for 2026 — and owe no federal income tax on it, while the business deducts the wages. Those wages are earned income, so the child can fund a Roth IRA with them, which is one of the most powerful long-horizon moves available to a family.

What Makes It Fail

• The work must be real, and the wage must be reasonable for that work. Paying a nine-year-old $15,000 to “help with social media” without documentation is not a plan, it is an adjustment waiting to happen.
• Keep the same records you would for any employee — a job description, timesheets, a W-4, actual payroll processing, a Form W-2, and payment into an account the child controls. Cash “paid” without a paper trail is not a deduction.
• Do not double-dip. If the child provides a genuine service and you also claim them as a dependent, that is fine. If you are simply relabeling an allowance, it is not.

One structural option worth discussing with a professional: an S corporation owner can sometimes establish a separate sole proprietorship — for example, a management or marketing entity — that employs the children, restoring the FICA exemption. It works, but it has to be a real business with real substance, not a paper shell.

Equipment, Assets, and Depreciation

This is the area where the 2025 law changes are most favorable, and where the old advice — “buy a laptop and put it through as a business expense” — is technically incomplete in a way that costs money.

Three Different Ways to Write Off an Asset

• De minimis safe harbor. Under the tangible property regulations, a business without an applicable financial statement can elect to expense items costing up to $2,500 per invoice or per item ($5,000 with an applicable financial statement) rather than capitalizing them. This requires a written capitalization policy in place at the beginning of the year and an annual election on the return. For a laptop, a monitor, a phone, or a piece of shop equipment, this is usually the cleanest treatment — no asset schedule, no depreciation, no recapture on disposal.
• Section 179 expensing. For 2025 the maximum is $2,500,000, reduced dollar for dollar once §179 property placed in service exceeds $4,000,000. For 2026 those amounts rise to $2,560,000 and $4,090,000. Section 179 is limited to taxable income from the active conduct of a trade or business, so it cannot create a loss — the excess carries forward. It also applies to qualified improvement property and to roofs, HVAC, fire protection, alarm, and security systems on nonresidential real property, which bonus depreciation does not always reach.
• Bonus depreciation. The One, Big, Beautiful Bill Act permanently restored 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025. It applies to new and used property with a recovery period of 20 years or less, and unlike §179 it can create or increase a loss. A taxpayer may elect 40% instead of 100% for the first taxable year with property acquired after January 19, 2025 — useful when you would rather spread deductions into higher-rate future years. You can also elect out entirely on a class-by-class basis.

The usual ordering is de minimis first for small items, then §179 on assets that bonus does not reach or where selective expensing is useful, then bonus depreciation on what remains. Doing it in the wrong order can waste a §179 election or push taxable income below the level that maximizes the QBI deduction.

Qualified Production Property

The Act also created a temporary 100% first-year deduction for qualified production property — nonresidential real property used in manufacturing, production, or refining of tangible personal property. Construction must begin after January 19, 2025 and before January 1, 2029, and the property must be placed in service before January 1, 2031. Office, administrative, lodging, parking, sales, and engineering space is excluded. For a manufacturer building or expanding a facility, this is a very large provision that did not exist two years ago.

Cost Segregation

If you own the building your business occupies, or any commercial or residential rental real estate, a cost segregation study reclassifies components — flooring, specialty electrical, land improvements, dedicated plumbing — from a 39-year or 27.5-year life into 5-, 7-, and 15-year property. Those shorter-lived components then qualify for bonus depreciation. With 100% bonus back permanently, a study on a recently acquired property can produce a very large first-year deduction. The offsetting considerations are cost, depreciation recapture on sale, and the passive activity rules, so it should be modeled rather than assumed.

Business Travel — What Is Actually Deductible

Travel is one of the most frequently overstated deductions and one of the most reliably examined. The commonly repeated advice to “combine personal travel with a justifiable business purpose” is a good way to lose the deduction and pay a penalty. Here are the rules.

The Primary Purpose Test

For domestic travel, if the trip is primarily for business, the full cost of getting there and back is deductible, and lodging and meals are deductible for the business days. If the trip is primarily personal, transportation to and from the destination is not deductible at all, even if you conduct some business while there. Expenses directly attributable to business activity at the destination remain deductible either way.

“Primarily” is determined mainly by the number of days spent on business versus personal activity. Travel days and days when business is genuinely conducted count as business days; weekend days sandwiched between business days generally count if staying over is reasonable. Foreign travel has its own allocation rules and is stricter.

Family Members

The cost of a spouse, dependent, or other individual accompanying you is not deductible unless that person is an employee of the business, the travel serves a bona fide business purpose for them, and their expenses would otherwise be deductible. In practice, taking the family along means you deduct what the trip would have cost you alone — a single hotel room rate rather than a family suite, one airfare rather than four.

Substantiation

Travel is subject to the strict substantiation rules of section 274(d). You need the amount, the time, the place, and the business purpose, contemporaneously recorded. A credit card statement showing a hotel charge proves you spent money, not that you spent it on business. Reconstructed logs prepared after a notice arrives carry very little weight.

Per Diem

Rather than tracking actual meal and incidental costs, an employer can reimburse employees using the federal per diem rates under an accountable plan, which simplifies substantiation considerably. Self-employed individuals may use the meals and incidental expenses per diem but must use actual costs for lodging. Note that a more-than-10% owner of an S corporation cannot use the per diem method for their own meals.

Frequent Flier Miles

The often-repeated claim that miles earned on business travel can be used personally is broadly correct but frequently overstated. The IRS stated in Announcement 2002-18 that it would not pursue tax enforcement on personal use of frequent flier miles or other in-kind promotional benefits earned from business travel — while expressly reserving the position where the benefits are converted to cash or used as compensation. It is an enforcement forbearance, not a statutory exclusion, and it does not cover cashing miles out or routing them to employees as a substitute for pay.

Vehicles

Standard Mileage Versus Actual Expenses

You choose one method per vehicle. The standard mileage rate covers fuel, maintenance, insurance, registration, and depreciation in a single per-mile figure. The actual expense method deducts the business-use percentage of real costs, including depreciation, §179, and bonus depreciation.

The mid-year 2026 increase is unusual — the IRS has made only a handful of mid-year adjustments since the 1990s — and it means 2026 mileage logs must be split at June 30. Anyone running a single annual rate across 2026 will understate the deduction. The charitable rate remains fixed by statute at 14 cents.

If you want to use the standard mileage rate for a vehicle, you generally must use it in the first year the vehicle is placed in service; you can switch to actual expenses later but not the reverse. Heavy vehicles and the actual expense method with bonus depreciation frequently produce a much larger first-year deduction, subject to the luxury auto limitations and, for 2026, a §179 cap of $32,000 on sport utility vehicles.

What Is Not Deductible

Commuting between home and your regular place of business is never deductible, regardless of what you do in the car. If a home office is your principal place of business, trips from there to other work locations are business miles — which is one of the underappreciated benefits of qualifying for the home office deduction. Personal use of a company-provided vehicle is a taxable fringe benefit that must be valued and reported on Form W-2.

Vehicles are listed property under section 280F. Mileage logs — date, destination, business purpose, and miles — are required, and this is one of the first things an examiner asks for.

Meals and Entertainment — A Significant 2026 Change

The Current Baseline

• Entertainment is not deductible. Tickets, golf, sporting events, and club dues have been nondeductible since 2018. Food and beverages purchased separately at an entertainment event can still qualify if separately stated on the invoice.
• Business meals are 50% deductible where the taxpayer or an employee is present, the expense is not lavish, and the meal is with a client, customer, prospect, or business contact. The temporary 100% deduction for restaurant meals applied only to 2021 and 2022.
• Meals treated as compensation to the employee, meals sold to customers, and food provided at recreational or social events primarily for non-highly-compensated employees remain fully deductible under the section 274(e) exceptions.

What Changed on January 1, 2026

Section 274(o) — enacted in 2017 with a delayed effective date and modified by the One, Big, Beautiful Bill Act — now disallows the deduction entirely for amounts paid or incurred after December 31, 2025 for:

• Meals furnished to employees that are excludable as furnished for the convenience of the employer under section 119(a); and
• Food, beverages, and the operating costs of an employer-operated eating facility under section 132(e)(2), including staffing and third-party food service contracts.

These categories were 50% deductible through 2025 and are 0% deductible now. The Act preserved narrow exceptions — most notably for businesses that sell food and beverages to customers, which may continue to deduct meals provided to their own employees, and for certain commercial vessels, oil and gas platforms, and fishing and fish-processing operations.

Practitioners currently differ on whether break-room coffee and snacks that are not provided at an employer-operated eating facility and are not furnished under section 119 fall inside the disallowance. Until further guidance arrives, the defensible approach is to segregate meal categories in the general ledger — client meals, employee-compensation meals, customer-facing food operations, convenience meals, and facility costs — so that the correct percentage is applied to each and the schedule M-1 adjustment can be supported. Businesses that ran a catered lunch program or a stocked kitchen should expect a real increase in taxable income in 2026 and should decide now whether to continue the benefit, convert it to taxable compensation, or restructure it.

Home Office, Accountable Plans, and the Augusta Rule

Home Office

The space must be used regularly and exclusively for business and must be your principal place of business, a place where you meet clients, or a separate structure. “Exclusively” means exactly that — a desk in the corner of a bedroom used for anything else does not qualify.

Two methods: the simplified option at $5 per square foot up to 300 square feet, a maximum deduction of $1,500 with no depreciation and no recapture; or the regular method, allocating actual mortgage interest or rent, property taxes, insurance, utilities, repairs, and depreciation by the business-use percentage. The regular method usually produces more, particularly with high rent, but it requires records and creates depreciation recapture on sale of the home.

Important structural point: employees cannot deduct home office expenses — the miscellaneous itemized deduction was suspended and is now permanently repealed. If you own an S corporation, you are an employee of it. The correct mechanism is not a deduction on your personal return; it is reimbursement from the corporation under an accountable plan.

Accountable Plans

An accountable plan is a written arrangement under which an employer reimburses employees for business expenses. If the plan requires a business connection, substantiation within a reasonable period, and return of any excess advances, reimbursements are deductible by the business and not taxable to the employee — no payroll tax, no W-2 inclusion.

For an S corporation owner, this is the mechanism for home office, personal vehicle mileage, cell phone, internet, and out-of-pocket costs. Without a written plan and expense reports, those amounts either become nondeductible personal expenses or taxable wages. Setting one up takes an afternoon and is one of the highest return-on-effort items in this entire guide.

The Augusta Rule (Section 280A(g))

A taxpayer may rent a personal residence for fewer than 15 days a year and exclude the rental income entirely, while the paying business deducts the rent. Used correctly — a genuine business meeting, a board meeting, an annual planning session held at the owner’s home — it moves money out of the business tax-free.

Used carelessly, it fails. The rent must be at fair market value, supported by comparable local venue quotes. There must be a real business purpose with documentation — agenda, attendees, minutes. There must be an invoice and an actual payment. And it does not work for a sole proprietor renting to their own Schedule C business, because you cannot rent to yourself. Fourteen days is a hard ceiling; on day 15 the entire arrangement becomes taxable rental income.

Health Coverage and Benefits

• Self-employed health insurance deduction. A self-employed individual, a partner, or a more-than-2% S corporation shareholder can deduct premiums for medical, dental, and qualified long-term care coverage for themselves, a spouse, and dependents as an adjustment to income, limited to net earnings from the business. For the S corporation shareholder there is a mechanical requirement that trips people every year: the corporation must pay the premiums and include them in the shareholder’s Form W-2 wages in box 1. If that step is missed, the deduction is lost.
• Health savings accounts. Paired with a qualifying high-deductible health plan, an HSA is deductible going in, tax-free growing, and tax-free coming out for qualified medical expenses — the only triple-tax-advantaged account in the code. For an owner-operator on a high-deductible plan, funding it fully every year is close to automatic.
• Qualified small employer HRA (QSEHRA). An employer with fewer than 50 full-time equivalent employees and no group health plan can reimburse employees for individual insurance premiums and medical expenses tax-free. For 2026 the total payments and reimbursements cannot exceed $6,450 for self-only coverage or $13,100 for family coverage.
• Individual coverage HRA (ICHRA). Available to employers of any size, with no dollar cap, reimbursing employees for individual market coverage. For a small employer facing group premium increases, moving to an ICHRA is often the single largest controllable cost decision of the year.
• Small Business Health Care Tax Credit (§45R). Up to 50% of premiums paid (35% for tax-exempt employers) for employers with fewer than 25 full-time equivalent employees, average annual wages under $67,000 for 2025, paying at least half the premium cost, with coverage bought through a SHOP Marketplace. Reductions begin above 10 FTEs and above $33,300 of average wages for 2025 ($34,100 for 2026). Available for only two consecutive years. Form 8941.

Credits: Where Deductions Stop and Real Money Starts

Deductions save your marginal rate. Credits save a full dollar. Most business owners never claim one because the credits live on source forms that feed Form 3800, General Business Credit, and nobody opens them unless they already know they exist. Unused general business credits carry back one year and forward twenty under section 39.

• Research credit (§41). Not just for laboratories — software development, process engineering, formulation work, and product design routinely qualify. A qualified small business can elect under section 41(h) to apply up to $500,000 of the credit against the employer share of payroll taxes instead of income tax, turning it into cash for a company with no income tax liability. Form 6765. Related: new section 174A permanently allows immediate expensing of domestic research and experimental expenditures paid or incurred in tax years beginning after December 31, 2024, reversing the capitalization requirement that inflated taxable income for engineering and technology firms since 2022. Certain small businesses may elect to apply it retroactively to 2022, and others may deduct remaining unamortized amounts over one or two years. Foreign research must still be capitalized over 15 years.
• Retirement plan startup credits. Discussed above: Form 8881, up to $5,000 per year for three years plus $500 per year for auto-enrollment plus up to $1,000 per employee in employer contribution credits.
• Employer Credit for Paid Family and Medical Leave (§45S). Now permanent, 12.5% to 25% of wages paid during leave, with a new six-month service election and a premium-based calculation method effective for tax years beginning in 2026. The written policy must be compliant for the full year. Form 8994.
• Employer-Provided Childcare Credit (§45F). For 2026 the rate rises from 25% to 40% with the cap jumping from $150,000 to $500,000 — 50% and $600,000 for an eligible small business meeting a $25 million gross receipts test. Form 8882.
• Work Opportunity Tax Credit (§51). Currently in hiatus — authorization lapsed for employees who begin work after December 31, 2025. It has lapsed and been retroactively reinstated repeatedly since 1996. Keep filing Form 8850 with your state workforce agency within 28 days of each eligible hire, because unfiled paperwork cannot be recreated if reinstatement comes.
• Disabled Access Credit (§44). 50% of eligible access expenditures between $250 and $10,250 — a maximum credit of $5,000 a year. Form 8826.
• Employer social security taxes paid on tips (§45B). For food and beverage establishments, a credit for employer FICA on reported tips above the amount needed to reach the applicable minimum wage. Restaurants that have never claimed this are typically leaving several thousand dollars a year on the table. Form 8846.

Timing, Accounting Method, and Year-End Moves

Cash Versus Accrual

A business meeting the gross receipts test — average annual gross receipts of $32,000,000 or less for 2026 over the prior three years — can generally use the cash method, which puts the timing of income and deductions substantially under your control. Cash-method businesses can defer December invoicing into January and accelerate deductible payments into December.

Year-End Moves That Actually Work

• Pay deductible expenses before December 31 — a check mailed in December is generally deductible in December for a cash-method taxpayer even if it clears in January.
• Place assets in service — not merely order them — before year end. An unopened crate on the loading dock on December 31 is not placed in service.
• Fund retirement contributions, or at least establish the plan, before the applicable deadline.
• Review accounts receivable for genuinely worthless amounts (accrual method only — a cash-basis taxpayer never included the income, so there is nothing to write off).
• Take inventory of obsolete stock and dispose of it properly, with documentation.
• Model whether accelerating or deferring income produces a better result across two years, particularly around the QBI thresholds.

Estimated Taxes and Penalty Safe Harbors

Underpayment penalties are pure waste — they buy nothing. The safe harbors: pay at least 90% of the current year’s tax, or 100% of the prior year’s tax (110% if prior-year adjusted gross income exceeded $150,000), in four timely installments. Because the penalty is computed quarter by quarter, a large fourth-quarter payment does not cure earlier shortfalls — though increasing withholding late in the year does, since withholding is treated as paid ratably throughout the year. That is a genuinely useful move for an S corporation owner who can adjust a December payroll.

Excess Business Losses

Noncorporate taxpayers cannot use business losses without limit. For 2026 the excess business loss threshold is $256,000 ($512,000 on a joint return). Losses above that are disallowed for the year and carried forward as a net operating loss. This interacts directly with aggressive depreciation planning — a bonus depreciation deduction that creates a very large loss may not be usable in the year you generated it.

Inventory, Cost of Goods Sold, and the Small Business Exemption

For any business that sells physical product, cost of goods sold is usually the largest number on the return, and the rules around it changed in a way that many owners never took advantage of.

The Small Business Exemption From UNICAP

The uniform capitalization rules of section 263A normally require producers and resellers to capitalize a share of indirect costs — purchasing, handling, storage, and certain administrative costs — into inventory rather than deducting them currently. A small business taxpayer meeting the gross receipts test — average annual gross receipts of $32,000,000 or less for 2026 over the prior three years — is exempt from section 263A entirely.

That same small business taxpayer may also elect to treat inventory either as non-incidental materials and supplies, or in accordance with its applicable financial statement or, absent one, its books and records. In plain terms: a qualifying small business can often deduct inventory costs much earlier than the default rules allow. This is a method-of-accounting question requiring a proper election, and for a growing business it is worth revisiting whenever revenue crosses a threshold in either direction.

Inventory Hygiene at Year End

• Count it. An estimated year-end inventory figure is the fastest way to produce an indefensible cost of goods sold number.
• Identify obsolete or damaged goods and write them down or dispose of them with documentation — a disposal log, photographs, or a salvage receipt. A write-down without evidence does not survive scrutiny.
• Be consistent in your valuation method. Switching methods without filing Form 3115 is a change in accounting method made improperly.

Owner Basis, Loans, and Distributions

This is the least glamorous section in this guide and one of the most expensive to get wrong. Owners of S corporations and partnerships routinely take losses they cannot legally deduct, or take distributions that turn into capital gains, because nobody was tracking basis.

Losses Are Limited by Basis

An S corporation shareholder can deduct losses only up to the sum of stock basis plus basis in direct loans made to the corporation. A partner’s deductible loss is limited to basis in the partnership interest, which — unlike an S corporation — includes a share of entity-level debt. This is one of the genuine structural differences between the two forms, and it matters enormously for a leveraged business.

An important trap: a shareholder guarantee of corporate debt does not create basis in an S corporation. Only a direct loan from the shareholder to the corporation does. Owners who fund the business by personally guaranteeing a bank line frequently discover they cannot deduct the resulting losses.

Distributions in Excess of Basis

A distribution that exceeds stock basis is treated as gain from the sale of stock — taxable, often at capital gain rates, in a year the owner may believe was a loss year. Because basis moves with income, losses, contributions, and distributions throughout the year, the only reliable way to avoid this is to maintain a running basis schedule rather than reconstructing it at filing time. Shareholders reporting losses, receiving distributions, disposing of stock, or receiving loan repayments must attach Form 7203 to their return.

The Loss Limitation Stack

Even with basis, a loss has to clear three more gates in order:

• At-risk limitation (section 465) — amounts financed by nonrecourse debt or protected against loss generally do not count.
• Passive activity limitation (section 469) — if you do not materially participate, losses offset only passive income.
• Excess business loss limitation (section 461(l)) — for 2026, aggregate business losses above $256,000 ($512,000 joint) are disallowed and carried forward as a net operating loss.

A deduction that clears basis but fails at-risk, or clears both but is passive, is deferred rather than lost — but it is not the current-year benefit the plan assumed. This is precisely why a large depreciation election should be modeled against the stack before it is made.

Multi-State Exposure

Remote work and online sales quietly created state tax obligations for businesses that never intended to operate outside their home state, and state agencies are increasingly effective at finding them.

• Economic nexus for sales tax. Since the Supreme Court’s decision in *South Dakota v. Wayfair*, states can require sales tax collection based on sales volume or transaction count alone, with no physical presence. Thresholds differ by state, and marketplace facilitator rules shift the obligation for some channels but not all.
• Income tax nexus. Most states assert income or franchise tax nexus on a similar economic basis. Public Law 86-272 still protects mere solicitation of orders for tangible personal property, but many states now take the position that common website functionality — chat support, cookies that gather customer data, post-sale assistance — exceeds solicitation and forfeits the protection.
• Payroll nexus. A single remote employee working in another state generally creates a withholding and unemployment insurance obligation there, and often income tax nexus as well. This surprises employers every year.
• Apportionment. Once you file in multiple states, income is divided among them by formula. Most states now use single sales factor apportionment, and the sourcing rules for services differ enough between states that the same dollar of revenue can be taxed twice or not at all.

The practical point: nexus is created by activity, not by intention or registration. Voluntary disclosure agreements exist in most states and generally limit the lookback period and waive penalties — but only if you approach the state before it approaches you.

The Real Cost of Hiring, and How Taxes Change It

Payroll is usually the largest expense in a small business, and the tax treatment changes the calculation more than owners expect.

The contractor column looks cheaper, and that is exactly why misclassification is so common and so heavily enforced. Two things belong in the analysis that owners routinely omit. First, W-2 wages feed the qualified business income deduction above the income thresholds — a business paying no wages may lose the deduction entirely, which can dwarf the payroll tax saved. Second, most employment-related credits require employees, not contractors.

And the classification question is not a choice. Federally it turns on behavioral control, financial control, and the type of relationship. California applies the ABC test under Assembly Bill 5, under which a worker is presumed to be an employee unless the hiring entity proves all three prongs: freedom from control, work outside the usual course of the hiring entity’s business, and an independently established trade of the same nature. The middle prong defeats most arrangements. Getting this wrong converts a modest payroll tax saving into back taxes, penalties, interest, and in California potential wage-and-hour liability that dwarfs the tax.

New Rules Every Business Owner Should Have on the Calendar

Business Interest Limitation Returns to an EBITDA Basis

The section 163(j) limitation on business interest deductions is computed against adjusted taxable income. Since 2022 that figure was EBIT-based — depreciation and amortization were not added back — which sharply reduced deductible interest for capital-intensive and leveraged businesses. The One, Big, Beautiful Bill Act permanently restored the EBITDA-based calculation. A business with $10 million of EBIT and $2 million of depreciation now computes the limitation against $12 million rather than $10 million. Businesses with average annual gross receipts under the applicable small business threshold remain exempt from the limitation entirely.

Information Reporting Thresholds Changed

• The reporting threshold for Form 1099-NEC and Form 1099-MISC rose from $600 to $2,000 for payments made after December 31, 2025 — the first change to that figure since 1954. It is indexed going forward. Note carefully: this changes your filing obligation, not the recipient’s obligation to report the income.
• The Form 1099-K threshold was permanently restored to more than $20,000 in gross payments and more than 200 transactions, reversing the $600 rule that had been repeatedly delayed. Platforms may still issue forms voluntarily and some states impose lower thresholds, so reconcile 1099-Ks against your own books either way.

Charitable Giving Gets Floors in 2026

For tax years beginning after December 31, 2025:

• Individual itemizers face a 0.5% of AGI floor — the first 0.5% of AGI in contributions is not deductible at all. At $400,000 of AGI, the first $2,000 of giving produces no deduction.
• Corporations face a 1% floor on top of the existing 10% ceiling.
• Non-itemizers gain an above-the-line deduction of up to $1,000 ($2,000 joint) for cash gifts.
• For taxpayers in the 37% bracket, the tax benefit of itemized deductions including charitable contributions is capped at the equivalent of a 35% rate.

The planning response is bunching: concentrating two or three years of giving into a single year clears the floor once instead of repeatedly, and a donor-advised fund lets the deduction happen in the bunching year while the grants go out over time.

Qualified Small Business Stock Became Far More Valuable

For C corporation stock issued after July 4, 2025, section 1202 was substantially expanded: the per-issuer gain exclusion cap rose from $10 million to $15 million, the corporate gross assets limit rose from $50 million to $75 million, and the all-or-nothing five-year holding period was replaced with a tiered exclusion — 50% at three years, 75% at four years, and 100% at five years. If you are choosing an entity for a business you intend to sell, or you hold stock from the same issuer acquired both before and after July 4, 2025, the sequencing of future sales is now a planning question worth real money.

Tips and Overtime Deductions Create a Payroll Reporting Obligation

The new individual deductions for qualified tips (up to $25,000) and qualified overtime (up to $12,500, or $25,000 joint) run from 2025 through 2028 and phase out above $150,000 of modified AGI ($300,000 joint). For 2025 the IRS provided transition relief from the separate reporting requirements, but for 2026 through 2028 employers must separately report qualified tips and qualified overtime on Form W-2, and payors must do so on Form 1099. If you have tipped staff or non-exempt employees earning FLSA overtime, your payroll system needs to be tracking those amounts now — the deduction belongs to your employees, but the reporting burden is yours.

SALT and Pass-Through Entity Elective Taxes

The state and local tax deduction cap was raised to $40,000 for 2025 and $40,400 for 2026, indexed through 2029 before reverting, with a phase-down for higher-income households. Because the federal cap survives, state pass-through entity elective taxes remain useful. California extended its PTE elective tax through tax years beginning before January 1, 2031, and changed the prepayment rule: beginning in 2026, missing the June 15 prepayment no longer voids the election, but the owner’s credit is reduced by 12.5% of their share of the unpaid amount. Many other states with PTE regimes scheduled to sunset at the end of 2025 have extended them for the same reason.

Audit-Proofing: The Positions That Get Challenged

Every strategy in this guide is legitimate. What determines whether it survives an examination is documentation and reasonableness, not aggressiveness.

• Reasonable compensation. The most common S corporation adjustment. Document the analysis before the fact with comparable data.
• Worker classification. Treating workers as independent contractors when they function as employees produces back payroll taxes, penalties, and interest, and in California the ABC test under AB 5 is considerably stricter than the federal common law test. This is one of the fastest ways to convert a tax saving into a much larger liability.
• Listed property. Vehicles, and any property used for both business and personal purposes, require contemporaneous logs under section 274(d). This is not a rule examiners waive.
• Travel and meals. Amount, time, place, business purpose, and business relationship — recorded contemporaneously. Reconstructed records are weak evidence.
• Hobby losses. An activity that generates losses year after year invites a section 183 challenge. The regulations list nine factors — businesslike operation, expertise, time and effort, expectation of appreciation, prior success, history of income and losses, occasional profits, financial status, and elements of personal pleasure. A business plan, separate bank accounts, and evidence of changes made in response to losses matter enormously here.
• Home office exclusivity. “Regularly and exclusively” is a bright line. Photographs and a floor plan cost nothing and settle the question.
• Family payroll. Job descriptions, timesheets, W-2s, and actual payments to an account the family member controls.
• Research credit claims on amended returns. The IRS requires five specific items for each business component — factual basis, activities performed, individuals who performed them, information sought to be discovered, and total qualified wage, supply, and contract research expenses. Deficient claims are rejected.

Advice Still Circulating That Will Cost You

• “A one-participant 401(k) lets you put away $57,000.” That was the 2020 limit. It is $70,000 for 2025 and $72,000 for 2026, before catch-up contributions.
• “Hire a professional and sit back.” The value comes from what you tell them and when. A preparer who first sees your numbers in March cannot change your 2025 outcome — only report it.
• “Sole proprietorships don’t pay Social Security and Medicare on their children’s wages.” True only for a child under 18, and only where the business is a sole proprietorship or a partnership in which every partner is the child’s parent. Incorporate — including as an S corporation — and the exemption disappears entirely.
• “Combine personal travel with a business purpose to make it deductible.” If the trip is primarily personal, the transportation cost is not deductible at all. Only expenses directly attributable to business activity survive.
• “Take the family on the trip and write it off.” A companion’s costs are not deductible unless that person is an employee traveling for a bona fide business purpose.
• “Business travel is completely tax deductible.” Business meals while traveling are generally 50% deductible, not 100%, and entertainment is not deductible at all.
• “Just buy a laptop and put it through as a business expense.” Correct treatment depends on cost and on whether you have a written capitalization policy and a de minimis safe harbor election in place. Without the policy, the item is capitalized rather than expensed.
• “Snacks and coffee for the team are a 50% deduction.” For 2026 and forward, meals furnished for the convenience of the employer and the costs of an employer-operated eating facility are entirely nondeductible under section 274(o).
• “Deductions are where the savings are.” Deductions save your marginal rate. Credits save a full dollar, and most small businesses claim none.
• “Spend money before year end to save on taxes.” Only if you needed the thing. Otherwise you converted a dollar of cash into roughly 24 to 37 cents of tax savings and a piece of equipment you did not want.

A Working Calendar

Every Quarter

• Review year-to-date profit against projection and adjust estimated tax payments (due roughly April 15, June 15, September 15, and January 15).
• Reconcile books. A tax strategy built on unreconciled books is a guess.
• File payroll returns and confirm deposits are current — payroll tax delinquency carries trust fund recovery penalty exposure that reaches the owner personally.

By June 15

• California pass-through entity elective tax prepayment (the greater of $1,000 or 50% of the prior year elective tax). For 2026 and later a shortfall no longer voids the election but reduces the owner credit by 12.5%.

September and October

• Establish a SIMPLE IRA by October 1 if you want it for the current year.
• Run a full-year projection. This is the last practical point at which the year can still be changed materially.
• Model entity structure, reasonable compensation, and retirement plan design together for the coming year.

November and December

• Establish a solo 401(k), defined benefit, or cash balance plan before December 31 if you want the full contribution.
• Place assets in service — not merely order them.
• Make deductible payments, bunch charitable giving if the 0.5% floor applies, and adjust December payroll withholding to cure any estimated tax shortfall.
• Confirm the accountable plan is in place and expense reports are submitted.
• Verify that S corporation shareholder health insurance premiums are in W-2 box 1.
• Confirm the retirement plan permits Roth contributions if any participant earned over $150,000 in the prior year.

January Through April

• Issue W-2s and 1099s (note the new $2,000 threshold for 1099-NEC and 1099-MISC for payments made after December 31, 2025).
• File, or extend and pay. An extension extends the time to file, never the time to pay.
• Fund a SEP up to the extended due date if that is the chosen plan.
• Review the prior three years for missed credits and amendable positions.

Frequently Asked Questions

How Mike Habib, a Federally Licensed Enrolled Agent, Helps

As a federally licensed Enrolled Agent governed by Treasury Department Circular 230, Mike Habib is authorized to represent taxpayers before the Internal Revenue Service in all fifty states, at every administrative level — examination, collection, and appeals — as well as before the California Franchise Tax Board, the Employment Development Department, and the California Department of Tax and Fee Administration.

That combination matters for business tax planning specifically. A strategy is only worth what it is worth after examination, and the person best placed to design a position is the person who defends positions for a living.

Working directly with Mike, you get:

• Proactive planning rather than annual reporting. Full-year projections, quarterly reviews, and decisions made while the year can still be changed.
• Entity and compensation analysis. Modeling S corporation election, reasonable compensation, payroll tax exposure, and the qualified business income deduction together rather than in isolation.
• Retirement plan design. Solo 401(k), SEP, SIMPLE, and defined benefit or cash balance analysis, coordinated with the SECURE 2.0 startup credits so the plan largely pays for itself in the first three years.
• Depreciation and fixed asset strategy. Section 179, 100% bonus depreciation, qualified production property, cost segregation, and the de minimis safe harbor, sequenced to protect the QBI deduction and stay inside the excess business loss limitation.
• Credit identification and computation. The Form 3800 components most businesses never claim — research credits with the payroll tax offset, retirement plan startup credits, paid family and medical leave, employer-provided childcare, small employer health insurance, disabled access, and the FICA tip credit.
• Compliance architecture that survives audit. Accountable plans, capitalization policies, mileage and travel substantiation systems, family payroll documentation, and reasonable compensation studies built before the fact.
• Representation when it matters. Examination, collection, appeals, payroll tax and trust fund recovery penalty matters, worker classification disputes, and state agency issues.
• Direct access. Every engagement is handled personally by Mike. There is no junior staffer learning your file, and no handoff between the person who sold the engagement and the person doing the work.

With more than twenty years of experience — including service as Controller at Xerox Corporation and Director of Finance at AEG before building this practice — Mike brings the perspective of someone who has run finance from the inside. The firm is a BBB A+ Accredited Business and holds memberships in the National Association of Enrolled Agents, the California Society of Enrolled Agents, and the National Association of Tax Professionals.

Get an Evaluation — Talk to Mike Directly

If the only conversation you have about taxes happens in March, you are paying more than you need to. The decisions that change a tax bill — entity structure, retirement plan design, how assets are purchased, how family members are paid, which credits get claimed — all have to be made while the year is still open.

Every engagement is quoted as a flat fee, based on the scope of work your situation actually requires, and agreed before any work starts. No hourly billing, no surprise invoices, no meter running while you ask a question.

Call 562-204-6700 or 1-877-78-TAXES [1-877-788-2937], or visit myirstaxrelief.com, to schedule a confidential consultation with Mike Habib, EA. Based in Whittier, Los Angeles County, California, serving individuals and businesses in all fifty states and Americans living abroad.

Sources and Verification

Figures, code sections, rates, and effective dates in this guide were verified against primary sources current as of August 2026:

IRS Notice 2025-67 (2026 retirement plan and IRA cost-of-living adjustments); IRS Revenue Procedure 2025-32 (2026 inflation-adjusted amounts, including section 179 limits, the qualified business income thresholds, the excess business loss threshold, the cash method gross receipts test, QSEHRA limits, and the 1099 reporting threshold); IRS Revenue Procedure 2024-40 (2025 amounts); IRS Notice 2026-10 and Announcement 2026-11 (2026 standard mileage rates, including the mid-year increase effective July 1, 2026); IR-2025-128 (2026 standard mileage rate announcement); IRS Revenue Procedure 2025-28 (domestic research and experimental expenditures); IRS Notice 2026-28 (section 45S premium method); IRS Notices 2025-62 and 2025-69 (qualified tips and overtime); IRS Announcement 2002-18 (frequent flier miles); IRS Instructions for Forms 3800, 6765, 8881, 8882, 8941, 8994, 8826, 8846, 8995, and 8995-A; IRS Family Help guidance on employment taxes for family members; Internal Revenue Code sections 41, 44, 45B, 45E, 45F, 45R, 45S, 45T, 51, 119, 132(e), 162, 163(j), 168(k), 170, 174A, 179, 183, 199A, 274, 280A, 280F, 401(a), 402(g), 415, 461(l), 1202, and 1402; Treasury Regulation section 1.263(a)-1(f) (de minimis safe harbor); Public Law 119-21 (the One, Big, Beautiful Bill Act), enacted July 4, 2025; and California Senate Bills 132, 167, and 175 with Franchise Tax Board pass-through entity elective tax guidance.

Important: tax law changes, and several provisions described here are the subject of pending legislation or awaited guidance — most notably the Work Opportunity Tax Credit and the scope of the section 274(o) meals disallowance. This guide is general information, not advice for your specific situation. Confirm current figures and your own eligibility before acting.

© 2026 Mike Habib, EA. All rights reserved.

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