Introduction

Small businesses are vital to the U.S. economy. Small businesses account for 99.9% of all firms, employ 46.8% of the country's private sector workforce, and contribute 43.5% of the nation's gross national product.

It's estimated there are more than 34.7 million small businesses-sole proprietorships, limited liability companies, partnerships, S corporations, and C corporations. Despite economic challenges-inflation, supply chain issues, labor shortages, and AI concerns-the entrepreneurial spirit is alive and well. The gig economy continues to expand and small businesses are present on Main Street, farms, homes, and anywhere else that a business can be found. According to the Small Business Administration, at the end of the first half of 2024: "Entrepreneurship rates are strong as self-employment and business applications remain high."

Small businesses fall under the purview of the Internal Revenue Service's (IRS) Small Business and Self-Employed Division (SB/SE). This division services approximately 57 million tax filers, including 41 million self-employed individuals filing Schedules C, E, or F, as well as (3.8 million partnerships and 6.8 million corporations with assets of $10 million or less), and about 7 million filers of employment, excise, and certain other returns. The SB/SE division accounts for about 40% of the total federal tax revenues collected. The goal of this IRS division is customer assistance to help small businesses comply with the tax laws.

There is also an IRS Small Business and Self-Employed Tax Center at https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed where you'll find links to topics of interest, such as stages of a business and free online learning opportunities.

As a small business owner, you work, try to grow your business, and hope to make a profit. What you can keep from that profit depends in part on the income tax you pay. The income tax applies to your net income rather than to your gross income or gross receipts. You are essentially taxed on what you keep after paying off the expenses of providing the services or making the sales that are the crux of your business. Deductions for these expenses operate to fix the amount of income that will be subject to tax. So deductions, in effect, help to determine the tax you pay and the profits you keep. And tax credits, the number of which has been expanded in recent years, can offset your tax to reduce the amount you ultimately pay.

Special Rules for Small Businesses

Sometimes it pays to be small. The tax laws contain a number of special rules exclusively for small businesses. But what is a small business? The average size of a small business in the United States is one with fewer than 20 employees with annual revenue under $2 million. Different government departments and agencies, as well as different industries, use their own definitions of "small business." For federal tax purposes, the answer varies from rule to rule, as explained throughout this book. It may depend on your revenue, the number of employees, net worth, total assets (capital), or outlays/outputs. In Table I.1 are more than 3 dozen definitions from the Internal Revenue Code on what constitutes a small business in 2024. You may be a small business for some tax rules but not for others.

TABLE I.1 Examples of Tax Definitions of Small Business

Tax Rule Definition Accrual method exception for small businesses (Chapter 2) Average annual gross receipts of no more than $30 million in the 3 prior years (or number of years in business, if less) Archer medical savings accounts (Chapter 19) Fewer than 50 employees Bad debts deducted on the nonaccrual-experience method (Chapter 11) Average annual gross receipts for the 3 prior years of no more than $5 million Building improvements safe harbor (Chapter 10) Average annual gross receipts for the 3 prior years of no more than $10 million and building's unadjusted basis no greater than $1 million Centralized audit regime for partnerships-election out (Chapter 33) 100 or fewer partners Disabled access credit (Chapter 10) Gross receipts of no more than $1 million in the preceding year or no more than 30 full-time employees Employer mandate exemption from providing affordable health coverage Fewer than 50 full-time/full-time equivalent employees Estimated tax for C corporations based on prior year's return (Chapter 30) Taxable income of less than $1 million in any of the 3 preceding years Employee retention income tax credit (Chapter 7) Fewer than 100 employees Employer differential wage payments credit (Chapter 7) Fewer than 50 employees Energy credit for qualified small wind energy property Property that uses a wind turbine of 100 kilowatts or less of rated capacity to generate electricity Excise tax on importers and manufacturers-reduced rate for small businesses Gross receipts in the previous year under $500,000 Exemption from mandatory auto-enrollment in 401(k)s 10 or fewer employees First-year expensing election (Chapter 14) Qualified property for 2024 of no more than $4.27 million Golden parachute payments exemption (Chapter 7) 100 or fewer shareholders Independent contractor versus employee determination-shifting burden of proof to IRS (Chapter 7) Net worth of business does not exceed $7 million Interest deduction limit exemption (Chapter 13) Average annual gross receipts of $30 million or less in the 3 prior years Late filing penalty for failure to file information return-cap (Appendix B) Average annual gross receipts of no more than $5 million for a 3-year period Military spouse retirement plan eligibility credit (Chapter 16) 100 or fewer employees Ordinary loss on the sale of small business stock Capital of $1 million or less at the time stock is issued Penalties-reduced amount for information returns Average annual gross receipts of $5 million or less in the 3 most recent years Qualified small employer health reimbursement arrangement (Chapter 19) Fewer than 50 full-time and full-time equivalent employees Reasonable compensation-shifting the burden of proof to the IRS (Chapter 7) Net worth of business not in excess of $7 million Recovery of legal fees from the government Net worth less than $5 million and fewer than 500 employees at the time the action is filed Repair regulations-deduction under safe harbor for items up to $2,500 per item or invoice (Chapter 10) No applicable financial statement (SEC filing; audited financial statement) Repair regulations-safe harbor not to capitalize improvements to buildings (Chapter 10) Average annual gross receipts under $10 million and building has unadjusted basis under $1 million Research credit-offset to AMT(Chapter 23) Businesses with average annual gross receipts in the 3 prior years of $50 million or less Research credit-offset to employer's Social Security and Medicare taxes (Chapter 23) Corporation or partnership with gross receipts of no more than $5 million for current year and no gross receipts during the 5-year period ending with the current year (similar for sole proprietors) Retirement plan start-up and other plan-related credits (Chapter 16) No more than 100 employees with compensation over $5,000 in the preceding year S corporations (Chapter 1) 100 or fewer shareholders Savings Incentive Match Plans for Employees (SIMPLE) plans (Chapter 16) Self-employed or businesses with 100 or fewer employees who received at least $5,000 in compensation in the preceding year Section 1244...