Taxes and Accounting
What Is Tax Optimization?
Your business goal is always to pay the least amount of taxes as legally possible and retain the most of your cash inflows or income. Therefore, tax optimization is the strategic process of minimizing the amount of income subject to tax liability. This involves deliberate planning of the precise timing of income and expenses so that your business can capitalize on tax credits and incentives, exemptions, deductions, and so-called havens provided under the Internal Revenue Code and IRS interpretive guidance. This article provides a guide that identifies where businesses may be able to reduce or defer taxes over time in a question-and-answer format.
When should a business begin the tax optimization process?
Proactive tax planning has to be a yearlong process. You should not wait until the end of the tax year or April 15. Otherwise, you will likely be missing great opportunities to shield your income from tax liability. At tax reporting time, your accountant is often at the mercy of the tax code and there is little legal maneuvering that can be done. Even so, if you begin planning late in the tax year, opportunities still exist to minimize your liability particularly if credits or deductions are expiring at the end of that tax year or the IRS is implementing new tax provisions in the next tax year.
What are the tax rates for 2024?
Good tax planning begins with knowing the tax rates applicable to you. The best source for tax rates is IRS Revenue Procedure 2023-34. Some of the rates that most affect businesses are identified below:
|For Single Filers
|$0 to $11,600
|Long-Term Capital Gains Rate
|CG Tax Bracket
If your company is a pass-through entity like a limited liability company (LLC), a partnership, or an S-corporation, the business income will appear on a business owner’s individual IRS Form 1040. Thus, the rates above apply to a pass-through entity’s income and profits. The table shows graduated tax brackets that determine how much each portion of your earnings is taxed. For example, the IRS taxes the first $11,600 of a taxpayer’s income at 10%. The IRS taxes the next $35,500 at 12%, and so on.
The Corporate tax rate is a flat 21%. The net investment income tax (NIIT) rate is 3.8% (sale price less purchase price). This tax applies to those earning over $200,000 for individuals and over $250,000 for married couples filing jointly. The NIIT applies to the lesser of x) your net investment income and y) the portion of your modified adjusted gross income that goes over the threshold. The NIIT and the capital gains tax both apply to investment profits so it is easy to confuse the two.
All qualifying investment profits are subject to the Long-term capital gains tax. High-income taxpayers who owe capital gains tax have to pay the additional NIIT. Everyone who pays the NIIT will also pay capital gains tax. On the other hand, not everyone who pays the capital gains tax owes the NIIT.
There are some exceptions to the maximum 20% long-term capital gains tax rate shown in the table above. Long-term gains from the sale of collectibles can be taxed as high as 28%. The sale of “qualified small business stock” (QSBS) purchased after September 27, 2010, that you held for at least five years is generally exempt from tax. Conversely, for any gain that is not exempt from tax, the maximum capital gains tax rate jumps to 28%. In both cases, if you are in a tax bracket below 28%, then that lower rate will apply.
When real property is sold for which you have claimed depreciation deductions, the IRS may assess a capital gains tax of up to 25% on any unrecaptured depreciation (known as the “unrecaptured Section 1250 gain”). The rest of your long-term gain is taxed according to your income bracket as outlined in the table above.
For the most part, the tax you pay on short-term gains will be higher than the tax for long-term capital gains. Short-term capital gains are taxed at your regular income tax rate. You may be able to reduce tax liability by keeping stocks, bonds, and other capital assets for more than one year before selling.
What new taxes were introduced by the August 16, 2022 Inflation Reduction Act (IRA)?
The IRA added the corporate alternative minimum tax (CAMT), which imposes a 15% minimum tax on the adjusted financial statement income (AFSI) of large corporations for tax years beginning after Dec. 31, 2022. The CAMT generally applies to large corporations with an average AFSI over $1 billion. The Treasury Department and the IRS issued Notice 2023-7, Notice 2023-20, and Notice 2023-64 (the “Notices”) to provide interim guidance designed to help corporations determine whether the CAMT applies to them and how to compute the tax. See also Notice 2023-42 for information on the IRS’ temporary waiver of the penalty for noncompliance with the CAMT. There is a simplified safe harbor addressed in the Notices and the rules are complex. Please refer to the Notices for more details.
The IRA also created a new 1% excise tax on the repurchase of corporate stock by certain publicly traded corporations, or their specified affiliates effective for repurchases after December 31, 2022. The tax is equal to 1 percent of the fair market value of any stock that is bought back by a covered corporation during the tax year. Corporations do not get a tax deduction for paying the stock repurchase excise tax. The IRA provides exceptions for certain repurchases. You can find interim guidance on the stock repurchase excise tax in the IRS-published Notice 2023-2.
How does your business structure affect the taxes you pay?
A key part of the tax optimization process starts when you form your business. Tax planning must be an integral part of the company structure decision. Below is a chart of the different levels of taxation for different types of business structures.
|Self-employment tax and Personal tax. Sole proprietorships do not produce a separate business entity. They are the same as individuals working for themselves without a business form.
|Self-employment tax (except for limited partners) and Personal tax. Profits are passed through to personal tax returns, and the general partner must also pay self-employment taxes.
|Limited liability company (LLC)
|Self-employment tax and Personal tax or corporate tax (depending on election). Profits and losses extend through to your personal income without facing corporate taxes. However, members of an LLC pay self-employment tax contributions towards Medicare and Social Security.
|Corporation – C corp
|Corporate tax. Corporations pay income tax on their profits. Corporate profits are subject to double taxation — taxed on profits and then taxed on dividends when paid to shareholders on their personal tax returns.
|Personal tax. An S Corp is a corporation that avoids the double taxation drawback of C Corps. S Corps are pass-through entities.
|B Corp – Benefit Corporation
|Corporate tax. B Corps are responsible for producing some public benefit in addition to profit but they aren’t different in how they’re taxed.
|Exempt. Nonprofits must file with the IRS for tax exemption, but dividends are not permitted.
What are some tax optimization strategies that my business should consider?
I. Shifting the Recognition of Income and Expenses
- Create more cash flow through changes in tax accounting methods and wise maneuvering. Changing from the accrual or cash method may result in the acceleration or deferral of taxable income or deductible expenses.Companies wishing to reduce their tax liability have at their disposal various tax elections to defer revenue recognition to a subsequent taxable year and step up tax deductions to a previous one.
- You have the option of accelerating taxable income into the current tax year to maximize the use of the net operating losses or if your tax rates will increase in the next tax year.
- Capital losses offset capital gains at tax time. When there are more losses than gains, you can deduct up to $3,000 in capital losses from income.
- Maximize interest expense deductions. You can deduct interest expense in the current tax year but if the section 163(j) limitation applies, the amount of deductible business interest expense in a taxable year cannot exceed the sum of: x) your business interest income for the tax year; y) thirty percent of your adjusted taxable income (ATI) for the tax year; and z) your floor plan financing interest expense for the tax year. Any interest expense that exceeds the limit may be carried over until zero. See Revenue Procedure 2020-22 for more details.
- Filers may defer tax on capital gains. Contemplate not only current and future tax rates but also the intended deferral cycle, potential alternative uses of funds, cashflow needs in the short and long term, and other factors to optimize tax for capital gains. Consider potential long-term deferral strategies, including 1) reinvesting funds in Qualified Opportunity Zones, 2) “Like-kind” exchanges of real property, and 3) selling shares of a privately held company to an Employee Stock Ownership Plan.
- If you are the owner of a family or closely-held business, you may want to consider gifting an interest in the business (corporate stock or interests in family limited partnerships or LLCs). The annual gift tax exclusion will increase to $18,000 per gift recipient in 2024.
II. Maximizing Credits and Incentives
- All things being equal, filers should prefer tax credits over tax deductions because they directly reduce the amount of tax dollar for dollar. Deductions reduce the amount of your income subject to tax before the tax owed is calculated. The tax you pay depends on your tax bracket. Credits can increase your tax refund. Certain credits result in money to the filer even if no tax was owed or paid.
- The New Markets Tax Credit Program is currently set to expire on December 31, 2025. The program was designed to bring down the cost of capital in low-income communities. Taxpayers could receive a 39% tax credit over seven years for qualified investments into “Community Development Entities.”
- The R&D credit is available for approved research and development (R&D) activities.
- Filers that own residential low-income rental buildings are allowed a credit for each qualified building annually over a 10-year credit period. The low-income housing credit equals a credit percentage multiplied by the project’s qualified basis.
- If you are a small business employer, you may benefit from the small business health care tax credit. This credit pays at least 50 percent of the cost of employee-only – not family or dependent – health care coverage for each employee if you, among other things, offer a qualified health plan to your employees through a Small Business Health Options Program (SHOP) Marketplace. The IRS provides a few exceptions to the SHOP Marketplace requirement.
- The IRA completely transformed many of the current green energy credits and energy security provisions resulting in a significant expansion of IRS involvement. The new ways for taxpayers and other entities to monetize energy security and clean energy incentives are an important focus area for the implementation of the IRA.` Certain entities can even receive cash to transfer their energy security and clean energy credits to other parties that may be better positioned to benefit from the incentives. Consumers will be able to transfer their clean vehicle tax credit to a car dealer for an equivalent price discount starting in 2024. 
- Clean vehicle credits are available for the purchase of certain electric vehicles (EVs) or fuel cell vehicles (FCVs).
- In March 2023, the IRS issued proposed guidance on the implementation of the Advanced Manufacturing Investment Credit, established by the Creating Helpful Incentives to Produce Semiconductors Act of 2022, also known as the CHIPS Act. The credit allowable to a taxpayer is generally equal to 25 percent of the basis of any qualified property that is part of an eligible advanced manufacturing facility if placed in service during such taxable year and after December 31, 2022.
- Other incentives for employers include the Work Opportunity Tax Credit, the Federal Empowerment Zone Credit, the Indian Employment Credit, and credits for paid family and medical leave (FMLA). There has been a high fraud risk with the Employee Retention Credit and the IRS placed a temporary moratorium on processing claims in September 2023.
III. Capitalizing on All Available Deductions
- Pass-through entities may be entitled to a deduction of up to 20% of their qualified business income. The reduction in business income does not correspondingly reduce the self-employment tax.
- For single filers, the standard deduction for 2024 will be $14,600. The standard deduction will be $29,200 for married filing jointly. You can itemize your deductions to potentially save more than the standard deduction.
- Small business owners do well to take advantage of the home office deduction. It is an indispensable tax planning strategy for large corporations as well if they operate from a home office or have employees who work remotely. Keep good records if you use this deduction.
- The charitable contribution deduction may be utilized by businesses. A corporation is generally limited to 10% of its taxable income for cash contributions.
- You can take a deduction for any write-downs associated with subpar finished goods/inventory so long as you offer it for sale within 30 days of the inventory date. Note that it only has to be offered for sale not sold within that timeframe.
- Qualified retirement plans (including 401(k) and 403(b) plans) provide the opportunity for tax deferral by the person contributing to the plan.
- A bonus that is reasonable and represents pay rather than a gift is deductible under most circumstances. Accrual method taxpayers have to fix the bonus amount by year-end but they can be paid within two and half months of year-end. Cash method filers must determine and pay the bonus by year-end. However, special rules apply if the bonus is paid to a shareholder or owner by a Personal Service Corporation such as a law firm, physician practice, accounting firm, etc. The bonus compensation can only be deducted in the year actually received and claimed by the employee-owner.
- You can deduct the entire cost of certain property as an expense when the property is first placed in service under Section 179 of the tax code. The maximum deduction is $1 million. The deduction begins to phase out at $2.5 million. This deduction applies to tangible property, such as machinery and equipment purchased for use in a trade or business. Eligible property includes qualified real property and certain property used to supply lodging. Qualified real property includes improvements to roofs, HVAC, fire alarm systems, and security systems if nonresidential real property.
- Bonus depreciation – The one hundred percent additional first-year depreciation deduction applies to qualifying property (new and used) acquired and placed in service after September 27, 2017. It generally applies to business assets with a recovery period of 20 years or less. Furniture, computers, equipment, appliances, and machinery generally qualify.
- Business deductions for meal and entertainment expenses are still available with thoughtful planning.
IV. Choosing the Right Business Structure
If necessary, you can reevaluate your entire entity structure to reduce tax liability. For an otherwise eligible C corporation, you can consider whether an S corporation election would make sense. The current administration’s tax proposals would increase the corporate tax rate to 28%, which with the tax on dividends could increase the overall rate on distributed earnings to 45%—or even higher depending on your tax bracket. Entity conversion may trigger immediate tax consequences and cost-benefit analysis should be done prior to making a change.
V. Creatively Managing Foreign Operations
- If your organization benefits from Foreign Tax Credits (FTCs) review the jurisdictions where you operate and assess whether taxes paid to such jurisdiction(s) are still available as FTCs.
- You can find worthwhile tax advantages under US law if you repatriate profits from overseas operations. Additionally, planning to mitigate foreign withholding taxes on distributions should be considered.
- Analysis of relevant country transfer pricing rules and documentation requirements may provide an opportunity for savings if you have a company with cross-border operations. Intellectual property (IP) assets must comply with local country transfer pricing rules to optimize IP management strategies.
- Any time a transaction includes either the purchase or transfer of IP assets, inter-affiliate decisions that implicate both tax and IP issues are involved. As evident from recent US Tax Court cases, cross-border IP structures come with increased audit risk. See Rawat v. Commissioner of Internal Revenue, T.C. Memo. 2023-14 (U.S.Tax Ct., 2023) (nonresident sale of an interest in U.S. partnership); 3M Company and Subsidiaries v. Commissioner of Internal Revenue, 160 T.C. No. 3 (U.S.Tax Ct., 2023) (IRS allowed to allocate income between a group and its subsidiaries, to account for Brazilian subsidiary’s use of domestic subsidiary’s intellectual property pursuant to three licensing agreements). A company can optimize its tax position through the strategic placement of its IP assets.
- Monitor and model information reporting and withholding requirements under the US Foreign Account Tax Compliance Act (FATCA).
- Develop a strategy now to counteract the financial impact of the Global Minimum Tax. In June 2023, the OED/G20 project voted to implement a minimum 15% global tax for large multinational enterprises. In the future, if a corporate group pays less tax in one country, it can be taxed by other countries until the 15% is reached. This tax will affect only the largest of companies.
VI. Minimizing State and Local Taxes
Plan for your state and local tax obligations. Not all states follow federal tax rules. A number of states have enacted PTE (pass-through entity) tax elections that seek a workaround for the federal limit on the state tax deduction for individual owners of PTEs. State and local property taxes and sales and use taxes can be the largest piece of your entity’s state tax expenditures, even surpassing income and franchise taxes. You may be subject to these state and local taxes without having a physical presence in the state.
In the well-known case, South Dakota v. Wayfair, Inc., the United States Supreme Court ruled that sellers who engage in a significant business within a state may be required to collect taxes from their customers despite not having a physical presence in the state. 138 S. Ct. 2080 (2018). A state tax will be upheld so long as it 1) applies to an activity with a substantial nexus with the taxing state (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides.” Id.
VII. Maintaining detailed documentation to support your return
Keeping good records helps document your compliance with tax laws and allows you to identify and claim all available credits, incentives, and deductions. That documentation will be crucial in the event of an audit, a lawsuit, or a notice of deficiency. In Ahaiwe v. Commissioner of Internal Revenue, the Tax Court found that the insolvency exception to reporting cancellation of debt income did not apply when the taxpayer did not maintain good records and provided only a worksheet that was “little more than numbers on a page.” 2023 WL 2399907, at *2 (U.S.Tax Ct., 2023). In Patacsil v. Commissioner of Internal Revenue, the Tax Court required a couple to report a discharged debt as income because they failed to adequately substantiate certain losses and tax deductions. T.C. Memo. 2023-8 (U.S.Tax Ct., 2023).
VIII. Collaborating with Skilled Tax Professionals
To excel at tax planning, get the help of qualified tax professionals, including tax lawyers and accountants. Certified public accountants (CPAs) and tax attorneys are both specially qualified and trained professionals who can help you with taxes and financial strategizing. Which professional do you call for what task? If you need someone to handle the numbers and what you owe, you want a CPA; if you want to know what the IRS will allow, you want a tax lawyer. A tax lawyer would not usually prepare a tax return or financial statements. A CPA can represent you before the IRS but not in court and usually will not handle tax controversies and dispute resolution.
Implementing an excellent tax optimization program will help you stay ahead of tax law changes that may affect your business entity’s tax liability. Constant changes to the Internal Revenue Code and new legislation present substantial challenges but can also offer new opportunities to help reduce your tax burden. Consult with a tax attorney to keep your company’s bottom line on the right track.
 The source for this article is the IRS website unless international law is addressed. Unless otherwise indicated, I based the information in this article on tax laws and policies promulgated as of the publication date. As tax laws and regulations change, the accuracy of the information may also change.
 The White House 2024 Budget Proposal aims to increase many of these rates, for example, the corporate rate would increase to 28% and the highest individual bracket would increase to 39.6% at a threshold of $400,000.
 Some advisers may say the top capital gains rate is 23.8% and in this case, they are including the 3.8% NII tax with the 20% CG tax.
 Long-term in this context means investments held for more than a year.
 A tax accounting method change request will likely require taxpayers to file Form 3115, Application for Change in Accounting Method, with the IRS.
 Organisation for Economic Co-operation and Development (OECD) and the Group of Twenty major developed and emerging economies (G20).