Tax Planning and Advice Prep for 4 Business Entity Types

If you’re a Business Owner, read this short post to ensure that you’ve addressed the following to improve accuracy and capture those deductions that you’re entitled to take.

First – Gross Income – Verify that it is not Overstated or Understated:

Folks, This is the number one problem that leads to a poor filing and often, overstated Gross Income and overstated Taxable Income.

If you’re a Business Owner, Partner or Shareholder, how do you know if your Gross Income for a taxable period is fairly stated?

Check the following:

• If you use QuickBooks (or other Accounting Platform) check that your Sales entries are not duplicated. If you use your Accounting Platform to Invoice your Customers, tie (reconcile) your payments (received) back to your Invoices.
• If you use a third-party Customer Relationship Manager (CRM) tool to Invoice, make sure that your Gross Income in your Accounting Platform ties to your CRM for the taxable period.
• If your business is cash-basis, you only reflect Sales Income when you (constructively) receive payments from your Customers. If you receive a check, you count that as Income. The fact that you haven’t deposited yet, does not matter. It counts.
• If your business is accrual-basis, you count Income when the product or service is complete and you Invoice your Customer for payment, in advance of receiving payment. If, ultimately, you do not receive payment, write off these Invoices as bad debt expense to offset the amount of Gross Income that you will not realize.

Sole Proprietors (Schedule C Filers):

Tax Planning:

• The simplest form of business. You can file as a “Doing Business As” DBA entity with your state.
• This entity form includes single-member LLC’s.
• The most important consideration with the majority of these businesses is to keep your personal and business transactions SEPARATE.

Tax Preparation:

Three of the most common (possible) deductions to consider (if you qualify) are:

• Health insurance premiums – for you, your spouse, your family paid by you (the business owner) will offset income derived from your business as long as you do not qualify under another plan like your spouse’s plan from their job.
• Home Office deduction. Be aware. There are rules and requirements that must be met to qualify and how much you could be eligible for.
• Mileage deduction for personally owned vehicle used for business. You’ll need the make, model, date placed in service, total mileage and business mileage. You should have kept a log to substantiate your mileage for a taxable period. The Standard Mileage deduction is pretty generous, but be aware that this amount includes depreciation that could be clawed back if you sell the vehicle. Actual expenses require more record keeping for fuel, repairs and maintenance and insurance to name just three of the larger parts of your total deduction.

Partnerships (Form 1065) and Things to Keep in Mind:

Tax Planning:

• Multi-member LLC’s (at the state level) are Partnerships (by default) for federal tax purposes.
• Partnerships should have detailed operating agreements that define how each Partner should share in Partnership profits, gains, losses and deductions as well as duties and responsibilities including how residual assets and liabilities are to be allocated if the Partnership ceases operation.
• Partnerships are what is termed – flow-through entities, that is, Partners are taxed on their proportionate share of Partnership Net Income (Profit), not property or money distributions that they take out of the Partnerships. This is probably the most misunderstood and misapplied aspect of Partnership tax filings. So, consider two Partners (A & B) that share Partnership Net Income in a ratio of 51%/49%. If the Partnership earned $100,000 in Net Income, Partner A would reflect $51,000 (of ordinary income) on their Partner K-1 and on their individual 1040 return, and Partner B would reflect $49,000. If Partner A takes a $10,000 cash distribution and Partner B takes a property distribution with a fair market value of $5,000, Partner A would still reflect $51,000 in ordinary income and Partner B, $49,000. Distributions impact Partner Capital Accounts and Partner Basis not taxable income, unless distributions exceed basis.
• Individual Partners are taxed on the Profitability of the Partnership but must also include Self-Employment (SE) taxes on their individual 1040. Self-Employment taxes are taxes for Medicare and Social Security. This is identical to how Sole Owners (Proprietors) are taxed on their individual returns.
• Note: Partners are not considered employees of the Partnership. This is different than for Shareholders (that are actively engaged in the business) in S and C-Corporations.

Tax Preparation:

• Partners that pay for their own health insurance can deduct these premiums on their individual 1040.
• Pay special note to those (Partnership) expenses paid for by Partners that are not reimbursed by the Partnership. These are termed UPE for Unreimbursed Partnership Expenses. Create/keep solid documentation that details these expenses (amount, business purpose, date, mileage), to address any challenge you may receive from any taxing authority.
• Partners are required to keep Capital Accounts of their Outside Basis in the Partnership. In plain English, these Capital Accounts detail how much “skin each Partner has in the game.” This becomes more relevant in situations where the Partnership suffers a (net) loss and Partners need to have enough basis to reflect that loss on their individual return. These Capital Accounts are required to be maintained under a tax basis, not a book (or other) basis.

Shareholders – S-Corporations (Form 1120S):

Tax Planning:

• Keep in mind, S-Corporations are not default elections. Shareholder/Owners must file a form/forms to elect S-Corp status and must receive (acknowledgment from the IRS) that the election was accepted. A business can be an LLC (at the state-level) and taxed as an S-Corp for federal tax purposes.
• S-Corp Shareholders that are actively engaged in the business (there are tests in the tax code that define what active engagement means) are both employees and owners. As an employee, Shareholders are required under the Internal Revenue Code to take a reasonable salary that is deductible as an expense against the S-Corp’s earnings. Although the tax code does not specifically define what is (reasonable compensation), the tax code does introduce parameters that help Shareholders create reasonable estimates by showing examples of what would not be reasonable.
• Again, as for Partnerships, S-Corp’s are flow-through entities and Shareholders are taxed on their proportionate share of the Net Income of the S-Corporation. However, because Shareholders are considered employees, they are not subject to Self-Employment (SE) taxes.
• Tax courts have generally held that S-Corporation Shareholders cannot deduct unreimbursed expenses. Because of this, The S-Corporation should reimburse it’s Shareholders to reflect these expenses on the Books of the S-Corp. These deductions flow through to each Shareholder (to their individual 1040 return) in proportion to their ownership interest.

Tax Preparation:

• Cash and property distributions are not taxable to the Shareholder, but distributions should never exceed a Shareholder’s reasonable salary. The IRS interprets distributions that exceed salaries as evasion and could require the Shareholder to reclassify these distributions as taxable income subject to withholding, Medicare and Social Security taxes.

Shareholders – C-Corporations (Form 1120):

Tax Planning:

• Domestic (for profit) Corporations that are created at the state level, are normally C-Corporations (for federal tax purposes) by default.
• C-Corporations differ from S-Corporations in that they are considered legally separate entities from their Owners (Shareholders).
• C-Corporations are taxed at a flat 21% for federal tax purposes and 6% (for Michigan). Different states have different tax rates.
• Be careful what you wish for. C-Corporation Shareholders are subject to double taxation – Shareholders are taxed as a percentage of their ownership interest on the profitability of the Corporation as well as any dividend (distributions) such as cash or property they receive.
• Shareholders that are actively engaged (there’s that active engagement, again) in the operation of the business are required to be employees of the business. If you’re considered to be actively engaged, and you’re not an employee, where your pay was subject to federal and state tax withholding, you’re not in compliance.

In Closing:

Link to our internal tax articles – Tax Issues and Solutions.

Link to an external Small Business Tax Calculator (Taxfyle):  Estimate your 2025 business refund or liability.

Note: Sole Proprietorships, Partnerships, and S-Corporations do not pay tax – these are flow-through entities, meaning that the Net Income (or loss) is taxable (deductible) to the Owner, Partners or Shareholders on their personal 1040 filing. C-Corporations which are a legally separate entity – separate from the Owners/Shareholders pay taxes. 

Remember these calculator tools (like all tools) provide estimates, only. They do not and should not replace a qualified Tax Pro.