Small business owners will face some new tax challenges and opportunities in 2024, as the federal tax code undergoes some significant changes. Some of these changes are temporary, while others are permanent, and they will affect different types of businesses and income differently. Here are some of the key tax issues and strategies that small business owners should be aware of and plan for in the new year:
- SALT cap: The state and local tax (SALT) deduction, which allows taxpayers to deduct their state and local income, sales and property taxes from their federal taxable income, is currently capped at $10,000 per year. This cap is set to expire after 2025, but some lawmakers are pushing to repeal or modify it sooner. The SALT cap affects mostly high-income earners and residents of high-tax states, such as California, New York and New Jersey. Small business owners who operate as sole proprietors, partnerships, S corporations or LLCs may be able to reduce their SALT cap exposure by electing to be taxed as C corporations, which are not subject to the cap. However, this option may have other tax implications, such as double taxation and lower qualified business income (QBI) deduction, so it should be carefully evaluated with a tax professional.
- QBI deduction: The QBI deduction, which allows eligible taxpayers to deduct up to 20% of their income from certain pass-through businesses, such as sole proprietorships, partnerships, S corporations and LLCs, is also set to expire after 2025. The QBI deduction is subject to various limitations and exclusions, depending on the type and amount of income and the industry of the business. Small business owners who qualify for the QBI deduction should take advantage of it while it lasts, and plan ahead for the potential tax increase after 2025. One possible strategy is to accelerate income into 2024 and defer expenses into 2026, to maximize the QBI deduction and minimize the taxable income in the later year.
- Personal income tax brackets: The personal income tax brackets and rates, which were lowered by the Tax Cuts and Jobs Act of 2017, are also scheduled to revert to their pre-2018 levels after 2025. This means that the top marginal tax rate will increase from 37% to 39.6%, and the income thresholds for each bracket will be adjusted downward. Small business owners who pay taxes at the individual level, such as sole proprietors, partners, S corporation shareholders and LLC members, should be prepared for the higher tax rates and brackets in the future, and consider strategies to reduce their taxable income, such as contributing to retirement plans, donating to charities, and harvesting capital losses.
- Corporate income tax rate: The corporate income tax rate, which was reduced from 35% to 21% by the Tax Cuts and Jobs Act of 2017, may be increased by the Biden administration in the near future. The proposed rate is 28%, but it could be negotiated lower by Congress. Small business owners who operate as C corporations, or who are considering switching to C corporation status, should weigh the pros and cons of the potential tax hike, and explore alternative ways to lower their effective tax rate, such as claiming tax credits and incentives, deducting business expenses, and distributing dividends.
- Digital transactions reporting: The IRS has delayed the implementation of a new reporting requirement for digital transactions over $600, which was originally set to take effect in 2023. The requirement, which is part of the American Rescue Plan Act of 2021, aims to improve tax compliance and collection by requiring third-party payment providers, such as Venmo, Zelle, PayPal and online marketplaces, to report the gross amount of payments made or received by their users to the IRS and the users themselves. The requirement will now take effect in 2024, and the IRS is expected to issue more guidance and clarification on the rules and exceptions. Small business owners who use digital platforms to conduct their business transactions should keep track of their income and expenses, and report them accurately on their tax returns, to avoid any discrepancies or penalties.
