Tax Strategies for Business Owners: Entity Selection, QBI, Retirement Plans, and the Year-End Moves That Actually Work

Entity Selection: Schedule C vs. LLC vs. S Corp vs. C Corp

Entity choice is the foundation. A single-member LLC defaults to Schedule C, which means every dollar of profit hits both income tax and 15.3% self-employment tax. A multi-member LLC defaults to partnership taxation (Form 1065). An S corporation (Form 1120-S) lets you split your income between W-2 salary and distributions, where only the salary portion is hit with payroll tax. A C corporation pays a flat 21% federal rate at the entity level, then shareholders pay tax again when profits come out as dividends — useful in narrow situations, painful in most.

The rough rule we use: under about $50K of net profit, stay on Schedule C. Between $50K and roughly $80K, run the S-corp math carefully because payroll costs can eat the savings. Above $80K of consistent profit, the S-corp election usually wins. Above $500K with profits you genuinely do not need personally, C-corp starts becoming a real conversation, especially if you want to reinvest or eventually sell qualified small business stock under IRC §1202.

We walk through this with every business owner client when we onboard them, and the answer is rarely what people expect.

Reasonable Salary and the S-Corp Distribution Split

The S-corp savings come from the gap between W-2 salary (subject to FICA) and shareholder distributions (not subject to FICA). The catch: the IRS requires the salary to be reasonable for the services you actually perform. Pay yourself $20K out of $400K in profit and you are inviting an audit.

What we look at when setting salary: what would you have to pay someone to do your job, the breakdown of your time between operational work and ownership/investor work, regional comp data, and what other people in your industry pay themselves. For a solo professional service business pulling $300K of profit, a salary in the $120K–$160K range is usually defensible. For a contractor where most of the profit comes from crew labor and capital, salary can run lower.

This is one area where over-optimizing is dangerous. The savings from paying yourself $5K less in salary are real but small. The cost of losing an audit on reasonable compensation includes back FICA, penalties, and interest, plus the risk that the IRS reclassifies multiple years of distributions.

The QBI Deduction (IRC §199A) and the PSB Cliff

IRC §199A gives most pass-through business owners a deduction of up to 20% of qualified business income. It is reported on Form 8995 (or 8995-A for the long version). For 2026, the phaseout for specified service trades or businesses begins at $197,300 single / $394,600 joint and the deduction is fully gone for SSTB owners about $100K above those thresholds.

Who qualifies as a Specified Service Trade or Business (SSTB)? Health, law, accounting, consulting, financial services, performing arts, athletics, and any business where the principal asset is the reputation or skill of one or more employees. Architects and engineers are specifically excluded from the SSTB list, which is why we see a lot of borderline structuring around that line.

The planning moves: if you are a high-income SSTB owner, pre-tax retirement contributions can pull your taxable income back under the phaseout. If you are a non-SSTB owner above the threshold, the deduction shifts to a W-2 wage and unadjusted basis test, which can favor businesses with employees or significant property. IRS Publication 535 covers the mechanics, but the planning work here is usually case-by-case.

Retirement Plans: SEP-IRA, Solo 401(k), and Defined Benefit at $300K+

Retirement contributions are the single largest legal tax deduction available to most business owners, and the tiers go higher than people realize.

SEP-IRA: Simple to administer. Contribute up to 25% of compensation, capped at $70,000 for 2026. Works for sole proprietors, partnerships, and corporations. The drawback is you cannot do Roth contributions and the employer-only design means staff coverage gets expensive once you hire.

Solo 401(k): Better for most owner-only businesses. Combines a $23,500 employee deferral (plus $7,500 catch-up at 50+) with employer profit sharing up to the same $70K total cap. Allows Roth contributions, after-tax voluntary contributions for mega-backdoor strategies, and loans up to $50K. Governed by IRC §401(k).

Defined Benefit / Cash Balance plans: For business owners over 45 with net profit above $300K who want to shelter $100K–$300K+ per year on top of a 401(k). These plans are governed by IRC §404 contribution limits and require actuarial certification each year. Setup cost runs $2K–$5K, annual admin is $2K–$4K, and the contribution is mandatory once you commit. For the right profile they are extraordinary.

We coordinate plan design with our tax strategy consulting work — picking the wrong plan can lock you into a structure that costs more to unwind than to set up correctly the first time.

The Augusta Rule (§280A(g)): 14 Days of Tax-Free Rental

IRC §280A(g), sometimes called the Augusta Rule after the home of the Masters tournament, lets you rent your personal residence to a third party for up to 14 days per year and exclude the rental income from gross income entirely.

Business owners use this by renting their home to their own business for legitimate meetings — board meetings, strategy sessions, client events, annual planning days. The business deducts the rental expense; you receive the income tax-free. Done right, this can shift $10K–$25K from taxable to non-taxable annually.

Done wrong, it gets thrown out in audit. The requirements are unforgiving: the rental must be at fair market rate (we use comparable hourly conference room and event venue pricing in the same neighborhood), there must be a real business purpose for each meeting, contemporaneous documentation (meeting minutes, agendas, attendee lists), a written rental agreement between you and the entity, and 1099-MISC issued from the business to you. If you skip the paperwork, expect to lose the deduction.

Hiring Your Kids: The Under-18 Sole Prop Strategy

If you operate as a sole proprietorship or a husband-and-wife partnership, and your child is under 18, you can put them on a W-2 and the wages are exempt from Social Security, Medicare, and FUTA. The wages are deductible to the business and the child can earn up to the standard deduction ($15,000 for 2026) at a 0% federal income tax rate.

The rules tighten if you operate as an S-corp or C-corp — FICA exemption goes away, though the income tax benefit at the kid’s bracket still works. Many of our clients with corporations create a family management LLC (sole prop) that the corporation pays for services, which restores the FICA exemption.

What the IRS wants to see: real work being performed (filing, social media, shoot assistance, modeling for the business, cleaning, office tasks), age-appropriate hours and duties, market-rate wages, time logs, and the W-2 + payroll filings actually run. Paying a 6-year-old $15K to “help with email” is the kind of position the IRS denies routinely. Paying a 14-year-old $400 a week to run your social media accounts with documented posts is far more defensible.

Year-End Moves: §179 Equipment and State PTET Prepayment

Two year-end moves consistently show up in our planning conversations.

Section 179 equipment expensing: IRC §179 lets you deduct the full cost of qualifying equipment and software in the year placed in service, up to $1.22M for 2026 (phaseout begins at $3.05M of total purchases). Combined with bonus depreciation, most business equipment purchases can be fully written off. Place in service is the key phrase — the equipment has to be installed and ready for use by December 31, not just ordered. We have seen too many December 28 deliveries that ended up sitting in a warehouse until January.

PTET (Pass-Through Entity Tax) prepayment: New York and most other states with income tax now offer a SALT-cap workaround where the entity pays state tax at the partner/shareholder level and deducts it federally, bypassing the $10K SALT cap on personal returns. For New York PTET, the election is annual and the December estimate matters: paying the Q4 PTET estimate by December 31 makes it deductible federally that year. Miss the cutoff and you push a meaningful deduction into the following year.

We run a year-end review with every business client in November to catch both of these before the calendar flips.

When to Convert a C-Corp to an S-Corp (and When Not To)

C-to-S conversion comes up most often when an owner realizes the double taxation is bleeding cash. The conversion itself is straightforward — file Form 2553 by the 15th day of the third month of the tax year you want the election to take effect — but the tax consequences require planning.

The two big traps: built-in gains tax under IRC §1374 (a corporate-level tax on appreciated assets sold within 5 years of conversion) and LIFO recapture for inventory businesses. If your C-corp owns appreciated real estate, intellectual property, or significant goodwill, the big tax can eat the savings for half a decade. We model the holding period and the projected asset sales before recommending the conversion.

When we typically say yes: service businesses with no significant appreciated assets, businesses where the C-corp was an accident of formation (someone checked the wrong box), and situations where the owner now wants the QBI deduction and salary flexibility that S-corp status enables. When we say no or wait: businesses planning a §1202 stock sale within 5 years, businesses with heavy appreciated inventory or real estate, and owners who actually need the C-corp’s fringe benefit treatment (medical reimbursement plans, for example).

For a deeper conversation about your specific structure, our business management team works with the planning side day in and day out.