The tax law has a variety of definitions for small businesses that are used for different deductions, credits, and other tax breaks. The term “small” is based on the value of a company’s assets, number of employees, number of owners, gross receipts, or something else.
Using different standards to define small business makes it very challenging to know when a company may or may not qualify for a tax break. There are many different small business tax definitions and below are 10 of these definitions:
1. Independent Contractor Status Determination
One of the hottest IRS issues is whether employers are properly classifying workers as employees or independent contractors. If the IRS challenges an employer’s classification, it’s usually up to the company to prove the classification was correct. However, the burden can be shifted to the IRS under certain conditions. This applies to “small” businesses, which means those with a net worth of business not exceeding $7 million.
2. Late Filing Penalty for Failure to File Information Returns
Companies that fail to file required information returns are penalized. The longer they go without filing, the greater the penalty. However, penalties are capped for small businesses. “Small” means that the business has average annual gross receipts of no more than $5 million for a 3-year period.
3. Reasonable Compensation—Shifting the Burden of Proof to the IRS
As in the case of providing correct worker classification, it’s up to a company to prove that compensation it pays to an employee is reasonable in order to deduct it. However, the burden of proof can be shifted to the IRS if the employer is “small,” which means having a net worth not in excess of $7 million.
4. Retirement Plan Startup Credit
An employer that starts a qualified retirement plan can take a tax credit of up to $500 for the first 3 years of the plan to cover the costs of employee education and certain other administrative costs. This credit applies only if the company has no more than 100 employees with compensation over $5,000 in the preceding year.
5. S Corporations
These are entities organized under state law that offer owners personal liability protection. From a federal (and usually state) income tax basis, if the corporation makes an election, its profits and losses pass through to owners and are taxed on their personal returns. S corporations can have no more than 100 shareholders.
6. Savings Incentive Match Plans for Employees (SIMPLE) Plans
Self-employed individuals or businesses can use a type of retirement plan that limits employer contributions and avoids annual reporting. These plans, called SIMPLE IRAs, are available only for those with 100 or fewer employees who received at least $5,000 in compensation in the preceding year.
7. Simple Cafeteria Plans
Cafeteria plans allow employers to offer their staff a menu of employee benefits from which they can choose benefits or cash. These plans are deemed to meet nondiscrimination standards in the tax laws as long as they satisfy certain conditions. Simple cafeteria plans can be used only if a small business has 100 or fewer employees on business days during either of the 2 preceding years.
8. Small Employer Health Care Credit
To encourage small businesses to offer or continue health coverage for their staff, the tax law offers a 50 percent tax credit for company-paid premiums as long as certain conditions are met. This credit applies only if there are no more than 25 full-time equivalent employees (the full credit applies only for companies with up to 10 such employees). However, there are also caps on the wages that these employees can receive to make the company eligible for the credit.
9. Small Business Stock Breaks
The sale of qualified small business stock presents two opportunities: (1) deferral for gain if the proceeds of the sale are reinvested in other small business stock, or (2) an exclusion for some or all of the gain (depending upon the exclusion percentage, which is set by law, that is in effect when the stock is acquired). These breaks apply only to C corporation stock issued by a company with gross assets of no more than $50 million when the stock is issued and immediately thereafter.
10. UNICAP Small Reseller Exception
The uniform capitalization (UNICAP) rules are an accounting method that requires certain costs to be capitalized and recovered through depreciation rather than simply claiming a current deduction. However, “small” businesses are exempt from these rules. “Small” means having average annual gross receipts of no more than $10 million for a 3-year period.
Just because you qualify as a small business for one tax break, don’t assume you also qualify for other size-based deductions, credits, and other special tax rules exclusive to small businesses. Check eligibility. Ask your tax advisor.
Tax Break Photo via Shutterstock
I’m all for putting the burden of proof on the IRS. They have too much power and it often feels like guilty until proven innocent with them.
It’s nice to learn something about this. It is not like your accountant knows everything anyway. Learning it yourself is good because you can understand how things work.