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Understanding Medicare Premiums and Taxes
Understanding Medicare Premiums and Taxes 850 500 smolinlupinco

Medicare health insurance premiums can be a significant expense—especially for high-income earners and married couples paying separately for coverage. Here’s what you need to know about how taxes factor in.

Medicare Part B: what it covers and who pays

Medicare Part B, often called Medicare medical insurance, helps cover doctors’ visits and outpatient services. Most people age 65 and older qualify, but it’s also available to some people with disabilities, ALS (known as Lou Gehrig’s disease), and end-stage renal disease. Unlike Medicare Part A, Part B plans require monthly premiums, which can add up.

Your monthly Part B premium is based on your modified adjusted gross income (MAGI) from two years prior (as reported on your Form 1040. MAGI is your adjusted gross income (AGI) plus any tax-exempt interest.

In 2025, most individuals will pay a base monthly premium of $185 per person for Part B coverage.

Higher-income individuals pay an additional surcharge on top of the standard premium. In 2025, this surcharge applies if your 2023 MAGI was over $106,000 as a single filer or over $212,000 for joint filers. You can find a breakdown of 2025 Part B premiums and their applicable surcharges here.

Part B premiums, including any surcharges, are automatically deducted from your Social Security benefit payments and appear on the annual Form SSA-1099 from the Social Security Administration (SSA).

Part D prescription drug coverage premiums

Medicare Part D provides private prescription drug coverage, with base premiums that vary by plan. Higher-income individuals are subject to an additional surcharge on top of the base premium.

For 2025, this surcharge applies if you:

  • Filed as an unmarried individual for 2023 with a MAGI above $106,000
  • Filed jointly for 2023 with a reported MAGI over $212,000.

You can find each covered person’s 2025 monthly Part D surcharges here.

You’ll pay the base Part D premium directly to your chosen private insurance provider. If you owe a surcharge, it will be deducted from your Social Security benefits and shown on your annual Form SSA-1099 from the SSA.

Deducting Medicare premiums

Medicare premiums can be combined with other eligible healthcare expenses to claim an itemized medical expense deduction. You can deduct the portion of total qualifying expenses that exceed 7.5% of your adjusted gross income (AGI).

Your 2024 tax return and 2026 Medicare premiums

The income reported on your 2024 Form 1040 will influence your 2024 MAGI, which will determine your 2026 Medicare premiums. If you’re self-employed or own a pass-through business (LLC, partnership, or S corporation), you have more flexibility to manage your MAGI through deductible retirement contributions or depreciation strategies.

Maximize savings on Medicare costs

Medicare premiums can add up quickly, and your 2024 tax decisions may directly impact what you pay in 2026. And, while 2026 may seem far off, smart planning now can help you avoid unexpected premium increases in the future.

Reach out to your Smolin advisor to discuss your options to minimize costs and optimize your financial situation.

Self-Employment Tax 101: What You Need to Know
Self-Employment Tax 101: What You Need to Know 850 500 smolinlupinco

If you own a growing, unincorporated small business, high self-employment (SE) tax bills might already be on your radar. The SE tax covers your contributions to Social Security and Medicare as a self-employed individual.

SE tax basics

The 15.3% SE tax rate applies to the first $168,600 of your 2024 net self-employment income. This rate includes 12.4% for Social Security and 2.9% for Medicare. In 2025, the rate will apply to the first $176,100 of your net income.

Beyond those thresholds, the 12.4% Social Security tax component of the SE tax drops off, but the 2.9% Medicare tax still applies to all income.

How high can your SE tax bill climb? Higher than you might think. The main driver is the 12.4% Social Security tax, because the Social Security tax ceiling increases every year.

To calculate your SE tax, start with your taxable self-employed income (usually from Schedule C of Form 1040) and multiply by 0.9235 to get your net SE income. For 2024, if your net SE income is $168,600 or less, multiply the amount by 15.3% to find your SE tax. If it’s more than $168,600, multiply $168,600 by 12.4% and the total by 2.9%, then add them together.

Example: If your net SE income for 2024 is $200,000, your SE tax bill will be $26,706 (12.4% × $168,600) + (2.9% × $200,000)., totaling $26,706. That’s a hefty tax bill!

Projected tax ceilings for 2026–2033

The current Social Security tax on your net SE income may seem steep, but it will likely get worse. As your business income grows, the Social Security tax ceiling will continue to rise with inflation.

Here are the latest projections from the Social Security Administration (SSA) for the tax ceilings from 2026–2033:

  • 2026 – $181,800
  • 2027 – $188,100
  • 2028 – $195,900
  • 2029 – $204,000
  • 2030 – $213,600
  • 2031 – $222,900
  • 2032 – $232,500
  • 2033 – $242,700

Could these projections be too low? Definitely. The SSA’s estimates often come in lower than the final numbers. For example, the 2025 ceiling was initially projected to be $174,900 but ended up at $176,100. But if the projected ceiling holds, by 2033, the SE tax on $242,700 of net SE income will be a whopping $37,133 (15.3% × $242,700).

Disconnect between tax ceiling and benefit increases

While it may seem logical that the Social Security tax ceiling would rise at the same rate as Social Security benefits, they don’t. For example, the 2024 Social Security tax ceiling is up 5.24% from 2023, but benefits for Social Security recipients increased by just 3.2%. Similarly, the 2025 Social Security tax ceiling will rise by 4.45%, but the benefits are only going up by 2.5%

This discrepancy is due to different inflation measures being used. The Social Security tax ceiling rises with average wage increases while benefits are adjusted based on general inflation.

S corporation strategy

While your SE tax bills are steep and likely to rise, there are ways to reduce them to more manageable levels. One strategy is to start running your business as an S corporation.

You could pay yourself a reasonable salary and distribute the remaining income as dividends. Only your salary would be subject to Social Security and Medicare taxes, potentially saving you money.

Reach out to your Smolin advisor to explore strategies for managing your SE tax.

How Defined-Value Gifts Can Strengthen Your Estate Plan
How Defined-Value Gifts Can Strengthen Your Estate Plan 850 500 smolinlupinco

The clock is ticking on the federal gift and estate tax exemption ($13.61 million for 2024). Unless Congress steps in, the amount will drop to an inflation-adjusted $5 million in 2026. Now’s the time to make impactful gifts to loved ones and shrink your taxable estate before the window closes.

Certain hard-to-value gifts, like interests in a closely held business or family limited partnership (FLP), can trigger IRS scrutiny. If the IRS determines that a gift was undervalued, you could face gift tax, interest, and penalties. To avoid such unexpected outcomes, consider making a defined-value gift instead.

Formula vs. savings clauses

A defined-value gift involves transferring assets valued at a set dollar amount, rather than a fixed number of stock shares, FLP units, or percentage of a business. When structured properly, defined-value gifts prevent future gift tax assessments.

The key is to draft the transfer document with a “formula” clause rather than a “savings” clause. A formula clause transfers a fixed dollar amount, adjusting the number of shares to match that amount based on a final valuation of the shares for federal gift and estate tax purposes. A savings clause, on the other hand, allows for part of the gift to be returned to the donor if it is later determined to be taxable.

Precise language matters

For a defined-value gift to be effective, they must have precise language in the transfer documents. In one case, the U.S. Tax Court rejected a defined-value gift of FLP interests, siding with the IRS’s gift tax assessment based on percentage interests. The issue was that the documents stated the transfer of FLP interests should be valued “as determined by a qualified appraiser” within a specific time after the transfer, which lacked clarity necessary for the gift to qualify as defined value.

The court ruled that the transfer documents did not meet the requirements of a defined-value gift because an appraiser determined the fair market value. The documents lacked provisions to adjust the number of FLP units if their value was ultimately determined to exceed the specified amount for federal gift tax purposes.

The bottom line: Before making a gift to a loved one, reach out to your Smolin advisor to ensure your gift’s transfer documents are properly worded to meet IRS requirements. We’re here to help!

A Guide to the Tax Implications of Intangible Assets
A Guide to the Tax Implications of Intangible Assets 850 500 smolinlupinco

Patents, trademarks, copyrights and goodwill, are vital intangible assets in modern businesses. While their tax treatment can be complex, businesses need to have an understanding of the issues involved.

Here are answers to some common questions about these assets.

What are intangible assets?

The term “intangibles” covers a wide range of items and determining whether an acquired or created asset qualifies as intangible isn’t always straightforward. Examples include debt instruments, prepaid expenses, non-functional currencies, financial derivatives (such as options, futures, and foreign currency contracts), leases, licenses, memberships, patents, copyrights, franchises, trademarks, trade names, goodwill, annuity contracts, insurance contracts, endowment agreements, customer lists, and ownership interests in entities like corporations, partnerships, LLCs, trusts and estates.

Other rights, assets, instruments and agreements may also fall under this category.

What are the expenses?

Expenses associated with acquiring or creating intangible assets that fall under capitalization rules include payments made for:

  • Obtaining, renewing, renegotiating or upgrading business or professional licenses
  • Modifying contract rights like lease agreements
  • Defending or securing title to intangible property like patents
  • Terminating agreements, including, leases of tangible property, exclusive licenses for your property, and certain non-competition agreements

According to IRS regulations, payments to “facilitate” the acquisition or creation of an intangible are those incurred in the process of investigating or pursuing a transaction. These facilitation rules apply broadly, impacting businesses and everyday transactions. Examples of facilitation costs include payments made to:

  • Legal counsel to draft and negotiate lease agreements
  • Attorneys, accountants, and appraisers to assess a corporation’s stock value during a minority shareholder buyout
  • Consultants to research competitors when preparing a contract bid
  • Legal counsel for preparing and filing trademark, copyright, and license applications.

Why are intangibles so complex?

The IRS requires businesses to capitalize costs that:

  • Acquire or create an intangible asset
  • Develop or enhance a separate and distinct intangible asset
  • Establish or enhance a “future benefit” identified as capitalizable under IRS guidelines
  • Facilitate the acquisition or creation of an intangible asset

Capitalized costs can’t be deducted in the year they were paid or incurred. If they are deductible, they must spread out over the asset’s lifespan or over a time period specified by the tax code. However, costs under $5,000 and those paid to create or facilitate the creation of a right or benefit that expires within 12 months or by the end of the following tax year do not require capitalization.

Are there any exceptions to the rules?

Yes, there are exceptions. Taxpayers can choose to capitalize items that aren’t typically required to be capitalized. The lists of examples provided above are not exhaustive.

Due to  the complexity of the regulations, it’s important to scrutinize transactions involving intangibles and the related costs to understand the full tax implications.

Need support with intangible assets?

For businesses to take full advantage of potential tax benefits and stay compliant with regulations, the tax treatment of these intangible assets need to be properly managed. Contact your Smolin advisor to discuss the capitalization rules and determine if costs you’ve incurred need to be capitalized. We can also help identify potential transactions your business has engaged in that might trigger these rules to keep your business compliant.

Is a C Corporation the Right Choice for Your Business?
Is a C Corporation the Right Choice for Your Business? 850 500 smolinlupinco

Choosing the right business structure is a pivotal decision, and a C corporation is one option that comes with its own set of advantages and disadvantages. This structure can have a notable impact on how your business operates and its financial health.

Let’s break down the key benefits and drawbacks of operating as a C corporation.

Tax implications

A C corporation is treated as a separate legal entity, which is taxed separately from you as the principal owner. With a corporate tax rate currently set at 21%, this can be lower than the top individual tax rate of 37%.

However, one of the notable drawbacks of a C corporation is the potential for double taxation. Profits are taxed first at the corporate level, and then dividends distributed to shareholders are taxed again at the individual level. This structure can result in a higher overall tax burden compared to other business entities.

But, if most of the corporate earnings are tied to your role as an employee, the impact of double taxation may be reduced since the corporation can fully deduct any reasonable salary it pays you.

Since a C corporation is taxed as a separate entity, all income, credits, losses, and deductions are calculated at the corporate level to determine taxable income or loss. One potential downside for a new business is that losses are confined to the corporation and generally cannot be deducted by the owners. However, if you anticipate turning a profit in the first year, this might not be an issue.

Liability protection

One key advantage of a C corporation is the limited liability protection it provides. Shareholders are not personally responsible for the corporation’s debts or liabilities, meaning their personal assets are typically shielded if the business encounters legal troubles or bankruptcy.

Complying with requirements

To maintain a corporation’s status as a separate entity, it’s important to follow certain formalities as set by your state, including:

  • Filing articles of incorporation
  • Adopting bylaws
  • Electing a board of directors
  • Holding organizational meetings
  • Keeping minutes of meetings

Adhering to these requirements and maintaining a solid capital structure will help protect you from unintentionally assuming personal liability for the corporation’s debts.

Fringe benefits

A C corporation can also offer fringe benefits and fund qualified pension plans with tax advantages. The corporation can deduct the costs of benefits like health insurance and group life insurance, within certain limits, without triggering negative tax consequences for you. Similarly, contributions to qualified pension plans are typically deductible by the corporation but are not taxed to you at the time of contribution.

Raising capital

A C corporation offers significant flexibility in raising capital from outside investors. It can issue multiple classes of stock, each with distinct rights and preferences, tailored to meet your needs and those of potential investors. Also, if you choose to raise capital through debt, the interest paid by the corporation is deductible.

The right fit

While a C corporation might be the right structure for your business now,  you can opt to convert it to an S corporation if that better suits your needs. This change is typically tax-free, but any built-in gains on the corporate assets could be taxed if the assets are sold within 10 years of the change.

This is a high-level overview of the benefits and drawbacks of a C corporation. Contact your Smolin advisor with specific questions or to explore which business entity is best for you.

Secure Your Business Partnership with a Buy-Sell Agreement
Secure Your Business Partnership with a Buy-Sell Agreement 150 150 smolinlupinco

Buying a business with co-owners or already sharing the reins? A buy-sell agreement isn’t just a smart move–it’s essential. It gives you a more flexible ownership stake, prevents unwanted changes in ownership, and avoids potential IRS complications. 

The basics

There are two main types of buy-sell agreements: cross-purchase and redemption agreements (also known as liquidation agreements).

  • Cross-purchase agreements. This contract between co-owners specifies what happens if one co-owner leaves due to a trigger event, like death or disability. In these cases, the remaining co-owners are required to purchase the departing owner’s interest in the business.
  • Redemption agreements. This is a contract between the business and co-owners which outlines that if one co-owner leaves, the business itself buys their stake.

Triggering events

Co-owners work together to outline what triggering events to include in the buy-sell agreement. Common triggers like death, disability, or reaching retirement age are standard but you can also opt to include other scenarios like divorce.

Valuation and payment terms

Make sure your agreement includes a solid method for valuing ownership stakes. This could be a set price per share, an appraised fair market value, or a formula based on earnings or cash flow. It should also spell out how amounts will be paid out–whether a lump sum or installments–to withdrawing co-owners or their heirs upon a triggering event.

Using life insurance to fund the agreement

The death of a co-owner is a common triggering event, and life insurance is often used to fund buy-sell agreements. 

In a basic cross-purchase agreement between two co-owners, each buys a life insurance policy on the other. If one co-owner dies, the survivor uses the payout to buy the deceased co-owner’s share from the estate, surviving spouse or another heir (s). These insurance proceeds are tax-free as long as the surviving co-owner is the original purchaser of the policy.

Things get complicated when there are more than two co-owners because each co-owner must have life insurance policies on all the other co-owners. In this scenario, the best decision is often to use a trust or partnership to buy and maintain one policy on each co-owner. 

That way, if a co-owner dies, the trust or partnership collects the death benefit tax-free and distributes it to the remaining owners to fund the buyout.

In a redemption agreement, the business buys policies on the co-owners and uses the proceeds to buy out the deceased’s share.

Be sure to specify in your agreement what to do if insurance money does not cover the cost of buying out a co-owner. By clearly outlining that co-owners are allowed to buy out the rest over time, you can ensure some breathing room to come up with the needed cash instead of having to fulfill your buyout obligation right away.

Create certainty for heirs 

If you’re like many business owners, your business is likely a big chunk of your estate’s value. A buy-sell agreement ensures that your heirs can sell your share under the terms you approved. It also locks in the price for estate tax purposes, helping you avoid IRS scrutiny. 

A well-drafted buy-sell agreement protects you, your heirs, your co-owners, and their families. But remember, buy-sell agreements can be tricky to handle on your own.

Reach out to your Smolin advisor to set up a robust agreement that protects the interests of everyone involved.

Your Need-to-Know Tax Guide for Inherited IRAs
Your Need-to-Know Tax Guide for Inherited IRAs 850 500 smolinlupinco

A 2019 change to tax law ended the “stretch IRAs” strategy for most inherited IRAs. This means that beneficiaries now have 10 years to withdraw all of the funds. Since then, there’s been a lot of confusion about required minimum distributions (RMDs).

Thankfully, the IRS has now issued final regulations clarifying the “10-year rule” for inherited IRAs and defined contribution plans, like 401(k)s. In a nutshell, the final regulations largely align with proposed rules released in 2022.

The SECURE Act and 10-Year Rule

Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, most heirs except surviving spouses must withdraw the entire balance within 10 years of the original account owner’s death. In 2022, the IRS proposed regulations to clarify the rule. It outlines that beneficiaries must take their taxable RMDs over the course of the 10-year period after the account owner dies. 

They are not permitted to wait until the end of 10 years to take a lump-sum distribution. This annual RMD requirement significantly limits beneficiaries’ tax planning flexibility and, depending on their situations, could push them into higher tax brackets during those years.

Confused beneficiaries reached out to the IRS trying to determine when they needed to start taking RMDs on recently inherited accounts. The uncertainty posed risks for both beneficiaries and the defined contribution plans. 

This is because beneficiaries could have been assessed a tax penalty on amounts that should have been distributed but weren’t. And the plans could have been disqualified for non-compliance.

In response, the IRS waived penalties for taxpayers subject to the 10-year rule who missed 2021 and 2022 RMDs due to the death of the account owner in 2020 or 2021, respectively. 

The waiver guidance also stated that the IRS would issue final regulations no earlier than 2023. When 2023 rolled around, the IRS extended the waiver relief to excuse 2023 missed RMDs if the participant died in 2020, 2021 or 2022.

As of April 2024, the IRS again extended the relief, this time for RMDs in 2024. If certain requirements are met, beneficiaries won’t be assessed a penalty on missed RMDs for these years, and plans will be safe from disqualification based solely on the missed RMDs.

2024 final regulations

The final regulations require certain beneficiaries to take annual RMDs from inherited IRAs or defined contribution plans within ten years following the account owner’s death. These regulations will take effect in 2025.

If the deceased hadn’t begun taking their RMDs before their death, beneficiaries have more flexibility. They can take annual RMDS or wait until the end of the 10-year period and take a lump-sum distribution. Ultimately, the IRS eliminated the requirement to take annual distribution, allowing beneficiaries greater tax planning flexibility. 

For instance, if Ken inherited an IRA in 2021 from his father, who had already begun taking RMDs, under the IRS-issued waivers, Ken doesn’t need to take RMDs for 2022 through 2024. Under the final regulations, he must take annual RMDs for 2025 to 2030, with the account fully distributed by the end of 2031.

If Ken’s father had not started taking RMDs, Ken could have waited until the end of 2031 to take a lump-sum distribution. As long as the account is fully liquidated by the end of 2031, Ken remains in compliance with the rules.

Contact us with questions

If you’ve inherited an IRA or defined contribution plan in 2020 or later, it’s understandable to feel confused about the RMD rules. Reach out to your Smolin advisor for help understanding these regulations and developing a personalized tax-saving strategy.

Tax Implications of Disability Income
Tax Implications of Disability Income 850 500 smolinlupinco

If you are one of the many Americans who rely on disability benefits, you might be wondering how that income is taxed. The short answer is it depends on the type of disability income you receive and your overall earnings.

Taxable Disability Income

The key factor is who paid for the benefit. When the income is paid to you directly from your employer, it’s taxable like your ordinary salary and subject to federal income tax withholding. Depending on your employer’s disability plan, Social Security taxes may not apply. 

Often, disability income isn’t paid by your employer but rather from an insurance policy that provides the disability coverage. Depending on whether the insurance is paid for by you or by your employer, the tax treatment varies. If your employer paid, the income is taxed the same as if it was paid directly to you by the employer as above. But if you paid for the policy, payments received are usually tax-free.

Even if the insurance is offered through your employer, as long as you pay the premiums instead of them, the benefits are not taxed. However, if your employer pays the premiums and includes that amount as part of your taxable income, your benefits may also be taxable. Ultimately, tax treatment of benefits received depends on tax treatment of paid premiums.

Illustrative example

Scenario 1: 

If your salary is $1,050 a week ($54,600 a year) and your employer pays $15 a week ($780 annually) for disability insurance premiums, your annual taxable income would be $55,380. This total includes your salary of $54,600 plus $780 in disability insurance premiums. 

The insurance premiums are considered paid by you so any disability benefits received under that policy are tax-free.

Scenario 2:

If the disability insurance premiums are paid for by your employer and not included in your annual wages of $54,600, the amount paid is excludable under the rules for employer-provided health and accident plans.

The insurance premiums are considered paid for by your employer and any benefits you receive under the policy, are taxable income as ordinary income.

If there is permanent loss of a body part or function, special tax rules apply. In such cases, employer-paid disability might be tax-free, as long as they aren’t based on time lost from work.

Social Security disability benefits 

Social Security Disability Insurance (SSDI) benefits have their own tax rules. Payments are generally not subject to tax as long as your annual income falls under a certain threshold. 

For individuals if your annual income exceeds $25,000, a portion of your SSDI benefits are taxable. The threshold for married couples is $32,000. 

State Tax Implications

Though federal law treats disability payments as taxable income as outlined above, state tax laws vary. It’s wise to seek out professional support to determine if disability payments are taxed or exempt in your state. 

As you determine your disability coverage needs, remember to consider the tax implications. If you purchase a private policy yourself, the benefits are generally tax free since you are using your after-tax dollars to pay the premium. 

On the other hand, if your employer pays for the benefit, you will lose a portion of the benefits to taxes. Plan ahead and look at all your options. If you think your current coverage will be insufficient to support you should the unthinkable happen, you might consider supplementing any employer benefits with an individual.

Reach out to your Smolin advisor to discuss your disability coverage and how drawing benefits might impact your personal tax situation.

Understanding Taxes on Real Estate Gains
Understanding Taxes on Real Estate Gains 850 500 smolinlupinco

If you own real estate held for over a year and sell it for a profit, you typically face capital gains tax. This applies even to indirect ownership passed through entities like LLCs, partnerships, or S corporations. You can expect to pay the standard 15% or 20% federal income tax rate for long-term capital gains.

Some real estate gains can be taxed at even higher rates due to depreciation deductions. Here are some potential federal income tax implications of these gains.

Vacant land

Specifically for high earners, the current maximum federal long-term capital gain tax on vacant land is 20%. For 2024, the 20% rate kicks in for 

  • Single filers with taxable income exceeding $518,900
  • Married joint-filing couples with taxable income exceeding $583,750
  • Head of household with taxable income exceeding $551,350. 

If your income is below these thresholds, you’ll only owe 15% federal tax on vacant land gains. Remember that you may also owe the 3.8% net investment income tax (NIIT) on some or all of the gain.

Gains from depreciation

Depreciation-related gains from real estate, also known as unrecaptured Section 1250 gains, are generally taxed at a flat 25% federal rate. However, if the gain would be taxed at a lower rate without this special treatment, this 25% rate does not apply. However, you could owe the 3.8% NIIT on some or all of the unrecaptured Section 1250 gain.

Gains from qualified improvement property

Qualified improvement property or QIP, refers to improvements to the interior of nonresidential buildings after being placed in service. QIP excludes enlargements such as elevators, escalators, and structural changes.

You can claim tax deductions for QIP through Section 179 deductions or bonus depreciation. When you sell QIP for which you’ve claimed Section 179 deductions, part of the gain may be taxed as ordinary income at your regular tax rate rather than the lower long-term capital gains rate. This is known as Section 1245 recapture. You may also owe the 3.8% NIIT on this portion of the gain.

If you sell QIP for which first-year bonus depreciation has been claimed, part of the gain might be taxed as ordinary income at your regular tax rate via Section 1250 recapture, rather than lower long-term gain rates. This applies to the portion of the gain that exceeds the depreciation calculated using the applicable straight-line method. Again, you may still owe the 3.8% NIIT on some or all of the recapture gain.

Tax planning point: Choosing straight-line depreciation for real property, including QIP, there won’t be any Section 1245 or Section 1250 recapture. You will only have unrecaptured Section 1250 gain from the depreciation taxed at a federal rate below 25%. The 3.8% NIIT on all or part of the gain may still apply.

Handling the complexities

The federal income tax rules for real estate gains are obviously very complex. There’s a lot to consider: different tax rates applied to different categories of gain, the possibility of owing the 3.8% NIIT, and potential state income tax. 

Our team of skilled tax advisors can help you understand the intricacies and minimize the tax liability of capital gains. Contact a Smolin advisor to discuss your specific situation.

Cash or Accrual Accounting: Which is Right for Your Business?
Cash or Accrual Accounting: Which is Right for Your Business? 850 500 smolinlupinco

Your business can choose between cash or accrual accounting for tax purposes. While the cash method can provide certain tax advantages to those that qualify, the accrual method might be a better fit for some businesses. 

To maximize tax savings, you need to weigh both methods before deciding on one for your business. 

Small business tax benefits

Small businesses, as defined by the tax code, generally enjoy the flexibility of using either cash or accrual accounting. Various hybrid approaches are also allowed for some businesses. 

Before the Tax Cuts and Jobs Act (TCJA), the gross receipts threshold to classify as a small business was $1 million to $10 million depending on factors like business structure, industry, and if inventory significantly contributed to business income.

The TCJA established a single gross receipts threshold and increased it to $25 million (adjusted for inflation), expanding small business status benefits to more companies. In 2024, a small business is defined as having average gross receipts of less than $30 million for the preceding three-year period, up from $29 million in 2023.

Small businesses also benefit from simplified inventory accounting and exemptions from the uniform capitalization rules and business interest deduction limit.  S corporations, partnerships without C corporation partners, and farming businesses and certain personal service corporations may still use the cash accounting method, regardless of their gross receipts. 

Regardless of size though, tax shelters are ineligible for the cash accounting.

Potential advantages

Since cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid, they have more control over their tax liability. This includes deferring income by delaying invoices or shifting deductions forward by accelerating expense payments.

Accrual-basis businesses, on the other hand, recognize income when earned and expenses are deducted as they’re incurred, regardless of cash flow. This limits their flexibility to time income and deductions for tax purposes.

The cash method can improve cash flow since income is taxed in the year it’s received. This helps businesses make their tax payment using incoming funds. 

If a company’s accrued income is lower than accrued expenses though, the accrual method can actually result in a lower tax liability than the cash method. The accrual method also allows for a business to deduct year-end bonuses paid in the first 2½ months of the following tax year and tax deferral on some advance payments.

Considerations when switching methods

If you’re considering a switch from one method to the other, it’s important to consider the administrative costs involved. If your business follows the U.S. Generally Accepted Accounting Principles (GAAP), you’ll need to maintain separate books for financial and tax reporting purposes. You may also be required to get IRS approval before changing accounting methods for tax purposes. 

Reach out to your Smolin advisor to learn which method is best for your business.

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