Introduction
Small business owners are retailers, professionals, tradespeople, inventors, gig workers, techies, and more, and their businesses are everywhere…Main Street, farms, office buildings, homes, and anywhere else that a business can be found. Small businesses have been referred to as the backbone of the U.S. economy, accounting for 99.9% of all firms, employing 46.8% of the private sector workforce, and contributing 43.5% of the nation’s gross national product. And this has been accomplished despite the challenges of inflation, labor shortages, learning new technologies (including AI), dealing with regulations and red tape, and of course, taxes.
Small businesses fall under the purview of the Internal Revenue Service’s (IRS) Small Business and Self-Employed Division (SB/SE). This division services approximately 57 million tax filers, including 41 million self-employed individuals filing Schedules C, E, or F, as well as (3.8 million partnerships and 6.8 million corporations with assets of $10 million or less), and about 7 million filers of employment, excise, and certain other returns. The SB/SE division accounts for about 40% of the total federal tax revenues collected. The goal of this IRS division is help “small business/self-employed taxpayers understand and meet their tax obligations, while applying the tax law with integrity and fairness to all.”
As a small business owner, you work, try to grow your business, and hope to make a profit. What you can keep from that profit depends in part on the income tax you pay. The income tax applies to your net income rather than to your gross income or gross receipts. You are essentially taxed on what you keep after paying off the expenses of providing the services or making the sales that are the crux of your business. Deductions for these expenses operate to fix the amount of income that will be subject to tax. So deductions, in effect, help to determine the tax you pay and the profits you keep. And tax credits, the number of which has been expanded in recent years, can offset your tax to reduce the amount you ultimately pay.
Special Rules for Small Businesses
Sometimes it pays to be small. The tax laws contain a number of special rules exclusively for small businesses. But what is a small business? The average size of a small business in the United States is one with fewer than 20 employees with annual revenue under $2 million. Different government departments and agencies, as well as different industries, use their own definitions of “small business.” For federal tax purposes, the answer varies from rule to rule, as explained throughout this book. It may depend on your revenue, the number of employees, net worth, total assets (capital), or outlays/outputs. In Table I.1 are more than 3 dozen definitions from the Internal Revenue Code on what constitutes a small business in 2025 (and in 2026 where indicated). You may be a small business for some tax rules but not for others.
TABLE I.1 Examples of Tax Definitions of Small Business
| Accrual method exception for small businesses (Chapter 2) | Average annual gross receipts of no more than $31 million in the 3 prior years (or number of years in business, if less) |
| Archer medical savings accounts (Chapter 19) | Fewer than 50 employees |
| Automatic enrollment required for 401(k) plans—exemption (Chapter 16) | 10 or fewer employees and employers in existence for less than 3 years |
| Bad debts deducted on the nonaccrual-experience method (Chapter 11) | Average annual gross receipts for the 3 prior years of no more than $5 million |
| Building improvements safe harbor (Chapter 10) | Average annual gross receipts for the 3 prior years of no more than $10 million and building’s unadjusted basis no greater than $1 million |
| Centralized audit regime for partnerships–election out (Chapter 33) | 100 or fewer partners |
| Disabled access credit (Chapter 10) | Gross receipts of no more than $1 million in the preceding year or no more than 30 full-time employees |
| Employer mandate exemption from providing affordable health coverage | Fewer than 50 full-time/full-time equivalent employees |
| Estimated tax for C corporations based on prior year’s return (Chapter 30) | Taxable income of less than $1 million in any of the 3 preceding years |
| Employer differential wage payments credit (Chapter 7) | Fewer than 50 employees |
| Employer-provided child care credit-small business limit* (Chapter 23) | Average annual gross receipts of no more than $31 million for the 3 prior years (or number of years in business if less) |
| Energy credit for qualified small wind energy property | Property that uses a wind turbine of 100 kilowatts or less of rated capacity to generate electricity |
| Excise tax on importers and manufacturers—reduced rate for small businesses | Gross receipts in the previous year under $500,000 |
| Exemption from mandatory auto-enrollment in 401(k)s | 10 or fewer employees |
| First-year expensing election (Chapter 14) | Qualified property for 2025 of no more than $6.5 million |
| Golden parachute payments exemption (Chapter 7) | 100 or fewer shareholders |
| Gross receipts test | Average annual gross receipts of $31 million or less in the 3 prior years |
| Independent contractor versus employee determination—shifting burden of proof to IRS (Chapter 7) | Net worth of business does not exceed $7 million |
| Installment agreement (IBTF-Express IA) for payroll taxes (Chapter 35) | $25,000 or less owed |
| Interest deduction limit exemption (Chapter 13) | Average annual gross receipts of $31 million or less in the 3 prior years |
| Late filing penalty for failure to file information return—cap (Appendix B) | Average annual gross receipts of no more than $5 million for a 3-year period |
| Military spouse retirement plan eligibility credit (Chapter 16) | 100 or fewer employees |
| Ordinary loss on the sale of small business stock | Capital of $1 million or less at the time stock is issued |
| Penalties—reduced amount for information returns | Average annual gross receipts of $5 million or less in the 3 most recent years |
| Qualified small employer health reimbursement arrangement (Chapter 19) | Fewer than 50 full-time and full-time equivalent employees |
| Reasonable compensation—shifting the burden of proof to the IRS (Chapter 7) | Net worth of business not in excess of $7 million |
| Recovery of legal fees from the government | Net worth less than $5 million and fewer than 500 employees at the time the action is filed |
| Repair regulations—deduction under safe harbor for items up to $2,500 per item or invoice (Chapter 10) | No applicable financial statement (SEC filing; audited financial statement) |
| Repair regulations—safe harbor not to capitalize improvements to buildings (Chapter 10) | Average annual gross receipts under $10 million and building has unadjusted basis under $1 million |
| R&D expensing–retroactive to 2022 (Chapter 14) | Average annual gross receipts of $31 million or less in the 3 prior years |
| Research credit–offset to AMT(Chapter 23) | Businesses with average annual gross receipts in the 3 prior years of $50 million or less |
| Research credit—offset to employer’s Social Security and Medicare taxes (Chapter 23) | Corporation or partnership with gross receipts of no more than $5 million for current year and no gross receipts during the 5-year period ending with the current year (similar for sole proprietors) |
| Research credit—exemption from completing Section G of Form 6765 (Chapter 23) | Being a qualified small business (see Research credit—offset to employer’s Social Security and Medicare taxes below) or having total QREs no more than $1.5 million and gross receipts no more than $50 million |
| Retirement plan start-up and other plan-related credits (Chapter 16) | No more than 100 employees with compensation over $5,000 in the preceding year |
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