Tax planning for business owners and executives for 2024

Agility is king. The economic environment has brought nearly unprecedented volatility in recent years. COVID-19 upended long-standing business practices, but also created new investment opportunities.

Now several years out, macroeconomic factors, such as persistent inflation and high interest rates, can affect investment and tax planning strategies. The rapid changes to the tax and regulatory landscape only make tax planning more difficult.

As a business owner or executive, it’s critical you adjust your planning as conditions evolve. As income increases, so can your tax burden. Planning decisions become even more important for your long-term investments and your ability to pass your wealth on to the next generation. As 2023 closes and a new year begins, it’s the perfect time to revisit your tax situation. Tax planning means acting well before your return is due.

In this guide we’ll highlight some of the key tax considerations for business owners and executives in the current environment, including:

• The impact and planning options for the SALT cap
  
• Tax-efficient ways to leverage retirement incentives
• How to manage increasing IRS scrutiny on charitable giving
• The evolving rules for employment and investment taxes
• The impact of the alternative minimum tax
• New tax savings opportunities
• Strategies for passing wealth along to heirs
• Your compliance and reporting responsibilities

We’ll also cover key things you should consider doing before the year ends on Dec. 31, including:

• Making any required minimum distributions from retirement accounts
  
• Using your annual gift tax exclusion
• Making all necessary withholding or estimated tax payments (individual fourth-quarter payments are due Jan. 15, 2024)

Remember, tax law changes are always possible after this guide is published, and there are many tax considerations not covered. You should check for the most up-to-date tax rules and regulations before making any tax decisions. Contact your local Grant Thornton LLP professional to discuss your situation or for an update on tax legislation. 

The basics

Your tax planning should start with understanding the basic rules for income tax rates and deductions. Some of the simplest strategies about when you recognize income and deductions can profoundly affect when and how much you pay.

First, your rates. Different types of income are taxed differently. The biggest chunk of your income is likely ordinary income. It includes items like salary and bonuses, self-employment and pass-through business income and retirement plan distributions. Most types of investment income—like rents, royalties and interest—are also taxed as ordinary income. Two kinds of investment income are subject to special lower rates: qualified dividends and long-term capital gains from assets held more than one year.

The top rate on ordinary income is 37%, while the top rate on long-term capital gains and qualifying dividends is 20%, not including employment taxes and taxes on net investment income, discussed later. The Tax Cuts and Jobs Act repealed or limited many itemized deductions, but there are still many exclusions and deductions that benefit individual taxpayers. We’ve included a table with the 2023 and 2024 figures for many important tax rules and benefits.  

Deferring tax can be a powerful strategy, particularly with high inflation. With the time value of money, postponing a tax bill can help you generate a return that blunts the impact. The idea is to delay recognizing income while accelerating deductions. There are many items for which you may be able to control timing.

• Income
  • Consulting income
  • Self-employment income
  • Real estate sales
  • Gain on stock sales
  • Other property sales
  • Retirement plan distributions
• Expenses
  • Losses on sales of stock and other investment property
  • Mortgage interest
  • Margin interest
  • Charitable contributions

But be careful, certain circumstances may affect your strategy. You may want to delay an itemized deduction to bunch it with future expenses, or your tax planning may be affected by the AMT. There are also limits on deducting prepaid expenses. You will likely benefit from multiyear tax planning. Special consideration should be given to state taxes and charitable giving because of the limit on state tax deductions and the IRS scrutiny of charitable deductions.

SALT deductions

The $10,000 cap on the individual state and local tax deduction can be painful for successful business owners and executives, particularly in years with transactions that can generate significant gain.

Owners of pass-through entities have a unique opportunity to obtain relief from the cap with the help of the business entity. To date, 36 states and one locality have enacted regimes that allow pass-through businesses to deduct SALT taxes at the entity level in exchange for a credit or exemption from state tax on the pass-through income of owners. This allows a partnership or S corporation to fully deduct state tax against entity level business income, rather than having owners pay tax themselves and take a limited SALT deduction at the individual level. It can be especially powerful in years where there is a transaction that causes significant state tax on capital gain.

The explosion in state pass-through entity (PTE) tax regimes over the last two years came partly in response to IRS guidance (Notice 2020-75) confirming the viability of the entity-level deductions. Although these regimes can offer significant benefits to owners, there are potential drawbacks. Whether electing into a PTE tax ultimately makes sense is a complex determination that depends on a variety of factors that involve both federal income tax rules as well as state tax rules.

The lack of uniformity among state laws presents particular challenges. State rules vary on when taxpayers can make an election to shift tax to the entity level. The timing of an entity-level deduction may depend both on when the election is made and when the entity makes payments for the tax. State laws also vary (and are not always clear) on whether PTE taxes paid in one state are creditable against other PTE regimes or personal income tax liability in other states.

It’s also important to understand that PTE tax elections may benefit certain owners more than others, particularly for partnerships operating across many states or with partners residing in different states. Partnerships should weigh the burdens of paying the entity-level tax against the benefits of passing the entity-level deduction to partners, and also consider whether the partnership agreement will permit any necessary adjustments to allocations or distributions. States are still updating their laws to address technical considerations. You should carefully analyze the most current state laws and fully assess the potential implications. 

Charitable deductions

Charity is good for more than just the soul. It also comes with valuable tax benefits, and those benefits can be leveraged with intentional planning. It’s important to understand key limits on charitable deductions. Taxpayers should also be aware that the IRS is stepping up its scrutiny of this area.  

Limits

Charitable deductions are generally limited to a percentage of adjusted gross income, with any excess carried over for the next five years. The percentage limitation can be quite complex, and depends both on whether the gift is cash or property and the type of charitable organization that receives the gift. The table below illustrates the general (adjusted gross income) AGI limits by donation and the type of charity.

Outright gifts of cash (which include gifts made by check, credit card or payroll deductions) are the easiest. Yet despite the simplicity and higher AGI limits for outright cash gifts, gifts of property may be more beneficial. It’s a little more complicated to make them, but they often provide more tax benefits when planned properly. Your deduction depends in part on the type of property donated: long-term capital gains property, ordinary income property or tangible personal property. Your deduction could also depend on what the charity plans to do with the donated property. 

Ordinary income property includes items such as stock held for less than one year, inventory and property subject to depreciation recapture. You can receive a deduction equal to only the lesser of fair market value or your tax basis.

Long-term capital gains property includes stocks and other securities you’ve held more than one year. It’s one of the best charitable gifts because you can take a charitable deduction equal to its current fair market value without recognizing the gain on the property. Keep in mind that it may be better to elect to deduct the basis rather than the fair market value, because the AGI limitation will be higher. Whether this is beneficial will depend on your AGI and the likelihood of using — within the next five years — the carryover you would have if you deducted the fair market value and the 30% limit applied.  

Individuals over age 70½ can make distributions from an IRA of up to $100,000 to certain charitable organizations without including the distribution on gross income, which may provide a better tax result than a charitable deduction. See the discussion under the “required distributions” section later in the guide. 

Documentation

The IRS is concerned that the value of noncash gifts is being overstated, and this area is the focus of significant scrutiny.

Taxpayers are required to obtain written substantiation of the contribution with a contemporaneous written acknowledgment from the charitable organization. This requirement applies to cash gifts of over $250 and non-cash contributions of over $500.  There are specific items that must be included in the acknowledgement from the charity, a description of the property contributed, a description and good faith estimate of the value of any goods or services with more than an insubstantial value received in exchange for the contribution, and if the donee provides intangible religious benefits, a statement that it provides such benefits. The IRS has successfully disallowed sizeable charitable deductions when the taxpayer has not received the proper acknowledgement in a timely fashion.

A qualified appraisal is required for noncash contributions of over $5,000. This issue is especially troublesome when the property given to charity is art or an interest in real property.  This type of property can be hard to value, with disagreement possible even among appraisers. You should ensure that any appraiser selected for a valuation has the requisite experience in the specific type of property being appraised. Charitable gifts have been disallowed or limited for gifts without a proper valuation.  

There are some exceptions to the appraisal requirement.  The most important exception is for donations of publicly traded securities. Importantly, many digital assets are not considered traded on a public exchange. Since the assets are not considered cash either, they are generally subject to the appraisal requirement.    

The IRS is also strictly enforcing procedural filing requirements, so mistakes can be costly. The IRS requires all forms to be complete and accurate and filed on time. If any section of the form is not complete, the entire charitable deduction may be disallowed. 

There are several other key rules to keep mind:

• If you contribute your services to charity, you can deduct only your out-of-pocket expenses, not the fair market value of your services.
• You receive no deduction by donating the use of property, such as the use of a vacation property donated to a charity for an auction.
• If you drive for charitable purposes, you can deduct 14 cents for each charitable mile driven.
• Giving a car to charity results only in a deduction equal to what the charity receives when it sells the vehicle unless it is used by the charity in its tax-exempt function.

If you donate clothing or household goods, they must be in at least “good used condition” to be deductible.

Alternative minimum tax

The AMT is one of the most frustrating surprises hiding in the tax code. Just when you think you’ve figured out your taxes, you’re forced to run everything through a completely different set of calculations. The AMT is essentially a separate tax system with its own rules. The alternative minimum tax (AMT) applies to taxpayers with high economic income by setting a limit on certain tax benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax. Each year you must calculate your tax liability under the regular income tax system and the separate AMT system and pay the higher amount.

The good news is the AMT affects far fewer taxpayers than it used to thanks to the increased exemption enacted as part of the Tax Cuts and Jobs Act in 2017, as well as limits on deductions that used to be triggers for AMT, like state taxes. The bad news is that there are still millions of taxpayers affected.

The AMT has a lower top rate than the regular income tax system, with just two tax brackets of 26% and 28%, but many deductions and credits aren’t allowed against the it. Taxpayers with incomes well in excess of the exemption and with substantial deductions, or benefits that are reduced or not allowed under the AMT are the ones stuck paying it.

It’s critical to know whether you’ll be subject to the AMT before your tax return is due. You need to know if you’ll benefit from certain tax incentives before making business and investment decisions that hinge on the tax treatment. Common AMT triggers include the following:

• Investment advisory fees
  
• Incentive stock options
• Interest on a home equity loan not used to build or improve your residence
• Tax-exempt interest on certain private activity bonds
• Accelerated depreciation adjustments and related gain or loss differences on disposition

AMT planning

There are ways to mitigate or even benefit from the AMT by leveraging its low top rate. You just need to plan. Multi-year tax planning can help you accelerate income into years when you are subject to the lower AMT rates and postpone deductions into years when you can use them against the higher regular tax rates.

Long-term capital gains and qualified dividends deserve special consideration for the AMT. They are taxed at the same 15% and 20% rates under either the AMT or regular tax structure, but the additional income they generate can reduce your AMT exemption and result in an effective rate of 20.5% instead of the normal 15% (or 25.5% for capital gains in the 20% bracket). You should consider the AMT as part of your tax analysis before selling any asset that could generate a large gain.

Employment and investment taxes

Your tax planning must go beyond income taxes, particularly for certain types of business and investment income. This means looking at employment taxes and the net investment income tax.

Earned income

The taxes on earned income that are used to fund Social Security and Medicare are called employment taxes because they apply to salaries, wages and bonuses. The Social Security tax on earned income is capped ($160,200 in 2023 and $168,600 in 2024), but the Medicare tax has no limit. Both employees and employers pay Medicare tax at a 1.45% rate until earned income reaches $200,000 (single) or $250,000 (joint), and then the employee rate share increases to 2.35% for a total rate of 3.8%.

The business income from sole proprietors and partners is generally self-employment income with some key exceptions, meaning self-employment tax is due on both the employee and employer share of the Medicare tax. You can take an above-the-line deduction for the employer portion of self-employment tax.

Investment income

The tax on net investment income (NII) is designed to impose an equivalent 3.8% on investment income. The tax applies to NII to the extent AGI exceeds $200,000 (single) or $250,000 (joint). NII includes rent, royalties, interest, dividends and annuities. There is an exception if the income is derived in the ordinary course of a trade or business in which you are not passive. On the other hand, all income from businesses in which you are passive is regarded as NII regardless of the type of income. In addition, income from trading in financial instruments is always NII.

Business owners

It’s important to consider the employment taxes and NII together, particularly for business owners. If you have to pay employment or self-employment tax on a stream of income, it is not included in NII. You never have to pay both taxes on the same income. Self-employment tax provides a better result because of the deduction for the employer share of tax. There may be limited situations in which neither tax will apply.

Owners of S corporations who are not passive in the business must take a reasonable salary and pay employment tax on wages, but they otherwise may not face self-employment tax or NII on their pro rata share of income of the S corporation.

The treatment of partners for self-employment taxes is more complex and is one to which the IRS is giving increased scrutiny (e.g., the IRS has launched an audit campaign). The issue revolves around an exception from self-employment tax under Section 1402(a)(13) for the distributive share of partnership income of a “limited partner.” Partners can potentially avoid self-employment tax on their distributive share of partnership income if they can establish they are limited partners. But for this position to benefit the partners, they would also need to exclude the income from the NII tax by being active in the business.

Since the Tax Court ruled in favor of the IRS in Renkemeyer, Campbell, & Weaver, LLP v. Commissioner (136 T.C. 137) in 2011, it has become much more difficult for taxpayers to argue that they are both limited partners in a partnership while also being active enough in the business to avoid passive treatment. The Tax Court analysis established in Renkemeyer looks less at legal liability and more at whether activities the partner engages in are consistent with the general concept of a “limited partner.” The Tax Court has applied this analysis to LLCs and other entities organized as a partnerships, but several cases in litigation would address entities that are established as limited partnerships under local law.

The IRS is actively litigating the issue whether a person who is a limited partner under a state law limited partnership statute qualifies for the limited partner exception to SECA with regard to the partner’s distributive share of partnership income. The treatment of income for employment and investment tax purposes for limited partners may hinge on the outcome of three cases in the Tax Court involving investment management funds—Denham Capital Management LP v. Commissioner, Point72 Asset Management LP v. Commissioner, both pending, and Soroban Capital Partners LP v. Commissioner, in which the Tax Court issued its first opinion (responding to motions for summary judgement) in late November 2023.

The recent opinion in Soroban is noteworthy for the Tax Court’s rejection of the taxpayer’s argument that under the plain meaning of the statute, limited partners of state law limited partnerships are not subject to SECA tax on their distributive share allocations of income as a matter of law. The Tax Court denied Soroban’s motion for summary judgment and held that the determination of eligibility for the limited partner exception requires a “functional analysis test to determine whether a partner in a state law limited partnership is a ‘limited partner, as such." The Soroban decision did not address what a functional analysis would include or provide details on how it might be applied. Depending on the procedural route that the parties take, the court’s final resolution in Soroban might provide much needed insight as to how to apply a functional analysis to a taxpayer’s particular facts.

The IRS has signaled that it is actively considering regulations to address the issue. It originally proposed regulations in 1997, but never finalized them after they were heavily criticized, and Congress enacted a one-year moratorium on their finalization. In the last couple of years, the IRS had seemed to place the limited partner exception as a lower priority in its guidance projects, but in the fall of 2023, indicated that it was making the topic a priority guidance item. Ultimately, under judicial and administrative authorities, it may be very difficult to have a position that escapes both self-employment tax and NII at the same time. In addition, Democrats have proposed legislation that would generally close the gap between self-employment tax and NII tax, though it is not likely to be enacted in the near-term.

Retirement incentives

Retirement planning as a successful business owner or executive is often less about retirement and more about leveraging some of the best incentives the tax code has to offer. Several recent legislative changes have made retirement tax rules even more generous. Anyone with a substantial portfolio should be carefully assessing where investments are held in order to take advantage of the significant savings offered by tax-preferred retirement vehicles.

Employer accounts

Employer-sponsored defined contribution accounts like Section 401(k) plans have several advantages over IRAs, which are generally maintained by an individual. For one, many employers offer matching contributions, and there are no income limits for contributing. The tax benefits of these accounts in the traditional versions are twofold: Contributions generally reduce your current taxable income, and assets in the accounts grow tax-deferred — meaning you will pay no income tax until you receive distributions. Contributing the maximum amount allowed ($22,500 in 2023 and $23,000 in 2024) is usually a smart move. That also means making full catch-up contributions when you reach age 50.

The limit on catch-up contributions for qualified retirement plans reached $7,500 in 2023, and under recent legislation, taxpayers aged 60 to 63 will benefit from an increased limit beginning in 2025. But there’s a catch. Taxpayers with wages exceeding $145,000 will eventually be required to make all catch-up contributions on a Roth basis. This provision was originally scheduled to take effect in 2024, but the IRS delayed it until 2026.

IRAs

Individual IRAs have some limits that can make them harder for high-income taxpayers to use. Contributions to traditional IRAs aren’t deductible above certain income thresholds if you’re offered a retirement plan through your employer. The good news is that recent legislation repealed the 70½-year age cap on contributing to an IRA. The age for required minimum distributions has also increased, discussed more later.

IRAs have other advantages. You have more flexibility over how you invest and you can even self-direct an IRA. If you’re above the deductibility threshold, you can also consider making nondeductible contributions and then rolling over into a Roth version.

Roth accounts

Both qualified retirement plans and IRAs offer Roth versions. The tax benefits of Roth accounts differ slightly from those of traditional accounts. Roth accounts allow for tax-free growth and tax-free distributions, but contributions are neither pretax nor deductible.

The difference is in when you pay the tax. With a traditional retirement account, you get a tax break on the contributions: You pay taxes only on the back end when you withdraw your money. For a Roth account, you get no tax break on the contributions up front, but you never pay tax again if distributions are made properly.

There is an income limit for making Roth contributions to an IRA, but you can manage the issue by making nondeductible contributions to a traditional IRA and then rolling it over. There are potential pitfalls. Rolling over from a traditional IRA that received both deductible contributions and nondeductible contributions will create pro rata rollover in which some of the funds will be considered to come from deductible contributions, resulting in tax and potentially early withdrawal penalties.

Required distributions

You must begin making annual minimum withdrawals from most retirement accounts when reaching a certain age, but that age keeps rising under recent legislation. The age was recently set at 72, but is now 73 for those turning 73 in 2023 and later. It will rise to 75 for those turning 75 in 2033.

Required minimum distributions (RMDs) are calculated using your account balance and a life-expectancy table. They must be made each year by Dec. 31 or you are subject to a 50% penalty on the amount you should have withdrawn. If you are already subject to these rules, you should check to make sure you have fulfilled them before the end of this year to avoid steep penalties. You may not be required to make distributions if you’re still working for the employer who sponsors your plan.

Inherited IRAs

Taxpayers that inherit an IRA have separate distribution rules. These rules recently changed under legislation that applies to IRAs inherited from an account holder who died in 2020 or later. If you inherit an IRA from a spouse, you have more options, including rolling over into your own IRA or taking distributions based on your own life expectancy. Most other taxpayers are now required to empty the account within 10 years even if they are under the age for required minimum distributions. When you must begin making distributions under this 10-year rule is still in flux. The IRS initially proposed regulations holding that if the account holder had already reached the RMD age, then the beneficiary would be required to make distributions each year during this 10-year period. The IRS has provided transition relief, however, providing that taxpayers will not be penalized taxpayers for not making these distributions in 2021, 2022 and 2023.

Planning options

Consider leaving as much as possible in your tax-preferred retirement accounts except what is required to fulfill the RMD rules. Your investments inside the accounts are growing tax-free and you are deferring the tax on the income that occurs when you do distribute (except for Roth versions, which aren’t included in tax at distribution). If you can afford to, spend the money you have invested outside of tax-preferred accounts first to protect as much of your portfolio from tax as you can as long as you can. And if you die with money remaining in your IRA, your heirs can continue to defer tax on the income even longer.

You can also consider making a tax-free charitable contribution out of an IRA to satisfy the RMD rules.

This can save you more than making a taxable distribution and separately taking a charitable deduction for any gifts. A charitable deduction can be reduced by limitations and phaseouts, and erases taxable income only after you’ve already calculated your AGI. When you instead make the gift straight from an IRA distribution, the amount of the gift is not included in income at all, lowering your AGI. A lower AGI not only directly reduces the amount of income subject to tax, but also blunts the effect of many AGI-based limits and phaseouts.

Credits and incentives

Congress has loaded the code with tax incentives meant to spur specific types of business activity and investments. Some of the programs can offer valuable opportunities for individual investors, including energy credit transfers and opportunity zones.

Opportunity zones

The opportunity zone program allows individuals to defer the recognition of capital gains if within six months of selling the assets, they invest an equal amount in an opportunity zone fund. The fund must be dedicated to investing in the areas that a state has designated as an opportunity zone. The deferred gain is not recognized until the opportunity zone investment is sold or by Dec. 31, 2026, at the latest.

The even more powerful incentive kicks in if the opportunity zone investment is held for at least 10 years. If that’s the case, you recognize no gain on any appreciation of the opportunity zone investment itself. The two benefits combine to create a powerful tax benefit and there is no shortage of opportunities to use it. There are more than 8,700 census tracts that qualify as opportunity zones, including multiple tracts in every major U.S. city and many areas ripe for development.

There are strict rules for how the investment must be made, and complex requirement the funds themselves must fulfill in order for investors to enjoy the tax benefits.

Energy credit transfers

The Inflation Reduction Act created a new regime to allow taxpayers to monetize energy credits by selling them to unrelated parties. Taxpayers with significant tax bills can consider whether to buy energy credit at a discount to reduce their tax bill. A robust market is developing where some credits are selling at 85% to 95% of their value.

There are some very important risks and limitations, especially for individuals. For one, the buyer of a credit retains significant risk if the IRS audits and disputes the amount of the credit or if there is recapture of the credit from a change in ownership. Indemnification clauses and tax insurance can help mitigate these risks but can also come with transaction costs that reduce the return.

More importantly for individuals, the initial IRS guidance provides that the credit will be considered a passive activity credit, so individuals will only be able to benefit if they have tax from a passive activity. The credit is also subject to other limitations that apply at the individual level to limit credit usage. The IRS rules are only proposed for now, so it’s possible that more favorable rules are offered later to make the credit market more attractive for individuals.

Transfer tax planning

The favorable estate, gift, and generation-skipping transfer tax lifetime exclusions, which reached $12.92 million in 2023, and $13.61 million in 2024, have greatly reduced the number of taxpayers potentially subject to estate and gift taxes. It’s important to keep in mind, however, that these thresholds are scheduled to be cut in half in 2026 without any new legislation. Successful business owners and executives could find themselves unexpectedly exposed for potential estate and gift tax.

The IRS has issued helpful guidance allowing taxpayers to leverage the current exemptions without fear of future changes clawing back the benefit. The rules provide that the estate tax can be determined using the exemption amount allocated to gifts made during the increased exemption period or the exemption amount at the time of death, whichever is greater. Taxpayers who do not take advantage of the increased exemptions with gifts before 2026 could forfeit the benefit of the increased exemptions.

The current high interest rates complicate estate tax planning. Many transfer tax strategies hinge on the ability of assets to appreciate faster than interest rates prescribed by the IRS. Taxpayers should consider the current outlook for interest rate and the types of assets that are most likely to appreciate in the current environment.

Leveraging the annual gift tax exclusion is another key opportunity for taxpayers that may be subject transfer taxes. The annual exclusion reached $17,000 in 2023 and is set to increase to $18,000 in 2024. You can double the 2023 exclusion to $34,000 by electing to split gifts with a spouse. So even if you want to give to just four individuals, you and a spouse could give a total of $136,000 this year with no gift tax consequences. If you have more people you’d like to benefit, you can remove even more money from your estate every year. Consider whether you have opportunities to use the 2023 exclusion by Dec. 31 before it’s forfeited.