Tax Terms, Defined
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The vocabulary a business owner hears on the call and in the videos, defined once in plain words. Use the term the professional uses; understand what it means.
- 1031 Exchange
- A 1031 exchange, or like-kind exchange, lets an owner defer the tax on the sale of business or investment real estate by reinvesting the proceeds in replacement real estate within strict deadlines and rules. The gain is deferred, not erased, and carries into the new property.
- Accountable Plan
- An accountable plan is a written arrangement under which a business reimburses employees or owners for genuine business expenses without the reimbursement counting as taxable pay. It requires a business connection, substantiation, and return of any excess. It is the correct route for an owner to be repaid for business use of personal resources.
- Accrual vs. Cash Method
- The cash method records income when received and expenses when paid; the accrual method records them when earned and incurred, regardless of when cash moves. Which a business may use depends largely on its size and whether it carries inventory, and switching between them is a change in accounting method.
- Apportionment
- Apportionment is how a business that operates in more than one state divides its income among them for tax, using formulas based on factors such as sales, property, and payroll. Because states use different formulas, multi-state income can be counted differently in each.
- Basis
- Basis is your investment in an asset or a business interest for tax purposes, used to measure gain when you sell and to limit the losses and distributions you can take. It rises with contributions and income and falls with distributions and losses. Losing track of basis is a frequent source of return errors.
- Bonus Depreciation
- Bonus depreciation lets a business deduct a large share of the cost of qualifying assets in the year they are placed in service, rather than over their full life. The share available has been scheduled to change over time, so the year an asset is bought affects the deduction.
- Buy-Sell Agreement
- A buy-sell agreement is a contract among business co-owners setting what happens to an owner's interest if they die, divorce, become disabled, or leave — who buys it, at what value, and with what funding. Kept current and funded, it prevents a personal event from becoming a business crisis.
- Cash Balance Plan
- A cash balance plan is a type of defined benefit plan that states each participant's benefit as a hypothetical account balance, making it easier to understand than a traditional pension. It is often paired with a 401(k) to allow large deductible contributions for older, higher-earning owners.
- Charging Order
- A charging order is a remedy that generally limits a member's personal creditor to receiving distributions from an LLC, rather than seizing the business or forcing a sale. In some states it is the exclusive remedy against an LLC interest, which is why those states are favored for holding entities.
- Check-the-Box Election
- Check-the-box refers to the election, made on a short IRS form, that lets an eligible entity choose how it is taxed — for example an LLC choosing to be treated as a corporation or an S-corporation. The name comes from the form's simplicity, but the tax consequences of the choice are significant.
- Cost Segregation
- A cost segregation study breaks a building's cost into components that can be depreciated over shorter lives than the building itself, accelerating deductions into the early years of ownership. It is most valuable on larger properties and is documented by an engineering-based analysis.
- Defined Benefit Plan
- A defined benefit plan is a pension-style retirement plan that promises a set benefit at retirement, with contributions calculated by an actuary. It can allow much larger deductible contributions than other plans, which suits high, stable earners, at the cost of a fixed annual funding commitment.
- Depreciation
- Depreciation spreads the cost of a long-lived business asset — a building, equipment, a vehicle — across the years it is used rather than deducting it all at once. It is a non-cash deduction, meaning it lowers taxable income without a fresh outlay in that year.
- Depreciation Recapture
- When you sell an asset you have depreciated, depreciation recapture taxes back part of the gain that was created by those earlier deductions, often at a different rate than ordinary capital gain. It is why depreciation is best understood as a deferral rather than a permanent saving.
- Distribution
- A distribution is money a pass-through entity pays out to its owners from profit that has already been taxed to them. In an S-corporation, distributions are not subject to self-employment tax, which is why they are paired with a reasonable wage. Distributions are limited by the owner's basis.
- Economic Substance
- The economic substance doctrine lets the tax authorities disregard a transaction that has no real purpose or effect beyond producing a tax benefit. It is the principle behind the rule that a structure must be real: a step taken only to reach a tax number, with nothing genuine behind it, does not hold.
- Estimated Tax
- Estimated tax is the pay-as-you-go tax paid in installments during the year on income that is not covered by withholding, such as business or investment income. Missing the required amounts can trigger an underpayment penalty even if the balance is paid at filing.
- Form 3115
- Form 3115 is the application a business files to change a method of accounting — for example switching between cash and accrual, or correcting how an item has been treated over time. Changing a method without filing it, when filing is required, can be worse than the original treatment.
- Guaranteed Payment
- A guaranteed payment is compensation a partnership pays a partner for services or for the use of capital, set without regard to the partnership's profit. It is deductible to the partnership and ordinary income to the partner, and it is the partnership analog to a salary an owner cannot technically pay themselves.
- Holding Company
- A holding company is an entity that owns other entities and valuable assets rather than running day-to-day operations. Kept one layer away from where lawsuits arise, it is used to separate ownership of assets from the risks of the operating business.
- Limited Liability Company (LLC)
- An LLC is a state-created entity that separates the business's debts from the owner's personal assets when it is properly maintained. For federal tax it has no fixed treatment of its own: a single-member LLC is disregarded by default, a multi-member LLC is taxed as a partnership, and either can elect corporate or S-corporation treatment.
- Management Company
- A management company employs key people and provides services to related operating entities, billing them under a written services agreement at an arm's-length fee. It can consolidate functions and document a flow of income, but the services must be real and the fee must be defensible, not set to hit a tax number.
- Material Participation
- Material participation measures whether you are involved in a business or rental on a regular, continuous, and substantial basis, judged against a set of hour-based tests. Meeting it generally makes an activity non-passive, which changes how its income and losses are treated.
- Nexus
- Nexus is the connection between a business and a state that lets the state tax the business or require it to collect sales tax. It can come from a physical presence such as people or property, or from economic activity alone — economic nexus — where enough sales into a state create an obligation even without a physical footprint.
- Pass-Through Entity
- A pass-through entity does not pay income tax itself; its profit and loss flow through to the owners, who report their shares on their own returns. Sole proprietorships, partnerships, S-corporations, and most LLCs work this way, which is why an owner's business and personal tax pictures cannot be separated.
- Pass-Through Entity Tax (PTET)
- A pass-through entity tax is a state election that lets a partnership or S-corporation pay state tax at the entity level, which can restore a federal deduction that the cap on state and local tax deductions otherwise limits for the owners. The election and its deadlines vary by state.
- Passive Activity Loss
- The passive activity loss rules limit using losses from activities you do not materially participate in — most rental real estate, for example — to offset income from your job or business. Suspended losses carry forward and are generally freed when you dispose of the activity.
- Qualified Business Income (QBI) / §199A
- The qualified business income deduction under §199A lets many owners of pass-through businesses deduct a portion of their business income. It phases out for higher earners and is limited for certain service professions, so whether and how much an owner qualifies depends on income level and business type.
- Real Estate Professional Status
- Real estate professional status is a set of tests that, when met, can let rental losses offset other income by treating the rentals as non-passive. The tests are demanding — they measure the hours you spend in real property trades and businesses — and they are frequently examined.
- Reasonable Compensation
- Reasonable compensation is the wage an S-corporation owner who works in the business must pay themselves before taking distributions — an amount comparable to what the role would earn at arm's length. Setting it too low to avoid payroll tax is a common examination target.
- Research and Development (R&D) Credit
- The research and development credit rewards businesses for spending on qualified activities to develop or improve products, processes, or software. It is a credit against tax rather than a deduction, and claiming it requires documenting which activities and costs qualify.
- Revocable vs. Irrevocable Trust
- A revocable trust can be changed or undone by the person who created it, keeps control with them, avoids probate, and offers no creditor protection. An irrevocable trust generally cannot be changed, which is what lets it move assets out of the taxable estate and, when properly structured, beyond a creditor's reach.
- S-Corporation
- An S-corporation is a tax status a corporation or LLC can elect so that profit passes through to the owners and is taxed on their personal returns rather than at the entity level. Its main draw for an owner-operator is splitting pay between a reasonable wage and distributions, which can lower self-employment tax when profit is high enough to justify the added cost.
- Safe Harbor
- A safe harbor is a level of tax prepayment — withholding plus estimates — that prevents an underpayment penalty even if a balance remains at filing. It is defined by reference to the current or prior year's tax, giving owners a clear target to hit through the year.
- Section 179 Expensing
- Section 179 lets a business elect to deduct the full cost of qualifying equipment and certain property in the year it is placed in service, up to annual limits and subject to a phase-out for larger purchases. It cannot create a loss, which is the main way it differs from bonus depreciation.
- Self-Rental
- Self-rental is renting property you own to a business you also operate. Under the self-rental rules, net income from the arrangement is generally treated as active while net losses stay passive — an asymmetry that surprises owners who expect the rent to shelter other income.
- SEP-IRA
- A SEP-IRA is a simple retirement plan funded entirely by employer contributions, popular with self-employed people and small businesses for its low administrative burden. Contributions are flexible year to year but must generally be made for eligible employees on the same terms as for the owner.
- Solo 401(k)
- A solo 401(k) is a retirement plan for a business with no employees other than the owner and a spouse. Because the owner contributes both as employee and as employer, it often allows a larger total contribution than other self-employed plans at the same income.
- Step-Up in Basis
- A step-up in basis resets the tax basis of an inherited asset to its value at the owner's death, which can erase the built-in gain that would otherwise be taxed on a later sale. It is a central reason estate and asset planning are done together.
- Uniform Capitalization (UNICAP)
- The uniform capitalization rules require certain businesses that produce or resell goods to add specified indirect costs to the value of inventory rather than deducting them right away. Crossing the gross-receipts threshold that triggers UNICAP changes how and when those costs are deducted.
Mena Hemaia, CPA, CIA
Chief Executive Officer, Accountack — West Palm Beach, Florida
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