The Small Business Tax Dictionary: Essential Terms Every Owner Should Know
Navigating the tax landscape as a small business owner can feel like learning a new language and be complex, overwhelming, and, well, taxing. To make things easier, we’ve created this practical dictionary of common tax terms to help you better understand the concepts that could impact your business.
83(b) Election: Typically, if property (such as stock or a Profits Interest in a partnership) is transferred in connection with the performance of services and such property is subject to any vesting or forfeiture provisions, the service provider will include the value of the property as compensation (taxed at ordinary rates) when the vesting or forfeiture provisions lapse. An 83(b) election allows the service provider to be taxed on the value of the property when it is granted, rather than when it vests. This also allows for any future appreciation in the property to be taxed at more favorable capital gains rates, provided that certain holding periods and other conditions are met.
1031 Exchange: Also known as a “like-kind” exchange. If real property that is held for business or investment purposes is exchanged for other “like kind” real property that will also be held for business or investment purposes, the exchange is not taxed. Instead, the taxpayer defers paying tax until the property received in the exchange is eventually sold.
Adjusted Basis: The Cost Basis for an asset, adjusted for capitalizable costs (i.e., improvements), Depreciation, Amortization, or other cost recovery deductions, and casualty losses. When an asset is sold, the gain or loss on the sale is typically determined with reference to the asset’s adjusted basis.
Amortization: Depreciation, but for intangible assets. The cost of intangible assets is generally deducted over 15 years. However, only certain intangibles used in a trade or business (such as goodwill, patents, and licenses) are eligible for the deduction. These eligible intangibles are commonly referred to as “section 197 intangibles”.
Anti-churning Rules: Prohibits Amortization deductions for any section 197 intangible that (1) was in existence prior to August 1993 (i.e., the enactment of Section 197) and (2) was acquired as part of a transaction where there is no significant change in ownership. These rules were originally aimed to prevent the sale of intangible assets that were not amortizable under former tax laws to related entities that could take advantage of the new amortization provisions but remain relevant in M&A transactions where the seller receives a significant Rollover percentage.
Bonus Depreciation: Allows businesses to immediately deduct the cost of eligible property (generally, property with a useful life of 20 years or less, such as machinery and equipment, acquired after January 19, 2025), rather than depreciating them over time. The OBBBA also temporarily allows bonus depreciation for certain qualified production property (i.e., certain manufacturing or production facilities).
C Corporation: A tax classification where the business is taxed as an entity separate from its owners. A C corporation is subject to a flat federal rate of 21% on its taxable income, which results in taxation at the entity-level and then again at the owner-level when dividends are distributed (commonly referred to as double taxation). However, owners of a C corporation may be eligible for the Qualified Small Business Stock exclusion. Some legal entities (e.g., any state law corporation formed in the US) are automatically classified as C corporations for tax purposes, but eligible entities can elect to be taxed as a C corporation by filing a Check-the-box Election. C corporations file an annual IRS Form 1120, U.S. Corporation Income Tax Return.
Capital Account: For entities taxed as Partnerships, an account is established and maintained for each partner to keep track of their equity in the partnership. Contributions to the partnership and allocations of partnership income increase a partner’s capital account, while distributions and allocations of partnership loss decrease a partner’s capital account.
Capital Gains and Losses: Gains or losses on property held for investment or for business use. Gains or losses on property held for one year or less are considered “short-term capital gains or losses” and are treated as OrdinaryIncome or loss. Gains or losses on property held for more than one year are considered “long term capital gains or losses” and can be eligible for preferential capital gains rates (a maximum of 20%) but may be subject to Depreciation Recapture.
Carryover Basis: In certain property transfers, the recipient acquires the property with the same adjusted basis as the transferor (i.e., the recipient steps into the shoes of the transferor for purposes of calculating Depreciation and gain or loss on the property). For example, property contributed in a tax-deferred contribution to a C Corporation or Partnership or property acquired by gift.
Check-the-box Election: Certain state law entities (like LLCs) can make an election on how they would like to be treated for tax purposes (e.g., as a C Corporation or a Pass-through Entity). This election is made by filing IRS Form 8832: Entity Classification Election.
Cost Basis: Generally, the purchase price for a property. This is used to calculate the Depreciation deductions for the property.
Credit: A dollar-for-dollar reduction in the actual tax you owe. Unlike a Deduction, which lowers taxable income, a credit directly lowers the tax bill itself.
Deduction: An expense that can be subtracted from your gross income to reduce the amount of income that is subject to tax. But see Credit.
Deferral: Certain transactions allow taxes to be deferred to a later year. Exclusions, on the other hand, are never taxed. For example, when you contribute property to a partnership, there is no tax due on the contribution. However, gain is recognized later if the partnership sells the contributed property or if you sell your partnership interest.
Depreciation: Deductions to recover the cost of property over its useful life to account for wear and tear. But see Bonus Depreciation.
Depreciation Recapture: When you sell property that has previously been depreciated, a portion of the gain that would otherwise be treated as a Capital Gain is “recaptured” and taxed as Ordinary Income.
Disregarded Entity: The default tax classification for a state law entity with one owner (e.g., a single-member LLC). A disregarded entity is ignored for tax purposes, and all of the entity’s income and losses are reported on the tax return of its owner.
Employee Identification Number (EIN): A unique nine-digit number assigned by the IRS to identify a business entity, similar to a Social Security number for an individual. An EIN is required to operate most forms of state law entities (e.g., partnerships, corporations, LLCs, trusts, tax-exempt organizations) or to open a bank account or report payroll taxes. An EIN can be obtained directly through the IRS website or by filing IRS Form SS-4: Application for Employer Identification Number.
Estimated Taxes: Periodic tax payments (usually quarterly) made by individuals and corporations to cover income taxes and self-employment taxes, if applicable throughout the year. Partnerships and S Corporations typically do not withhold taxes on their owners’ income throughout the year, so the partners, members, shareholders, or other owners of these entities must estimate their allocable share of the entity’s income and make the appropriate estimated tax payments themselves.
Exclusions: Certain transactions are not taxed. For example, gifts, inheritances, and gains on Qualified Small Business Stock are excluded from gross income.
F Reorganization: A tax-free restructuring of a corporation that results in a change in form (e.g., converting an S corporation to an LLC) or place of organization (e.g., moving a corporation from one state to another for state law purposes). Commonly used in M&A transactions where the target company is an S corporation for buyers to achieve a Stepped-up Basis.
Flow-through Entity: See Pass-through Entity.
Form W-9: A tax form used by a business (or any other payor) to request a U.S. person’s name, address, and EIN so they can properly report payments to the IRS. The form also contains certifications that the taxpayer is a U.S. citizen or other U.S. person and is not subject to backup withholding. In M&A transactions, a buyer will request that the seller provides a Form W-9 at closing to confirm the seller’s exemption from backup withholding. Otherwise, the buyer will be required to withhold 24% of the sales proceeds from the seller.
Guaranteed Payments: Fixed payments made to a partner from a Partnership for personal services performed for the partnership or for the use of capital. Guaranteed payments are generally deductible Ordinary and Necessary Business Expenses for the partnership but are treated as Ordinary Income (and taxed at higher ordinary rates) and subject to Self-employment Taxfor the partner receiving the payment.
Installment Sale: A method of reporting gain from the sale of property where the seller receives payments over multiple years rather than in one lump sum. Instead of recognizing all of the gain in the year of sale, the seller reports a proportionate share of the gain as each installment payment is received, effectively deferring a portion of the tax liability into future years. This can be a useful planning tool for sellers who want to spread their tax burden or who expect to be in a lower tax bracket in future years. However, installment sale treatment is not available for certain transactions or with respect to certain income (e.g., Depreciation Recapture is recognized in full in the year of sale regardless of the installment method).
Itemized Deduction: Specific expenses that individual taxpayers may elect to deduct on their federal income tax return in lieu of taking the Standard Deduction. Common itemized deductions include mortgage interest, state and local taxes (subject to the SALT Deduction cap), charitable contributions, and certain medical expenses that exceed a threshold percentage of adjusted gross income. Because itemized deductions require substantiation and recordkeeping, taxpayers should compare their total itemized deductions against the standard deduction each year to determine which approach minimizes their tax liability.
Like-Kind Exchange: See 1031 Exchange.
Material Participation: A standard used to determine whether a taxpayer is actively involved in a trade or business activity. If a taxpayer meets one of several IRS tests for material participation (e.g., participating more than 500 hours in an activity during the year), income or losses from that activity are treated as non-passive and can generally be used to offset other ordinary income. Alternatively, if a taxpayer does not materially participate, the Passive Activity Loss (PAL) Rules may limit their ability to deduct losses from the activity against other income. This distinction can be particularly significant for small business owners who hold interests in multiple ventures.
Net Investment Income Tax: A 3.8% surtax imposed on certain types of investment income (e.g., interest, dividends, capital gains, rental income, and passive income) for individuals whose modified adjusted gross income exceeds certain thresholds ($200,000 for single filers; $250,000 for married filing jointly). The Net Investment Income Tax is separate from, and in addition to, regular income taxes.
One, Big, Beautiful Bill Act of 2025 (OBBBA): Federal tax legislation enacted on July 4, 2025 that includes significant changes affecting small businesses, such as the relaxation of certain Qualified Small Business Stock (QSBS) requirements, an extension and expansion of Bonus Depreciation, modifications to the Qualified Business Income (QBI) deduction.
Ordinary and Necessary Business Expense: The IRS standard for determining whether a business expenditure is deductible. To be deductible, an expense must be “ordinary” (i.e., common in a certain trade or business) and “necessary” (i.e., helpful and appropriate for the business, even if not strictly required). Examples include rent, utilities, employee wages, professional fees, and advertising costs.
Ordinary Income: Income that is taxed at regular marginal federal income tax rates, as opposed to the preferential rates that apply to long-term Capital Gains. Ordinary income typically includes wages, business profits, Guaranteed Payments, self-employment income, and short-term Capital Gains.
Partnership: A business arrangement between or an entity owned by two or more persons (or entities) who share in the profits, losses, and management of the business. For federal income tax purposes, a partnership is a Pass-through Entity, meaning the partnership itself does not pay federal income tax. Instead, each partner’s allocable share of income, gain, loss, deduction, and credit flows through to their individual tax returns via a Schedule K-1. Note, that the business/entity is not required to be a state-law partnership to be considered a partnership for tax purposes—a multi-member limited liability companies are automatically treated as a partnership for tax purposes. Tax partnerships offer flexibility in allocations of income and losses and structuring ownership, but they also come with complexity, particularly around Capital Account maintenance, treatment of Guaranteed Payments, and rules regarding transactions between the partnership and partners and among the partners themselves.
Pass-through Entity: A state law entity that does not pay federal income tax at the entity level (i.e., Partnerships, S Corporations, and single-member Disregarded Entities). Instead, the entity’s income, losses, deductions, and credits “pass through” to the entity’s owners and are reported on their individual tax returns. This avoids the double taxation that applies to C Corporations, which are taxed once at the corporate level as income is earned and again when earnings are distributed to shareholders. Most small businesses are structured as pass-through entities, though owners should also be mindful of potential Self-employment Tax and the availability of the Pass-through Entity Tax (PTET) Election at the state level.
Pass-through Entity Tax (PTET) Election: A state-level tax election available in certain states that allows eligible Pass-through Entities to pay state income tax at the entity level rather than having the obligation flow through entirely to the individual owners. Because taxes paid at the entity level are generally deductible by the entity as an Ordinary and Necessary Business Expense, this election effectively allows owners to obtain a federal deduction for state taxes that would otherwise be limited by the SALT Deduction cap at the individual level.
Passive Activity Loss (PAL) Rules: IRS rules that limit a taxpayer’s ability to deduct losses from “passive activities” against income from non-passive sources (such as wages or active business income). A passive activity is generally one in which the taxpayer does not Materially Participate. Rental activities are typically treated as passive by default, with a notable exception for Real Estate Professionals. Losses from passive activities that cannot be deducted in the current year are suspended and carried forward to offset passive income in future years, or recognized in full when the passive activity is disposed of in a taxable transaction.
Profits Interest: An ownership interest in a Partnership or LLC taxed as a partnership that entitles the holder to share in future profits and appreciation of the entity, but not in its existing value at the time the interest is granted. Because a profits interest recipient is not receiving any current value when the interest is granted, no income tax is generally recognized at the grant date, making it a tax-efficient way to compensate employees, managers, or other service providers with equity. If structured properly, future appreciation allocable to the profits interest may also be eligible for favorable long-term Capital Gains treatment rather than being taxed as Ordinary Income. An 83(b) Election may also be relevant depending on the vesting terms of the profits interest.
Purchase Price Allocation (PPA): When a business is acquired in a taxable transaction, the purchase price must be allocated among the acquired assets in accordance with the "residual method" under Section 1060. Assets are categorized into seven classes (ranging from cash and cash equivalents to goodwill and going concern value), and the purchase price is allocated to each class in order. The allocation determines the Cost Basis the buyer takes in each acquired asset (which drives future Depreciation and Amortization deductions) and the amount and character of gain or loss recognized by the seller.
Qualified Business Income (QBI): The net amount of qualified income from a domestic trade or business operated as a Pass-through Entity or Sole Proprietorship. Under Section 199A of the tax code, eligible taxpayers may deduct up to 20% of their QBI from their taxable income, subject to limitations based on the taxpayer’s income level and the nature of the business (for example, certain service-based businesses are subject to additional restrictions at higher income levels).
Qualified Small Business Stock (QSBS): Stock in a qualifying domestic C Corporation meeting certain requirements of Section 1202 of the Code (e.g., qualifying business activities, limitations on aggregate gross assets). If a taxpayer holds QSBS for the applicable required holding period (5 years for stock issued prior to the enactment of the OBBBA, 3 years for stock issued after the enactment), they may be able to exclude all or a portion of the capital gain on the sale of that stock from federal income tax, subject to certain limitations.
Real Estate Professional: A tax designation that allows certain taxpayers to treat losses from rental real estate as non-passive, making those losses available to offset other income, such as wages or active business profits. To qualify, a taxpayer generally must Materially Participate in real estate activities for more than 750 hours in a given taxable year. Additionally, more than half (50%) of the taxpayer’s total working hours in that year must be devoted to such real estate activities.
Rollover Equity: When a business is sold, rollover equity refers to a portion of the seller’s equity that is not cashed out but is instead “rolled” into the acquiring entity, meaning the seller receives an ownership stake in the buyer rather than cash for that portion of the deal. The tax treatment of rollover equity depends heavily on the deal structure and the types of entities involved, but it can often be structured to defer tax on the rolled portion of the transaction, allowing the seller to participate in the future upside of the combined business while reducing the immediate tax hit.
S Corporation: A corporation that has made a valid election under Subchapter S of the Internal Revenue Code to be treated as a Pass-through Entity for federal tax purposes. Like a Partnership, an S corporation does not pay federal income tax at the entity level; instead, income, losses, deductions, and credits flow through to the shareholders in proportion to their ownership and are reported on each shareholder’s individual return via a Schedule K-1. One notable advantage of S corporations is that shareholder-employees may be able to reduce their Self-employment Tax exposure by paying themselves a reasonable salary and taking additional profits as distributions (which are not subject to employment taxes). However, S corporations have restrictions that do not apply to partnerships, including limits on the number and type of eligible shareholders and a prohibition on having more than one class of stock. S corporations file an annual IRS Form 1120-S.
SALT Deduction: The “State and Local Tax” deduction, which allows individual taxpayers to deduct state and local income taxes (or, alternatively, general sales taxes) and property taxes paid during the year from their federal taxable income. For 2026, this deduction is capped at $40,000 per year for both single filers and married couples filing jointly, with a phase-out for taxpayers with modified adjusted gross income over $500,000. Prior to the increased limitation under the OBBBA, the Pass-through Entity Tax (PTET) Election was a common strategy that business owners use to effectively work around this cap by shifting state tax payments to the entity level, where they were generally fully deductible.
Schedule K-1: The annual tax document issued by a Pass-through Entity to each of its partners or shareholders. The K-1 reports the recipient’s allocable share of the entity’s income, loss, deductions, and credits for the year, which the recipient then reports on their individual tax return.
Section 179 Deduction: An elective provision that allows businesses to immediately deduct the full cost of qualifying property, such as machinery, equipment, computers, and certain off-the-shelf software, in the year it is placed in service, rather than recovering the cost over time through Depreciation. The maximum deduction is subject to an annual dollar limit (adjusted for inflation each year) and begins to phase out when total qualifying property placed in service exceeds a certain threshold. Section 179 is similar to Bonus Depreciation but operates under different rules and limitations.
Self-employment Tax: A tax imposed on net self-employment income that represents both the employer and employee portions of Social Security and Medicare taxes (FICA), since self-employed individuals do not have an employer to pay the employer’s share. For sole proprietors, partners, and others who work for themselves, self-employment tax is calculated on Schedule SE and is owed in addition to regular income tax. However, self-employed taxpayers may deduct one-half of their self-employment tax as an adjustment to income, which partially offsets the tax burden.
Sole Proprietorship: The simplest and most common form of business structure, in which a single individual owns and operates a business without forming a separate legal entity. For tax purposes, a sole proprietorship is treated as a Disregarded Entity, so its income and expenses are reported directly on the owner’s individual tax return (typically on Schedule C). While a sole proprietorship is easy and inexpensive to establish, the owner is personally liable for all business debts and obligations, and net business income is fully subject to Self-employment Tax.
Standard Deduction: A flat dollar amount set by the IRS each year that individual taxpayers may subtract from their adjusted gross income in lieu of claiming Itemized Deductions. The amount varies based on filing status (single, married filing jointly, head of household, etc.) and is adjusted annually for inflation. Most taxpayers claim the standard deduction because it is simpler and, for many, larger than the total of their available itemized deductions.
Stepped-up Basis: When a person inherits an asset, the asset’s Tax Basis is “stepped up” to its fair market value as of the date of the decedent’s death, rather than carrying over the decedent’s original (and potentially much lower) basis. As a result, if the heir were to immediately sell the inherited asset, little or no capital gain would be recognized on the pre-death appreciation. In the context of a sale of a business, if the transaction is an asset sale (or a deemed asset sale for tax purposes), the purchaser will receive a “step up” in the tax basis of each asset purchased equal to the portion of the purchase price allocated to such asset.
Substituted Basis: Tax Basis that is determined by reference to the basis of another asset, rather than by the actual cost of the property received. This most commonly arises in tax-free or tax-deferred transactions, where the recipient of property “inherits” a basis tied to the transferor’s original basis rather than the property’s current fair market value. For example, in a 1031 Exchange, the basis of the property received is generally the taxpayer’s basis in the original property that was exchanged. A substituted basis ensures that built-in gain is preserved and will ultimately be recognized when the substituted property is eventually sold.
Tax Basis: The value assigned to an asset for federal income tax purposes, used to measure gain or loss upon its sale or other disposition. At acquisition, a taxpayer’s basis typically equals the purchase price (i.e., Cost Basis), but basis can increase over time for improvements or additional investments, and decrease for Depreciation and certain other events, resulting in the asset’s Adjusted Basis.
Tax Year: The twelve-month accounting period that a taxpayer uses to compute and report income and expenses. Individuals and most businesses use a calendar tax year (January 1 through December 31), but businesses may adopt a fiscal year (any twelve-month period ending on the last day of a month other than December) if certain requirements are met.
Taxpayer: Any individual, business entity, trust, or estate that is required to pay taxes or file a tax return with a federal, state, or local taxing authority based on income, sales, property, payroll, or other taxable activities.
Taxpayer Identification Number: See Employer Identification Number (EIN).
Write-off: More colloquial term for Ordinary and Necessary Business Expense.
Understanding the language of taxes is a critical step toward making informed decisions for your business. While this guide covers many of the most common terms, tax planning is rarely one-size-fits-all. For small business owners, the right guidance early on can make a meaningful difference in staying compliant, minimizing risk, and planning ahead.
Click here to schedule a consultation with Kalaria Law today to ensure your business or potential transaction is structured in the most tax-efficient manner.
Disclaimer: This article is for general informational purposes only and does not constitute formal legal advice.
