The Biggest Tax Deduction Business Owners Overlook Is Hiding in a Plan They Already Have

Year after year, I find the same deduction hidden in the tax returns of successful business owners. This is not some tricky and controversial deduction that will draw the attention of the IRS. Nearly all of these owners have a retirement plan. They simply have the wrong type of retirement plan.

For example, one of my clients had a business with high profitability, very small staff and a SIMPLE IRA, which was put in place by the previous advisor. After analyzing the business, I suggested he look into a Cash Balance Plan where he could start contributing over $140,000 per year into the plan, every dollar of which is deductible. Nothing has changed in his business. The only thing that changed was the plan.

So where does the problem come from? Retirement plans are not one financial product. There is a wide variety of plans recognized by the IRS, and these are structured in a way of a ladder. Each rung requires more costs and effort but provides a much greater tax deduction. Being at the wrong rung is not a problem if you start there. It becomes one as soon as your profits grow past that level. Here is the ladder for you.

Begin with IRA-based plans

The simplest plans are based on individual retirement accounts. A payroll deduction IRA is the most basic option — employees fund their own traditional or Roth IRA using payroll; the maximum contribution for 2026 is limited to $7,500; there is no employer contribution and nearly no deduction for the business owner other than his/her own IRA contributions.

And it’s an actual upgrade. In a SEP IRA, the business can contribute up to 25% of compensation, up to $72,000 per person in 2026, and implementing it is close to plug-and-play. The drawback here is that if you contribute any percentage on your behalf, you must contribute the same percentage for every eligible employee, and this becomes prohibitively expensive with growing staff.

The SIMPLE IRA allows employees to defer up to $17,000 in 2026, plus employer matching or contributions. This plan is relatively inexpensive, so this is usually the advisor’s default choice. And it is where many business owners find themselves stuck — that limit is a fraction of what other plans can offer.

Step up to the qualified defined contribution plans

The next rung of our ladder consists of the 401(k) family. The standard 401(k) allows for employee deferrals of $24,500 in 2026, plus the $8,000 catch-up for those age 50 and above. Add a profit-sharing plan, where the business makes additional contributions on top of the deferrals, and total annual additions may become as much as $72,000 per person, or even $80,000 with the catch-up. For self-employed owners without any employees, a solo 401(k) offers the same limit with minimal administration.

There is a SIMPLE 401(k) combination plan as well, but with SIMPLE-level limits and 401(k)-level administration — not the best of deals. The money purchase pension plan requires making annual contributions, in contrast to the discretionary contributions of the profit-sharing plan. It makes sense only if you need to force yourself into saving discipline.

And then there is an employee stock ownership plan, or ESOP. Technically, it is a defined contribution plan as well, but in practice, it is much more of a succession plan than a retirement plan — subject of another article.

Move up to the defined benefit plans

Finally, the top of the ladder contains defined benefit plans, where the IRS places the limit not on the annual contribution but on the future benefit of the participant. For 2026, the limit allows for an annual benefit of up to $290,000, and an actuary calculates the annual contributions needed to provide for it.

The modern incarnation of the defined benefit plan suitable for business owners is a Cash Balance Plan. It is a defined benefit plan that expresses participants’ future benefit as a hypothetical account balance, so it feels like a 401(k) but allows for far greater contributions. It is the design that my client switched to. The cons are there — annual commitment, actuarial and administrative expenses of a few thousand dollars per year and required contributions for all eligible employees, which typically amount to 5-7.5% of their income.

Match the rung to your business

The right plan comes out of your numbers, not your advisor’s defaults. If you are an early-stage business with fluctuating profits, the simplicity of IRA-based plans is an advantage, not a problem. If you became consistently profitable and you are looking to shelter annual contributions exceeding $20,000, the 401(k) with profit sharing becomes your workhorse. And finally, if you are making strong profits with few employees — especially if you are over 45 and lag behind in retirement savings — it is where a defined benefit or cash balance plan on top of a 401(k) provides six-figure deductions.

Now ask your CPA two questions. First, when was the last time I’ve had my plan design reviewed against my current profits? If the answer is “at the time of establishment,” that’s a red flag. Second, what would be my maximum deductible contribution at each rung, and how much would I have to contribute on behalf of my employees? A good advisor should be able to run the numbers for all the scenarios in a single meeting.

Final note about the timing: Most plans must be established prior to the year-end to have current-year deduction, and switching from SIMPLE IRA requires advance notice to the employees. The tax code decided to reward the business owners who save for their retirement. All that remains is for you to stand on the right rung to collect.