Like many business owners, you may not have had the time to properly plan ahead regarding your business taxes, or maybe it simply hasn't been a priority for you. Not to worry. There are still a number of steps you can take to reduce both your business and personal tax bills for 2004. Read on to discover ten strategies that may help lower your taxable income and translate into greater tax savings for both you and your business:
1. Use the 50 percent bonus depreciation deduction. If you're planning major equipment purchases, you should buy and place items in service before January 1, 2005. Otherwise, you could miss out on the 50 percent bonus depreciation deduction that expires this year. This deduction allows you to write off half the costs of all new assets and recover the remaining 50 percent under regular depreciation schedules.
Qualifying property must be new and have a maximum depreciation life of 20 years. Certain leasehold improvements are also eligible such as lighting, signage, carpet and furnishings.
2. Take advantage of the Section 179 expense election. If you've purchased or need to purchase new computer systems, off-the-shelf computer software, furniture, fixtures, manufacturing equipment or other similar items for your business, you might be able to benefit from the Section 179 expense election. You can deduct up to $102,000 in 2004 for new and used equipment, including off-the-shelf software, placed in service before the end of the year. If your purchases total $410,000 or more, a phase-out applies. The benefit of this deduction is that you won't have to depreciate these assets over several years. You can receive the expense deduction on all purchases you make up to December 31, 2004.
Review your expected year-end profits before you deduct asset write-offs. If your capital expenditures exceed your profits, you should write off some of the capital assets that were used during the year and depreciate the remainder to possibly create a loss. By depreciating the remainder, you have the choice to carry forward the loss to offset future expected income or carry it back to recover previously paid taxes.
3. Watch out for the alternative minimum tax (AMT). An increasing number of taxpayers are affected by the alternative minimum tax--a parallel tax system with two tax rates (26 percent and 28 percent).
Many of the deductions allowed in calculating regular tax liability aren't allowed for the AMT, such as state and local income taxes and property taxes. It's important to know just what can increase your AMT liability. For example, you can trigger the AMT with municipal bonds and unreimbursed employee business expenses.
Large long-term capital gains, such as those that come from selling middle market business interests, can also trap you. Although capital gains are taxed at the same rates for the AMT as for regular tax purposes, they can increase your state income taxes.
If you're subject to the AMT this year, try to defer expenses that you can't deduct for AMT purposes, such as state and local income taxes and unreimbursed employee business expenses, until next year. In addition, you should defer expenses that are deductible for AMT purposes but that will provide a smaller benefit because of the lower tax rate, such as charitable contributions.
4. Create a retirement plan. Contributing to a retirement plan is a great way to reduce your small-business taxes while gaining a valuable benefit. If you haven't already done so, create and contribute to a retirement plan.
Some plans require you to meet discrimination tests or make matching contributions to participating employees' accounts. In addition, tax deductions vary depending on the type of plan you choose and when you make contributions. You can currently deduct payments to a qualified plan, such as a 401(k), a Savings Incentive Match Plan for Employees (SIMPLE), and Simplified Employee Pension (SEP) and Keogh plans--even though the funds aren't taxable to employees until later. But you generally can't deduct payments to a nonqualified plan until they're taxable to workers.
Plans have different deadlines for making contributions. You have until the due date of your tax return plus extensions to make SEP and profit-sharing Keogh plan contributions. You can even set up a SEP after the end of the year and still make contributions for 2004. This allows you to receive a current tax deduction and defer contributions for several months, which will help increase cash flow.
5. Claim bad debts. You may be able to claim a deduction for a business debt related to accounts or notes receivable if you included the amount owed in your gross income for the year you're claiming the deduction, or in a prior year. Please note, however, that if you use the cash basis method of accounting, you can't claim a bad debt deduction if someone fails to pay you for your services.
6. Take advantage of income shifting. You can reduce your family's overall tax bill by shifting taxable income from your high tax bracket to other family members in lower tax brackets. For instance, you might transfer income-producing property to custodial accounts for your minor children. Caution: Be aware of the "kiddie tax." To the extent that the unearned income attributed to a child under age 14 exceeds an annual limit ($1,600 for 2004), the excess is taxed at the top marginal tax rate of the child's parents.
7. Deduct your home office. Some operating costs can be deducted for the area of your home used exclusively for business. If you qualify, you may deduct depreciation allocated to your use of this business area of your home and other indirect expenses of operating your home office. You may also claim this deduction if your home office is the only place you use for conducting the administrative or management activities of your business or if only minimal administrative work is done outside your home office. Qualifying expenses include mortgage interest or rent, property taxes, homeowners insurance, repairs, cleaning, utilities and refuse removal.
8. Don't forget about interest payments If you use credit to finance business purchases, the interest and carrying charges are fully tax deductible. This shouldn't be an incentive to get into debt, but it can certainly help offset the cost of loans you may need to grow your business.
9. Pre-pay your bills and defer income. Cash-basis taxpayers may want to prepay as many bills as possible by December 31, 2004. If you wait until after the first of the year to pay bills, you won't be able to claim those expenses until 2005. You also have the option of deferring income. Consider notifying your clients in December that, as a holiday benefit, you're extending their credit terms from 30 days to 60 days. This is a great way to show appreciation for your customers--and reduce your deposits in December.
10. Claim business travel, meals and entertainment expenses. When you travel for business, you can deduct the cost of plane fare, taxis, lodging and 50 percent of meals and entertainment costs. Other expenses qualify as well, such as the cost of dry cleaning, telephone calls and computer rental fees. When you entertain present or prospective customers, you may also deduct 50 percent of the related cost if it's "directly related" to the business and business is discussed, or if it's "associated with" the business and the entertainment takes place immediately before or after a business discussion.
11. Plan throughout the year. Take any time you can to tax plan throughout the year. Be sure to speak with a CPA or other financial professional about which tax strategies are the best fit for your financial outlook. As a rule of thumb, keep good records, be organized, and understand what accounting teams need to prepare financial statements or tax returns. for more information on tax laws, visit the IRS website.
Jeffrey S. Parker is a principal with Roseland, New Jersey-based Rothstein Kass - Certified Public Accountants, one of the nation's top 20 largest international accounting and consulting firms. Jeffrey is also a certified public accountant and attorney.