Don't let the year slip away without reviewing your business's tax status. Even though the clock's ticking, there's still time to take a look at where you stand and implement some effective strategies to ease your tax burden.
Tax planning is especially important this year because of a host of new tax law changes brought about by recently passed tax legislation, such as the Restructuring and Reform Act of 1998 (see "Tax Talk," November ) and the Taxpayer Relief Act of 1997. Both laws include changes that will affect your 1998 return and add to its complexity.
Before you plot your strategy, though, take the time to gather all relevant information regarding the 1998 tax year. If you use a computer program to keep track of your tax records and prepare your return, you'll have most of what you need at your fingertips.
Year-end is also a good time to look at whether your company is organized properly, says Robert Webb, director of tax services for the Denver accounting firm Gelfond Hochstadt Pangburn & Co. If you're organized as a regular corporation, for example, you may want to switch to an S corporation or a limited liability company to reduce your tax bill, he says.
Once you've completed that review, start looking at some tried-and-true strategies, as well as some new tactics, that will help lower your yearly tax tab. Here's a list to get you started:
- Cash vs. accrual. If you use the cash method of accounting in your business, you can help reduce or defer your taxes by accelerating expenses for 1998 and pushing income you expect to receive into the 1999 tax year. Remember, the more deductions you take, the smaller your taxable income will be and the less you'll owe.
As you know, with the cash method of accounting, income is taxable when you receive it and expenses are deductible when they are paid. To defer taxable income into next year, wait until the end of December to mail invoices. That way, you won't receive payment for your products or services until 1999.
A good way to boost expenses is to buy needed equipment before the end of the year. Keep in mind, the yearly limit on the deduction for qualifying equipment placed in service in 1998 is $18,500; that's up $500 from 1997, says Webb. In 1999, that amount increases to $19,000. And remember, the deduction can't exceed the taxable income derived from your business.
You can also pile up expenses for 1998 by buying office supplies, having repairs done to your business, and giving holiday gifts to clients before the end of the year. Remember, the deduction limit for client gifts is $25 per recipient.
The IRS requires companies to use the accrual method of accounting if they have inventory. With the accrual method, sales are taxable and expenses are deductible when incurred. If you use the accrual method of accounting, one way to defer income is to delay shipping products until the beginning of 1999, says Webb. This works to your advantage because title for the goods doesn't pass until the items are actually received by the customer. "This is only useful if the customer doesn't need the products right away," Webb explains.
*Charitable deductions. If you haven't done so already this year, now's the time to give money to your favorite charities and take a deduction for it. The IRS allows a company to donate up to 10 percent of its net profits to charitable organizations. Be sure to get a written receipt from any charity to which you make a donation of $250 or more.
*Hire your kids. Consider hiring your children to work in the business, says Pat Mullin with Deloitte & Touche LLP's Cleveland office.
Be warned: Your kids have to actually perform work for your business. Pay them a reasonable salary for the work they do, and you can deduct that amount from your taxes. If you decide to hire your children in December, you won't receive much of a deduction for 1998, but that will improve for tax year 1999 if you keep them on the job.
Another plus to hiring your children is that they can set up a Roth IRA with the income they earn, giving them an early start on saving.
*No guessing game. Check to see if you're paying enough in estimated taxes. If you've made more money than you expected to make this year, you may fall short of the required estimated tax payments. If that's the case, send the IRS the taxes you owe by January 15, 1999, to avoid a penalty, says Webb.
The law requires estimated tax payments to add up to at least 100 percent of last year's tax or 90 percent of the tax you owe in 1998. (Choose whichever will help you avoid a penalty.)
*For the health of it. If you're self-employed, keep in mind that in 1998, your deduction for medical and dental insurance premiums for yourself, your spouse and your dependents increases from 40 to 45 percent.
*On the home front. If you have a home office, the 1997 tax law relaxes the rules governing deductions for home offices for the 1999 tax year. Business owners who keep records, schedule appointments and perform other administrative or management activities from a home office qualify for a deduction as long as they don't have another fixed place of business where they do a large amount of administrative or management work.
As a result of this change, "A lot more home businesses are going to be able to deduct expenses associated with their offices," says Webb. Therefore, it makes sense to defer expenses related to your home office until next year. That way, there's a better chance you'll be able to deduct them for 1999.
*Saving for tomorrow. Be sure to take advantage of the opportunity to sock away funds for retirement and receive a deduction (depending on the type of plan you select). Putting money into a deductible Individual Retirement Account (IRA), a 401(k) or a Keogh plan is one of the best ways business owners can lower their taxable income and watch their savings grow.
If you qualify to invest in a Roth IRA and have savings in a traditional IRA, determine whether it makes sense to continue funding the traditional deductible IRA; if not, convert to a Roth IRA, says Mullin. This is especially important this year, he explains, because if you do the conversion by December 31, 1998, the 1997 tax law gives you four years to pay the taxes you owe on the funds withdrawn from your traditional IRA.
With a 401(k) plan, you can set aside a tax-free portion of your salary each year and the funds are allowed to grow tax-free until they're withdrawn. The maximum 401(k) contribution for 1998 is $10,000.
Keogh plans, designed for self-employed individuals, must be set up by December 31 for contributions to be deductible in 1998. The maximum amount you can contribute varies depending on the type of Keogh you establish.
*Give it away. Another step to consider is using the annual gift tax exclusion to shelter large gifts to family members or anyone else you designate. Currently, you can exclude $10,000 for each individual or $20,000 for married couples. Keep in mind, it's possible to give shares of stock as gifts, rather than selling the shares and giving children or other individuals you designate the proceeds.
*Personal returns. Don't neglect ways to lower your personal tax liability, either. Mullin says a good way to accelerate deductions on your personal taxes is to prepay and deduct 1998 state income and property taxes that would otherwise be due in the first three or four months of 1999.
"Paying the balance of your estimated state tax liability in December 1998 secures that deduction on your 1998 tax return, even though the payment might not be required by the state until January 15 or April 15, 1999," says Mullin. If you might be hit by the alternative minimum tax (AMT), it probably doesn't make sense to accelerate your deductions for state and local income and property taxes because they're not deductible when calculating alternative minimum taxable income and won't yield a benefit if you're subject to the AMT.
On capital gains, the 1998 tax law has shortened the holding period from 18 months to 12 months for entitled long-term gains to the 20 percent capital gains tax rate that was approved by the 1997 law (10 percent rate for those in the 15 percent income tax bracket). This means investments don't have to be held as long to earn the lower capital gains rate.
With regard to deferring interest income on investments, think about buying short-term Treasury bills or bank certificates by December 31. This allows you to shift interest income into next year. When you buy bank certificates, be sure to specify that interest is to be credited only at maturity.
As you can see, there are a number of strategies available to lower your overall federal tax liability. Just be sure you act before the end of the year. Once the new year comes, there's little you can do to lower your income taxes for 1998. Trimming what you owe and deferring some of what you must pay to future years is a good strategy to follow every year. Don't let 1998 be any different.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 12 years.
Deloitte & Touche LLP, http://www.us.deloitte.com
Gelfond Hochstadt Pangburn & Co., (303) 831-5038, firstname.lastname@example.org