Tax Breaks for the New Year
Sometime after the last eggnog is drained and before the Rose Parade starts is that no-work zone we call the last week of the year.
Sure, it's difficult to get anything done after December 25 and before January 1. Nobody's at work, relatives are sleeping in your den, and there's all those awful gifts to return.
But one thing you can do before the new year rolls in is to organize your taxes. I know, April 15 is still a long time away. But the way the Internal Revenue Service operates, it's advantageous to clear up a lot of your tax records by December 31 to gain those all-important deductions and write-offs you'll be demanding of Uncle Sam come mid-April. Here are some good places to start:
- Income reporting. Your business's choice of an accounting method has a significant impact on your taxes. There are two basic methods: cash and accrual. Under the cash method, which most entrepreneurs use, a business reports income when it is received and reports expenses when cash is disbursed. Under the accrual method, a business reports income when the business has the right to receive the income, when a bill or invoice is due for example.
SOHOs who use the cash method of accounting can cut their tax bills by accelerating expenses and deferring income. One way to defer income is to mail your invoices at the end of December so you won't get paid until next year. On the expenses side, you may want to evaluate future equipment, furniture and office supply needs and consider purchasing those items before year-end.
- Charitable gifts. As a sole proprietor or partner of a homebased business, you can make cash gifts to charity of up to 50 percent of your adjusted gross income (AGI) and of appreciated long-term capital-gain property that's worth as much as 30 percent of your AGI. What's more, when you donate appreciated property, you not only get a deduction, you also don't owe any capital gains taxes. Another way to be charitable and earn a tax deduction is to donate excess inventory. The deduction for charitable contributions made by C corporations, though, is limited to 10 percent of modified taxable income.
- Deadbeat clients. One silver lining in an uncollectable debt situation is that the IRS allows business owners to write off bad debts. Under current law, each individual bad debt must be identified and deducted in the year in which it becomes partly or totally worthless. Remember to keep a paper trail showing that you took reasonable steps to collect the money due you.
- Expenses. At the end of every year, I empty a shoebox onto my desk with that year's work-related receipts. Computers, printer paper, meals with clients, airplane tickets-I save receipts for anything at all that I paid for out of my pocket to help run my business.
Every year, you can "expense" (write off all at once instead of depreciating) the cost of business equipment or other eligible personal property you acquire and use in your business-within limits. The limit is $20,000 in 2000. This is often referred to as the "Section 179" tax deduction. Due to recent tax legislation, this deduction will be increased in stages to $25,000 by 2003.
On the entertainment side, tax law allows you to deduct 50 percent of meals and entertainment expenses that are business-related. To qualify, you must be able to show that the expense directly preceded or followed a substantial, bona fide business discussion or that it's directly related to the active conduct of your trade or business. You must keep good records, which include a receipt for any expenditure of $75 or more. Holiday parties, picnics and other social events you put on for your employees and their families are an exception to the 50 percent rule. Such events are 100 percent deductible.
- Loans. Did you borrow any money for your business this year? When your business borrows funds, you can deduct 100 percent of the business interest expenses. If you use a credit card for your business, you are eligible to deduct the business portion of credit card fees and finance charges as well.
Brian O'Connell is a Framingham, Massachusetts-based freelance business writer. His most recent book, B2B.com(Bob Adams Media), is available this September. His earlier books, Generation E: How Young Entrepreneurs are Changing the Corporate Landscapeand The 401(k) Millionaire, are available in bookstores. A frequent contributor to many national business magazines, he can be reached at Bwrite111@aol.com.