As 2002 winds down, it's a good idea to review your tax situation. With several new provisions in effect, there are plenty of deductions and deferrals to take advantage of.
"With declining income tax rates, entrepreneurs with limited liability companies, S corporations, partnerships or sole proprietorships who file individual returns will probably do well to defer as much as possible into next year when the rates will be even lower," says Arnie Koonin, tax partner in charge of personal financial services in the Washington, DC, office of accounting firm PricewaterhouseCoopers.
For example, self-employed, cash-basis businesses can delay billing so payments won't be received until next year, advises Jennifer Jones, a CPA in Fairfax, Virginia.
Here are some other ways to make the federal tax laws work for you:
Take steps to increase deductions. The larger the number of deductions you claim, the smaller your taxable income will be and the less taxes you'll owe. One of the best ways to boost deductions for cash-basis businesses is to pay as many of your business expenses as possible during this year. With the cash method of accounting, income is taxable when you receive it, and expenses are deductible when they are paid.
To beef up those deductions, stock up on business supplies or get equipment or vehicle maintenance done this month if you planned to incur these expenses in 2003 anyway. You also will want to consider prepaying some deductible business expenses, including any rent, taxes and insurance due on the first month of the new year.
Thinking about buying some new equipment? Do it now and place it in service before the end of the year. Under the federal expensing provision, you can deduct the full cost of your equipment purchase rather than depreciating it over several years. The amount you can deduct for qualifying equipment in 2002 is $24,000. That will increase to $25,000 in 2003. The $24,000 is reduced for every $1 of new equipment in excess of $200,000.
Schedule C filers are
as likely to be audited as taxpayers filing 1040s.
Source: CCH Inc.
Beware: Under the expensing provision, you're not allowed to expense more than the amount of your trade or business income, and thus produce a net loss. Remember, you can use a credit card to charge your purchase before the end of the year and still claim the deduction in 2002--even if the bill is not paid until next year as long as the equipment is placed in service before year-end.
In addition to the expensing provision, the Job Creation and Worker Assistance Act of 2002 provides entrepreneurs with a temporary depreciation bonus. Under the new law, small firms can deduct an additional 30 percent of the cost of most new equipment purchased during a specific time period. (See "What a Relief!" for more information.)
The new laws have proved to be a good area to strengthen deductions for entrepreneurs like Terri Bowersock, founder and owner of Terri's Consign & Design Furnishings Inc. in Phoenix. Her company has already taken advantage of this temporary provision by upgrading its computer equipment. With $36 million in annual sales, the company has 17 consignment furniture stores throughout the United States and recently launched a furniture trade-up business.
Gimme an "S"
Look into the tax savings available by electing subchapter S corporate status in the new year. Accountant Jones says such a step could help you reduce your payroll taxes by taking a lower salary, with the remaining profit distributed as a dividend, which is subject only to income taxes. The salary must be reasonable for the services performed and not set artificially low.
With certain exceptions, a corporation that has an S election in place does not pay federal corporate income taxes. Instead, S corporation income, losses, deductions and credits "pass through" to the owner to be reported on their individual returns, explains Mallory Collier, with accounting firm Jackson, Rolfes, Spurgeon & Co. in Cincinnati.
IRS face-to-face audits are down
from 1996 to 2001.
Source: U.S. Treasury Department
As a result, S corp income generally is taxed only once to the shareholder. With a C corporation, income is taxed twice--once to the corporation and again to the shareholders when dividends are paid.
Bowersock says using this strategy in her company at the beginning of 2002 was a huge advantage, especially with profits on the rise. "With S corporation status," she says, "we are able to avoid the double taxation we felt as a regular C corporation."
Odds and Ends
Business owners using the accrual method also have some specific tax-saving steps they can follow. Review your accounts receivable if you are an accrual taxpayer to see if anything is partially worthless. If it is, you can take a deduction for a portion of the amount of the uncollected debt. Check with your accountant to determine whether you meet IRS requirements to claim a bad-debt deduction.
Also scrutinize your inventory for obsolete items. If you dispose of the inventory or sell it below cost by the end of this year, you can receive a deduction.
Another strategy for businesses using the accrual method is to delay shipping products or providing services until the beginning of your 2003 tax year.
of revenue collected by the IRS comes from small businesses and self-employed taxpayers.
Source: CCH Inc.
Be sure to take full advantage of qualified retirement plans, such as 401(k) plans, Simplified Employee Plans (SEPs), Keogh plans and Savings Incentive Match Plans for Employees (SIMPLE). With a SEP, for example, you have until the due date of your return (including extensions) to set up the plan for 2002 and make contributions of up to 25 percent of compensation, Collier says.
If you set up a pension plan this year, you are eligible for the small employer pension plan start-up credit for up to 50 percent of up to $1,000 of qualifying administrative and retirement education expenses incurred.
Fund charitable donations. While donating appreciated securities to charity worked well in the past when the stock market was bullish, this year you will want to "sell losers, claim the loss on your personal return to offset any capital gains you have, and give cash to charity instead of securities," recommends Marty Janowiecki of PricewaterhouseCoopers.
Once you've exhausted the capital gains to offset your losses, it's still possible to use $3,000 of capital losses each year to offset other types of income, such as interest, dividends, wages or earnings from your business.
If you haven't already done so, consider establishing a flexible spending account for medical expenses. These plans help your employees deal with the increasing cost of medical expenses, Janowiecki explains, by letting them set aside pre-tax dollars for expenses such as deductibles and copayments that aren't covered by medical insurance.
You can also start a gifting program for your children or other relatives or friends. For 2002, the annual amount you can give tax-free has increased from $10,000 to $11,000 ($22,000 for married couples).
While tax planning should be a task you handle year-round, don't despair. There's still enough time remaining in 2002 to make some smart tax-saving moves that will help reduce your overall federal tax liability for this year and next.
New Tax Laws & e-Filing
What a Relief!
New tax laws mean more money stays in your business.
The tax picture for your business is brighter this year, thanks to the Job Creation and Worker Assistance Act of 2002.
One of the biggest benefits the new law offers is a temporary provision that allows companies to immediately deduct an additional 30 percent of the cost of most new equipment. Under the law, qualified property must be purchased after September 10, 2001, and before September 11, 2004, and must be placed in service on or after September 11, 2001, and before January 1, 2005.
The law is especially beneficial to entrepreneurs because they can use the extra depreciation deduction in addition to the small-business expensing election. Keep in mind that real estate generally won't qualify for the depreciation bonus.
Another plus for businesses is a provision extending the period in which a company can carry back losses to offset its income tax liability from two to five years. To be eligible for the extended carry-back period, the losses must have taken place in tax years ending in 2001 and 2002. The law also allows a company's net operating loss deduction to trim its alternative minimum taxable income up to 100 percent.
If you have a net operating loss for 2002 but it would be more advantageous for your business to carry it back just two years rather than five, you must make the IRS aware of this or the loss will automatically be carried back for five years, says Paul Gada, tax analyst with CCH Business Owner's Toolkit, a division of Riverwoods, Illinois, tax and business law information provider CCH Inc.
The new law also extended some expiring tax credits. Check with your accountant to see if you qualify for any of these. Those most likely to affect entrepreneurs include the work-opportunity credit, the welfare-to-work credit, and medical savings accounts.
Wire your filing to the agency and avoid all the painstaking pencilwork.
The federal government wants the electronic filing of tax returns to grow. The Bush Administration has set a goal of providing a free-filing option for all taxpayers by 2004. As part of this effort, the Treasury Department and Office of Management and Budget recently announced a new program with sellers of electronic tax-preparation services. It will allow about 10 million more Americans to file their tax returns with the IRS for free starting in 2003.
Under the agreement, companies such as Intuit and H&R Block will work together to offer free online tax-filing services. The new free-tax-filing consortium Web page is slated to be online by December 31.
For business taxpayers, the Electronic Federal Tax Payment System (EFTPS) is available. While any business taxpayer can use EFTPS, many are required to do so. The system allows taxpayers to use the phone, personal computer software (for businesses only) or the Internet to initiate tax payment reports to EFTPS directly.
EFTPS must be used to make deposits for Social Security, Medicare, withheld income, and excise and corporate income taxes if you deposited more than $200,000 in federal depository taxes during a calendar year. If this occurs, the IRS requires that you use EFTPS beginning with the second year succeeding that calendar year.
For example, if you first met the $200,000 threshold in 2001, you must begin using EFTPS in 2003. If you are required to use EFTPS but fail to do so, you may be subject to a 10 percent penalty. Keep in mind that once you meet the requirement to use EFTPS, you must continue using the system even if your deposits in future years drop below the threshold amount. For more info, check out www.eftps.gov to see Publication 966, Now a Full Range of Electronic Choices to Pay All Your Federal Taxes.
Helpful Sites & Gear
Everything you ever wanted to know about taxes
The latest tax developments and planning advice are just a mouse click away on the Internet. Here are some of the most useful tax Web sites for small-business owners:
- IRS: The IRS' Web site gives you the official version of the latest tax developments. You can also download IRS forms and publications. Once at the site, click on "Business" and then "Small Bus/Self-Employed" for tax information affecting entrepreneurial companies.
- CCH tax group site: This site includes comprehensive tax information and resources on all types of personal and business tax issues.
- Small Business Taxes & Management: One of the best sites for entrepreneurs looking for in-depth tax information, it includes updates of federal rules, summaries of revenue rulings and procedures, and small-business links.
- Tax Planet: Tax planet is not just for business owners, but it does include many articles entrepreneurs will find useful, such as those dealing with the latest tax developments. The site also includes a 2002 tax season guide.
Gear Sound the alert: You can keep abreast of tax developments with Quicken's 2003 Premier Home & Business ($89.95, minus $20 rebate for upgrade; www.quicken2003.com, 800-952-2558). Its Tax-Informed Investing Alerts will notify you if there's a change in your portfolio. It includes three new tax reports and an improved paycheck setup, so you'll be able to track tax withholdings more efficiently.
Floor it:TurboTax 2002 Premier Home & Business ($79.95, www.turbotax.com, 800-782-9430) makes filing self-employment and personal taxes a breeze. It helps you figure out home office deductions and provides special resources for preparing Schedule C taxes. The Business edition ($99.99) offers a tax library and prepares and prints W-2 and 1099-MISC forms for employees and contractors.
Make the cut: TaxCut ($49.95; www.taxcut.com, 800-457-9525) from H&R Block lets you import data from Quicken and other tax software. Handy business features include the Home Office and Capital Gains assistants, as well as the Stock Options advisor. Got questions? The Platinum version lets you ask tax professionals specific questions about your tax return.
- Jackson, Rolfes, Spurgeon & Co.
(513) 595-8800, www.jrscpa.com
- Jennifer Jones
(703) 352-1587, www.jajonescpa.com
- Terri's Consign & Design Furnishings Inc.