Ten tax tips for the small business; here are the tax planing areas that will be important in 1990.

TEN TAX TIPS FOR THE SMALL BUSINESS

Here are the tax planning areas that will be important in 1990.

Tax practitioners often are asked two tough questions by the small business owner: What's left for tax planning? What tax strategies should I be looking at for my business?

Often these questions are raised with the expectation that tax incentives, shelters and gimmickry are still part of our tax system ("Give me that hot new idea to make a big cut in my taxes!"). However, since the Tax Reform Act of 1986, the word "loop-hole" has left the tax professional's vocabulary. In pre-TRA days, it was easy to add a quick yearend tax shelter rather than develop a tax plan. But today, tax planning is back to what it always should have been: a roll-up-the-sleeves and work-through-the-fundamentals approach. It's not easy and not glamorous. But now there's no substitute for a back-to-basics approach.

The following checklist of 10 key areas of tax planning for the small business owner is intended to provide the tax adviser with a working guide to what's important in the coming year:

[check mark] RECONSIDER QUALIFIED RETIREMENT PLANS

Most tax advisers look to forms of qualified retirement plans as their first choice for tax-saving techniques. The current deduction--combined with pretax compounding of invested funds--is hard to beat. For the self-employed business owner, careful consideration should be given to the best vehicle. Is it an

* Individual retirement account?

* Keogh plan?

* Simplified employee pension (SEP)?

While SEPs are attractive because they don't require Internal Revenue Service reports, the low threshold for part-time worker coverage can be a problem ($300 per year compared with the 1,000-hour-per-year Keogh rule). And for the business owner able to set aside larger amounts, a defined benefit plan--either a corporate retirement plan or a Keogh plan--still can produce a substantial annual tax deductible investment.

Conversely, those with established plans should evaluate their merits continually. Are plan administration costs with frequent amendments becoming burdensome? Are allocations to other employees outstripping the benefits to the employer-owners? And will the 15% tax on excess distributions present a problem in retirement years? In some cases, abandoning a qualified plan and increasing taxable income to owners currently at the 28% bracket may produce a better long-term result.

[check mark] MINIMIZE FICA 

While income tax rates have slid in recent years, FICA costs have risen dramatically. In 1990, the self-employed will have a particular shock as the self-employed rate jumps to 15.3% on a maximum base of $51,300. For small corporations, can earnings be extracted as rent or interest on shareholder loans, rather than as compensation? If there are related corporations with common employees, the common paymaster rule of Internal Revenue Code section 3121(s) should be used to centralize the payroll within one corporation and eliminate multiple FICA-base taxation. For those with proprietorship or general partnership structures, a switch to S status may be helpful. Only direct compensation from an S corporation is subject to FICA; distributions of income to S shareholders are exempt from FICA or self-employment tax. Remember, however, the IRS has the clear authority to attack arrangements where S shareholder compensation is artificially low.

[check mark] REVIEW STRUCTURE OF BUSINESS ENTITY

The TRA caused a wholesale reexamination of the choice of entity for a small business. Should it be an

* S corporation?

* C corporation?

* Partnership?

* Proprietorship?

Besides the influence of the changing tax laws, the tax adviser must recognize that ongoing business changes--new products and services, changes in ownership and additional business locations--can merit a change in the form of organization. For example, although a family partnership may have served well in the past, the addition of a new, unrelated owner may necessitate conversion to S corporation status.

Multiple entities controlled by the same owners are growing increasingly popular. Business real estate might be best placed within a family partnership (with active family members as general partners and uninvolved members as limited partners) while active business operations might be organized as a corporation or several corporations. C, or regular, corporations might be used to render management services, providing a vehicle for tax deductible medical and other fringe benefits, and S corporations can be used for remaining business operations.

[check mark] PLAN BEFORE YEAREND

While the recent low and broad tax brackets require less attention to yearend tax planning, important savings still can be recognized as yearend approaches. A taxpayer who has crept into the 33% individual bracket by a modest amount may gain impressive tax savings by simply accelerating yearend expenditures.

Remember tax brackets can be deceptively complicated these days. While a return at first blush may appear to be in the 33% bracket, phaseouts may be reducing deductions such as rental losses and IRAs--thereby increasing the true marginal bracket. For example, a self-employed taxpayer with preliminary form 1040 adjusted gross income of $150,000 might decrease taxable income by $15,000 when adding a Keogh plan deduction of $10,000 (that is, the $10,000 Keogh contribution reduces AGI so as to allow 50% or $5,000 of a rental loss to become deductible). Stated another way, the $10,000 Keogh plan investment has produced a 49 1/2% federal bracket impact rather than one of 33%.

[check mark] SEARCH FOR TAX-FREE FRINGES

In 1989 the new section 132 regulations on tax-free fringe benefits were issued. These fringes include employee discounts, working condition fringes, employer services and de minimis items, all of which can be furnished tax-free to employees--while remaining fully deductible by the employer. Has the business taken advantage of any of these items?

The regulations also clarified the methods for computing the personal-use value of employer-provided vehicles. Personal use of a company-provided vehicle may be valued in 1989 under either the annual lease value tables or the cents-per-mile method, but thereafter a consistency rule applies. Also, automobiles that have been stuck with a high original value for the four-year period commencing in 1985 now can be revalued to a lower amount for the 1989 calculation.

[check mark] ELECT SEGREGATED TREATMENT FOR PASSIVE ACTIVITIES

The regulations defining an "activity" for passive loss purposes were issued in 1989. (See JofA, Oct.89, page 50.) Small business owners and entities that have either rental properties or multiple business activities must make two important elections in filing their 1989 returns.

1. Those with multiple rental properties must include a disclosure statement in their returns identifying which rental properties are to be treated as separate activities and which are being combined as a single activity. In general, rental property owners will elect to segregate each property to allow use of any suspended losses on disposition.

2. Owners of multiple business undertakings in their 1989 returns can deem separate business locations as separate activities in the event of disposition--even though the separate locations are aggregated as a single activity by the regulations. This protective election assures the owner disposing of a single business location that suspended losses can be used--even though that location is otherwise part of a larger single activity.

[check mark] REVIEW THE OWNER'S ESTATE PLAN

Due to the recent increase in the estate exemption to $600,000 per individual, the need for estate planning has been minimized in the eyes of many. However, because the gift/estate unified rate schedule starts at 37% on any amounts in excess of that exemption--and quickly rises to 55%--the need for careful estate planning should not be overlooked.

IRC section 2036(c) in the 1987 Revenue Act added a new hurdle, causing businesses or other property to revert to an estate when there has been a transaction that has shifted a disproportionate amount of the potential appreciation while retaining an income or voting right. The new safe harbors to section 2036(c) added by the 1988 Technical and Miscellaneous Revenue Act as well as the guidance provided by recent IRS notice 89-99 (see JofA, July89, page 36) should be carefully reviewed by the tax adviser when reviewing the estate plan.

[check mark] ANALYZE COMPLIANCE WITH ACCOUNTING METHOD RULES

Legislation since the 1986 TRA has continued to tamper with accounting method rules. Has the business fully complied with section 263A uniform capitalization rules? Remember, virtually any manufacturer is subject to them--only larger retailers and wholesalers with average annual gross receipts over $10 million are exempted. If the business has been using the cash method, does it remain eligible to do so? Or has the sale of goods mandated the accrual method under regulations 1.471-1 and 1.466-1(c)(2)? If this is the case, perhaps the business activity representing the production or sale of merchandise can be segregated to preserve the cash method for the service activities. Also, are there any opportunities for a last-in first-out inventory valuation election?

[check mark] BEWARE OF INDEPENDENT CONTRACTORS

Carefully scrutinize any independent contractor arrangements, particularly those in which the worker performs services on the company premises in either a regular or extended manner.

The IRS has shown a renewed interest in the issue of independent contractors versus employees, and it's quick to impose substantial back payroll taxes and penalties on a business that erroneously has categorized employees as independent contractors. Practitioners should see revenue ruling 87-41 for a list of 20 factors used by the IRS to analyze this issue, as well as IRS form SS-8.

[check mark] COMPLY! COMPLY! COMPLY!

In this era of harsh IRS penalties, every business should give careful annual scrutiny to its compliance with forms W-2, 1099 and so forth. Expense disbursement accounts should be reviewed for the need to issue 1099s to noncorporate recipients of interest, rent and fees; and new IRS W-2 instructions should be analyzed. On the 1989 W-2, employers should include in box 10 only mileage reimbursements in excess of the $.25 1/2 standard rate (previously, the entire mileage reimbursement was treated as gross wages if the rate exceeded the IRS standard). Also, a new disclosure must be made in box 16 of the W-2 for employer-provided dependent care benefits.

ANDREW R. BIEBL, CPA, is a partner of Biebl, Ranweiler & Company, New Ulm, Minnesota. He is immediate past president of the Minnesota Society of CPAs.