saving tax dollars.
Although December 31, 1999, marks the end of the millennium, it will be business as usual over at the IRS. Do not underestimate the importance of year-end planning. Your business can save big tax dollars by deferring or shifting income from one year to another and making the right moves before year-end. Time is of the essence, though. Delay can cost you, says Barry Weisman, Esq., a tax lawyer with Goldstein & Manello in Boston. Weisman notes that many year-end tax moves require time to implement. Says Weisman, "Make sure you give yourself enough time to implement whatever tax-saving moves you decide to make. Many of them cannot be done overnight." Here's a rundown of some of the more important tax moves Weisman believes you can make before 1999 draws to a close.
There's a chance to save some tax dollars, if your business is a C (regular) corporation. Unlike an S corporation or a partnership, a C corporation is taxed as a separate entity. The first $50,000 of income is taxed at 15%. The next $25,000 is taxed at 25%; the next $25,000 is taxed at 34%. Taxable income from $100,000 to $335,000 is taxed at 39%. (This is done to eliminate the graduated rates on income below $100,000.) You may be able to take advantage of the graduated rates to substantially reduce this year's tax bite through "marginal tax rate analysis."
For example, Jim is an employee and the sole shareholder of XYZ Corp., a C corporation. Based on Jim's best estimates, XYZ will have taxable income of $125,000 during 1999. Thus far in 1999, Jim has taken only $65,000 in salary. Jim and his wife Mary together have taxable income of $60,000. That puts them well within the 28% bracket. On the other hand, the last $25,000 of income of XYZ will be taxed at 39%. If Jim increases his salary by $25,000, XYZ's income will decrease by that amount, saving $9,750 in taxes. His personal income will go up by the same amount, resulting in an additional $7,000 in taxes. The $9,750 reduction in corporate taxes less a $7,000 increase in personal taxes yields a permanent tax saving of $2,750. You can calculate your potential tax saving by finding the difference between your tax bracket and your corporation's. In this example, the difference is 11% (39% less 28%). Multiply that by the amount of the income shift ($25,000 in this case) and you have your answer.
Contributions to Keogh Plans. In order to ensure the tax deductibility of your contributions to a Keogh plan, make sure you make them in time. Your Keogh plan must be established by December 31, 1999, although you have until April 15, 2000, to make your 1999 contribution.
Sale of Real Estate. If your business owns real estate that has appreciated in value and you are considering selling it before 1999 draws to a close, one way to avoid incurring taxes on your capital gain is to make a "like-kind exchange" for another similar property that will also be held as an investment. If you make such an exchange, no income tax is due now. Income tax will be payable only when you dispose of the second property.
If you do business as an S corporation, partnership, sole proprietorship, etc., the net income (or loss) of your business is passed through to you and reported on your individual tax return. If you anticipate being in a lower personal income tax bracket next year, try to defer current year income. Conversely, if you think you'll be in a higher bracket next year, try to accelerate income into 1999. By now, you should have a good idea of which way your income is headed. If 1999 is going to be a big year and 2000 won't be as good, you want to push income into 2000. If it's a toss-up, you should probably still defer income; it will improve your cash flow by delaying tax payments.
Accelerate purchases. Buy office and operating supplies you'll need next year, perform necessary repairs and maintenance on equipment, get started on that advertising program. Be careful, though. Make sure the repairs are really repairs, not capital improvements.
You can't prepay certain expenses such as insurance, interest, or taxes, even if your business is on the accrual accounting method. For example, if you pay for a year's worth of insurance on November 1, you can only deduct 1/6 in 1999. The remainder is deductible in 2000.
If your business is on the cash basis accounting method, payments made by December 31 are generally deductible. So make sure you pay any bills before the end of the year. Payments made in cash, by credit card, or by check mailed before the end of the year count as tax deductible 1999 business expenses.
TIMING THE ACQUISITION OF DEPRECIABLE PROPERTY
The tax reform legislation enacted 13 years ago bars business owners from placing business equipment into service at the end of the year and still getting a full year's worth of depreciation. Under present rules, when you place depreciable assets into service has a direct bearing on the depreciation allowance you are entitled to. If you place more than 40% of your annual equipment purchases into service during the last quarter of the year, all of the business equipment placed in service during the year is subject to the "mid-quarter" rule. Under this rule, the quarter during which an asset is placed in service governs your depreciation allowance; the middle of that quarter is used to calculate the amount of depreciation you're entitled to. "Placing equipment into service" means that it's ready to be used; it need not actually be placed in use.
If you place 60% or more of your equipment into use during the first three quarters of the year, you are subject to the half-year rule, which treats all equipment placed into service during the year as having been placed into service halfway through that year.
If you're contemplating purchasing business equipment before the end of the year, it's prudent to ascertain where you stand with respect to the half-year versus the mid-quarter rules.
In order to determine whether you'll benefit more from the mid-quarter or the half-year rule, you must perform alternate calculations and vary the timing of asset acquisitions to see which acquisition schedule is most advantageous. If you're planning to acquire business equipment before the end of 1999, ask your accountant to go through these calculations with you. You may be in for a pleasant surprise.
Fringe benefits. You still have some time to set up a pension plan for this year. A Simplified Employee Pension (SEP) plan or a regular profit-sharing plan may make sense. Ask your tax advisor what form of pension plan is best for your business. In addition, don't forget to pay bonuses to employees before year-end if it has been a good year. Paying these bonuses in 1999 will reduce your business's taxable income.
Expense accounts. Make sure all of your employees turn in their expense reports on time. If your business is on the cash basis, consider a December 20 cut-off so that all reports can be processed and the checks cut before the end of 1999. If your business is on the accrual basis, get after those habitual late filers to ensure that your liability is booked in 1999.
Write-offs. You can write off the value of equipment abandoned before the end of the year, less any depreciation already claimed. In order to claim a loss you must take some positive action, such as selling it for scrap (make sure you get a receipt), donating it to charity, or selling it to another business. If you do nothing, you'll lose the tax deduction.
Business bad debts. You can deduct business bad debts that are partially or wholly worthless, but you must have proof that a debt is uncollectible. You should make a concerted effort to collect the debt before the end of the year. To prove that you have tried to collect the debt, keep copies of all correspondence, and send your letters by certified mail. Consider turning the collection over to an attorney who specializes in bad debts. You may have to pay 25% to 50% of what he or she recovers, but it'll be worth it if some cash is collected and you get a tax deduction for what's still left outstanding.
Inventory write-offs. Inventory write-offs can be tricky but may produce substantial savings. You must be able to show a decrease in the value of your inventory. That may not be difficult if you use the "lower of cost or market" inventory valuation method and can prove the current market prices. If that option isn't available, you can show a decline in the value of your inventory by documenting actual sales within 30 days of the inventory date. You should value the inventory at its selling price less the cost of disposal. Inventory items that may qualify for a write-down include shopworn, obsolete, out-of-style, etc., goods. You can also write down the value of unsalable goods such as goods damaged in processing, returns, etc.
You may take a full deduction and write off as an expense up to $19,000 of the cost of equipment placed in service during 1999 instead of depreciating it. If you haven't availed yourself of this option yet, keep in mind that equipment placed in service during 1999 that's going to be expensed can be written off regardless of when it's acquired. Even the last day of the year. If you decide to expense an equipment purchase, it doesn't matter when it is acquired during the year. One thing to watch out for is if you later on convert the equipment to nonbusiness use, you have to pay the government back for the deduction you previously took, so make sure you expense something that will remain in your business. The $19,000 expensing allowance is only available to you if you haven't already acquired other business equipment in 1999 that's valued at more than $200,000. If you have, this option is phased out on a dollar for dollar basis when you go over the $200,000 threshold and disappears entirely if you acquire more than $210,000 of business equipment in 1999. The $19,000 expensing allowance can only be used to offset taxable income from your business. If your taxable income falls below $19,000, you don't get the full benefit of taking the $19,000 expensing allowance. But if you have another business that has taxable income, the unapplied balance can be applied against taxable income from the other business.
Mark Prendergast, a CFP and CPA based in Fresno, Calif., makes an interesting observation about the expensing deduction. Some individuals take it who shouldn't. Individuals who have both a sideline business and wage income are often too quick to use the Section 179 expensing election. Says Prendergast, "If expensing an equipment purchase results in a net loss for your business, that will reduce your income tax liability on a dollar for dollar basis but not your self-employment (SE) tax liability." Prendergast explains that the 15.3% SE tax stops when your net income drops below zero. For example, if your business income is $10,000, the SE tax on that income is $1,530. But if you expense a $15,000 equipment purchase, and you only have $10,000 of self-employment income to apply it to, you'll only wipe out your self-employment tax liability on $10,000, not $15,000. So you're losing the ability to reduce your self-employment tax liability on an additional $5,000. But if you depreciate the equipment purchase, you won't get as much of a write-off this year, but over a five-year period that $15,000 purchase will offset your income and self-employment tax liability on $15,000.
ACCUMULATED CORPORATE EARNINGS
Small, family-owned corporations often retain earnings within the corporation rather than declaring a dividend so they avoid the double taxation of these earnings, i.e., initially as corporate earnings subject to the corporate income tax and then as personal income received by the officers of the corporation (your family members) through corporate dividends that are subject to individual income tax. There is a $250,000 limit set on the amount of accumulated earnings that a closely held family corporation can have. Any accumulated earnings in excess of the $250,000 limit are subject to a 39.6% penalty tax. To avoid incurring this tax, make sure by year's end that you declare sufficient dividends to stay clear of the $250,000 limit. The only exception IRS allows to the $250,000 limit is if you can show that the earnings are being retained in order to meet the reasonable needs of your business. Some examples of "reasonable needs" are retaining the earnings in your business to provide you with the money you need for working capital or future expansion. Another example is retaining the earnings in order to purchase a facility that you are currently renting. But if the IRS challenges the retention of corporate earnings in excess of $250,000, you'll have to be able to document the business purposes for which these excess retained earnings are being held. If your contention is that you're retaining the excess earnings in order to acquire property, you'll need to have documentation, such as cost estimates from builders, architects' plans, insurance estimates, etc., to show that you were retaining excess earnings for such a purpose. Without such documentation the IRS will disallow your claim and impose the penalty tax.
Milton Zall is a freelance writer based in Silver Spring, Md., who specializes in taxes, investments, and business issues. He is a Certified Internal Auditor and a Registered Investment Advisor. You can reach him at (301) 649-6044 or firstname.lastname@example.org.
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|Date:||Nov 1, 1999|
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