Hans Kasper, MS-CPA, PSBusiness
Tax Planning
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"A business, like
and automobile, has to be driven in order to get results."
~ B.C. Forbes, publisher
Even as a CPA, I do not believe that you should become overly concerned about taxes. That doesn't mean that the importance of income taxes should be ignored, but to spend your whole life trying to avoid them is very depressive.
The average business owner should spend about one day or two half days per year reviewing their income tax situation and finding ways to minimize their tax burden.
Review of the items below may help you with this process.
Many small business owners are afraid to be audited and are, therefore, afraid to take an Office in the Home deduction on their tax returns many people have heard that you will be audited if you do. That is very incorrect. If it were true that Congress did not want you to have such a deduction, then they would not have written it into the law. Therefore, if you know what the law is, then you can abide by the law, make it work for you, and not live in fear of it.
Here is what the law says: if you use a portion of your home exclusively (does not have to be the exclusive use of an entire room, it could be the exclusive use of a part of a room or garage) for business including the storage of inventory, supplies and tools, then you can take an office in the home deduction. This especially includes buildings that are separated from your home.
The deduction includes the business portion (a square footage of space used for business / total square footage of dwelling):
real estate taxes,
mortgage interest,
gas, electric, water, garbage, homeowner dues,
repairs,
home insurance, and
depreciation on major home improvements and the home.
Many people become confused about taking the depreciation on the office in the home and selling their home at a later date. Here is the rule and how it benefits you.
As you know, when you sell your home, if the gain on the sale is less than $500,000 and you are married filing jointly and you have lived in the home for two of the last five years, then you do not have to pay tax on that gain.
You also may know that when you take depreciation and later sell that property, then you have to pay tax on that depreciation.
When you take depreciation on the office in the home you will receive a tax benefit between 30% and 43% (income tax and self-employment tax) depending on your tax rate of the deduction taken. Example: if the depreciation deduction is $1,000, then the tax savings will be either $300 or $430.
When you sell the home, you must recapture or pay tax on that depreciation. However, the tax rate is the capital gains rate of 15% or $150.
That appears to be a tax savings of $150 or $250. In addition, you have also saved taxes on all of the other related deductions stated above.
An office in the home deduction looks like a winner to me.
Click here for very important information about office in the home insurance.
This section of the IRS code is more commonly called "additional first-year depreciation." Generally, it only applies to section 1245 property (equipment, vehicles, and other tangible-personal property--in other words, it does not apply to real estate) that is used in a business (this excludes the rental of real estate).
For 2006, the amount is $108,000. This means that you can immediately deduct as a business expense 100% of the first $108,000 of total equipment purchases during 2006. The amount of total equipment purchases in excess of the $10,000 must be depreciated. However, if the total equipment purchases during 2006 exceed $432,000, then you will not be able to utilize the first-year allowance and must depreciate all of your equipment. Why? Because, the intent of this section was to assist small businesses and anyone who can afford $432,000 of equipment is not deemed to be a small business.
Therefore, here is the policy that you will want to establish.
The first $108,000 (2006) of that equipment will be utilized against the section 179 allowance.
The excess above the $108,000 limit will have to be depreciated over their required lives.
And, of course, here is the exception--If you are in a low tax bracket this year and fully expect that this is RARE and the future years will be higher tax brackets, then you will not want to use the section 179 depreciation this year and will depreciate all of your current year's purchases. By doing this, you will be pushing the tax deduction into higher bracket years.
The election to use accrual vs. cash basis accounting for tax purposes is one of the most important decision you will make. In many cases, this election will not be available to you based on the type of business that you have--you will have to be accrual basis. If this election is available to you, in some cases you will want to be accrual basis and in other cases cash basis.
Accrual basis means that you will pay taxes on the difference between accounts receivable and accounts payable. If your accounts receivable is greater than the accounts payable, then that means that you will pay taxes on the net of ARs that you haven't collected yet less APs that you haven't paid yet.
Cash basis means that you will only pay taxes on income that you have collected less expenses that you have paid.
The types of businesses that must be accrual basis are those with inventory--manufacturing, retailing, and wholesaling.
All others can be cash basis if their revenues for the year are less than $10,000,000.
If you are currently accrual basis, are eligible to be cash basis, and want to switch to cash basis, then you can elect to do so by having us prepare a special election form. YES, eventually, you will have to pay the taxes anyway; however, since cash flow is very important to small business, I would put the cash in my pocket now and worry about taxes later.
Click here for full information on Section 105 tax plans that will allow you as the owner to deduct 100% of your medical insurance and medical expenses as a business expense.
Click here for full information on Section 125 tax plans that will allow the owner and employees to deduct 100% of your medical insurance and medical expenses as well as dependent care pre-tax from their payroll checks.
Hiring your children is one of the best income shifting opportunities available to the small business person. Congress legally allows this because they want small businesses to be family run into the next generation, to provide a tax benefit to small businesses, and to create small business owners for the future.
This section of the law is not meant to be an abuse of the law. You must:
Really hire your children (They should be at least 12 years old or it can be questionable if they are really able to work. I would not want you to ruin your children by giving them money without working. You would be teaching them that they should receive benefits without putting forth an effort.),
Keep time sheets for them,
Issue a W-2 for them and file the applicable payroll tax returns (Form 941 quarterly, Form W2 and W3 on January 31st, Form 940 January 31st, Labor and Industries report quarterly, Employment Security (N/A)),
Not overpay them (as compared to any other person you would hire to do the job),
Give them free control over the money they earn--go into a bank account in their name (of course you could always stop feeding them if they will not do what you want with the money),
Obtain a child work permit from the Department of Labor and Industries if the child is under 18, and
If you are a sole proprietor or a general partner in a general partnership and you child works for you, then you do not have to pay the following taxes: FUTA if your child is under age 21, Fica and Medicare if your child in under age 18, and Suta if your child is under age 18. You will have to pay Labor and Industries at all ages. If you are a "C" or "S" corporation, then you will have to pay these taxes no matter what age your child is.
The benefits are:
the work gets done and you didn't have to do it,
a significant tax savings since you get a tax deduction for the salary paid to your child, you are in the 30% or 43% tax bracket including S/E tax, the child (having no other income), if paid $4,000 or less, pays no income tax, and. on a child under 18, you pay no social security tax on the child's wages, and
the child starts a college saving program that they have worked for. A reminder: colleges assume when granting loans that money in the name of the child will be used 100% for college costs and money in the name of the parents will be used 33% for college costs.
Retirement plans for the small business are one of the greatest savings plans in the tax law. Congress, in recent years, has continuously increased the amount you can contribute to a retirement plan. The reason for these changes is that they realize that social security is not going to be sufficient and they want to encourage you to save.
For additional on types of IRS approved retirement plans, click here.
For a business owner, income taxes are an infringement on cash flows needed to operate the business. Every legal method should be used to reduce the cash flow impact of income taxes on the business. Besides utilizing the specific techniques mentioned on this page to reduce income taxes, you may also legally shift income and expenses into the current or next year.
Increasing net income--shifting income into the current year and expenses into the next year-- is important when you are coming into the end of the year with a net loss. This is particularly true if you are a sole proprietor, a partner, or an "S" corporation owner, and this loss will give you a negative taxable income on your personal tax return. A negative taxable income is a permanent, unrecoverable loss of tax benefits.
Decreasing net income--shifting income into the next year and expenses into the current year--is important when you are coming to the end of the year with a significant profit. This is particularly true if you are in an unusually high tax bracket for the current year. An irregularly high tax bracket is a permanent, unrecoverable payment of higher taxes.
Legally shift income into the next year by:
(accrual basis) delaying shipments of products or completion of services into the next year--do not ship product in this year and delay billing into the next year.
(cash basis) delaying deposit of cash receipts by going on vacation or closing the business during the last part of the year--do not collect the mail and hold the check for deposit early in the next year.
Legally shift income into the current year by:
(accrual basis) accelerating shipments of products or completion of services into the current year--do not ship product in next year and accelerate billing into the current year.
(cash basis) accelerating deposit of cash receipts by calling on collections during the last part of the year--do not receive the money into next year and backdate the deposit into the current year.
Legally shift expenses into the next year by:
(accrual basis) delaying the receipt of expensible products or services into the next year by contacting the vendors to delay delivery until after the end of the year--do not hold product on your shipping dock or book the expenses in the next year when they belong in the current year.
(cash basis) delaying the payment of expensible products or services into the next year--do not write the checks at the end of the year and book them in the next year.
Legally shift expenses into the current year by:
(accrual basis) accelerating the receipt of expensible products or services into the next year by contacting the vendors to deliver before the end of the year--do not book the expenses in the current year when they belong in the next year. Review accounts receivable and write off bad debts. Accrued, unrelated employee compensation that is paid within 2-1/2 months of the year end is a deduction in the current year.
(cash basis) accelerate payment of expensible products or services into the current year (you can not create a negative cash balance and receive a tax deduction on the cash basis as this would simply be treated as an accounts payable)--do not write the checks in the next year and book them in the current year. HOWEVER, if you buy it on a credit card that you will pay in the next year, then you can deduct it in the year you signed the charge slip. Credit cards are bank loans--you borrowed the money to pay the bill in the year you signed the charge slip.
A significant tax deferral and tax savings can be obtained by managing when and how much bonuses are paid to the owners.
Prior to 1986, a "C" or "S" corporation could, at the end of the year, accrue and take an expense for a bonus to the owner(s) and defer the payment of the bonus to the owner into the next year. By doing do, the corporation would receive a tax benefit in the current year and the owner(s) would not have to report the income until the next year.
However, since 1986 when the tax law was changed, an "S" corporation can not utilize this tax deferral technique and a "C" corporation can only do so if the bonus being accrued is for a 50% or less owner. Also, the bonus must be paid within 2-1/2 months from the year end of the corporation. Bonuses must be paid before the end of the year to "greater than 50%" owners of "C" corporations. Bonuses, as a tax deferral matter, are of no importance in an "S" corporation.
However, bonuses can be used to permanently save taxes by properly utilizing tax brackets in both the "C" and "S" corporations.
Owners of "C" corporations whose tax brackets are less than the tax brackets of the "C" corporation should pay themselves bonuses before year end to save taxes by shifting income from the higher "C" corporation tax bracket and to the lower owner's tax bracket. For example: shifting income from a corporate tax bracket of 39% to an owner's tax bracket of 15% can be a 24% tax savings.
Mathematically, it is never better to pay yourself a dividend from a "C" corporation in place of taking a salary or bonus. The one exception to this rule is that you have not paid in your payroll taxes or claimed a salary during the year, have taken money out of the corporation as a loan to live on, and now have to pay tax on the withdrawal. Then, the additional tax for paying dividends as opposed to a salary is less than the penalties for not paying your payroll taxes.
Owners of "S" corporations who have related owners in the business can save taxes by shifting income from their tax bracket to their relatives tax bracket by issuing bonuses to those relatives. The bonuses must be reasonable and reflect the position of the person within the company.
Some or all of a trip may be business related. Knowing the rules will allow you to take tax deductions you would have ordinarily missed.
Travel In The US
If the trip was primarily for business and some of it was for personal travel, then the total trip minus the personal portion can be deducted.
If the trip was primarily for personal reasons and some of it was for business purposes, then the business portion can be deducted.
Business travel on Luxury Cruise Ships have daily limitations of twice the highest federal per diem rate. Total expenses are limited to $2,000 per year.
You can not deduct the travel expenses for your family unless you can show that they work for the business in a decision making status.
Meals and entertainment are only 50% deductible.
Documentation must be kept including:
Receipts for all expenses.
A log for each day stating what your business activities were and who they were with.
WARNING: As a general rule, owners of "C" corporations should make all of their charitable contributions personally and not through the "C" corporation. However, with the itemized deduction phase out rules, if their personal income is in the phase out zone and the "C" corporation's net income is high, then it may be better have the "C" corporation make the contribution. Please call us on this matter.
A tax credit is available for research expenses incurred to develop new products. The amount of the credit is a function of the amount spent and the revenue of the company. For more information, please call us.
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