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If you are a cash basis calendar year taxpayer, consider paying any outstanding deductible expenses before the end of the year. This is based on the theory that due to the time value of money, taxes deferred are cheaper than taxes paid now. If you use a credit card, it still counts as paid this year. Do not do this if you expect your incremental tax rate to go up next year. On the personal side, if you itemize but don’t normally have enough medical to exceed the 7.5 percent AGI limit and you have unusually high, uninsured medical expenses this year, getting them paid off, even if you have to use credit, might benefit you. This approach is also often popular with your care providers.
Small business retirement plans work well for many small businesses and should be considered as a way to defer taxable income. SEP and SIMPLE plans are easy to set up, have low overhead and don’t have Form 5500 filing requirements. Unfortunately, SIMPLE plans must be set up by Oct. 1. However, if you find yourself at the end of the year in a higher than expected tax bracket, a SEP can be set up and funded as late as the due date plus extensions of your tax return.
Section 179 of the Internal Revenue Code allows an up front depreciation deduction of most business equipment placed in service during the year. This is commonly known as the expensing election and this year the maximum that can be expensed has been raised to $125,000. There is a phase-out of the expensing limit if you place in service too much qualifying equipment and that phase-out begins at $500,000 this year. The expensing election is severely limited for most passenger vehicles under 6000 pounds gross vehicle weight. For most SUVs and other vehicles between 6000 and 14000 pounds GVW the expensing election limit is $25000. Keep in mind, any amount of equipment purchases expensed can no longer be depreciated. Often clients ask if they should buy equipment before the end of the year. The short answer is; not if the after tax cost of the equipment does not exceed its economic benefit. I do like to point out that if all they care about is a tax deduction they could simply pay their accountant a lot more and that would be all currently deductible. So far, no one has wanted to do that. I don’t know why.
For those of you in the construction and manufacturing industries, don’t forget the Domestic Production Activities Deduction if you qualify. It’s not a real large deduction but it doesn’t cost anything and I suspect some folks are still missing this one.
Be advised that the IRS has increased its audit activity relating to several business issues including hobby loses, the employee vs. contractor issue, employee reimbursements and other “schemes for avoiding of payment of Social Security and Medicare taxes.” Perennial losses claimed on personal returns on schedules C and F (businesses and farms) are getting more attention. Remember, there has to be a reasonable profit potential. Be careful about unsubstantiated business expense reimbursements to employees. Giving cash for travel or a fixed amount to an employee for business use of their personal vehicle without substantiation will be treated as wages.
Contractors that are defacto employees due to the facts and circumstances of their employment may be treated as such. This is especially true if you fail to file forms 1099 for non-employee compensation. Get caught in any of these issues and in addition to paying the extra payroll tax, penalties and interest you get to amend your federal forms 941 and 940 and state Employment Security reports. You also have to amend your employees W-2’s which is always good for employee relations.
Then there is the issue of reasonable compensation. The net profit (after wages to owners) of a Subchapter-S corporation is not subject to payroll taxes. Some taxpayers have viewed this as an opportunity to drastically limit or avoid altogether payroll taxes on themselves. Simply leave themselves off payroll and treat anything taken out as earnings distributions. That would be great except the law requires reasonable compensation. Who gets to decide what is reasonable? If you get audited, the IRS does. The courts have been all over the map on this issue but generally there are three things I like to consider:
Compare the owner’s compensation to what he or she would have to pay someone else with similar credentials and experience to do their job.
Compare the owner’s compensation to what other non-owners in the business are getting paid. Compare the ratio of compensation paid to owners to earnings distributions. If you are not comfortable with the results of those comparisons, consider a bonus before year end.
Keep in mind the while IRS can re-characterize loans and distributions as compensation, if you have not taken anything from the corporation, there is nothing to re-characterize.
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