The year 2003 may be receding into memory, but it's not too late to save money on last year's tax return. Remember the Jobs and Growth Tax Relief Reconciliation Act of 2003, signed into law by President Bush on May 28? You probably heard loads about reductions in the capital gains tax and the dividend tax--both of which seem more useful to investors than to entrepreneurs. But small businesses were not left out. The new law also contains several lesser-known provisions that can save you serious money.
Tax time, of course, is fast approaching. If you still haven't filed--and especially if you've recently made significant equipment purchases--check out these four, little-heralded provisions, and take another look at your books. If you have filed, don't fret: These rules will be in effect at least through 2004--so get a jump on tax planning for next year. In some cases, you have the option of filing an amended return to take advantage of some of the tax breaks now.
1. Enhanced Expensing
If you purchased equipment for your business in 2003, you can now deduct a whole lot more of it than you ever could before. In 2002, the IRS capped the deduction for new equipment purchases at $24,000; any amount more than that had to be depreciated. The 2003 law bumped the maximum amount up to $100,000.
The new expensing rules apply to both new and used equipment, from a car to a server to a new set of desk chairs. What's more, for the first time ever, "off-the-shelf" software, such as Microsoft Office or Quicken, now qualifies as equipment in the eyes of the IRS. The only catch: If your annual spending exceeds $400,000, a "dollar-for-dollar phaseout" applies, says Janet Korins, partner at Proskauer Rose LLP in New York City. That means that for every dollar you spend over $400,000, a corresponding dollar is subtracted from your $100,000 maximum deduction. For example, if you spent $450,000 on equipment in 2003, your maximum deduction would be $50,000. And if you spent $500,000, you wouldn't be able to take advantage of this enhanced expensing at all. The new expensing rules will continue through 2005, and the thresholds will be adjusted each year for inflation. In 2004, the maximum deduction will be $102,000, and the limit will be $410,000, so keep that in mind when planning purchases this year.
The benefits of these new expensing laws go far beyond the smaller sum at the bottom of your tax return. They also give you a lot more flexibility, says Carol E. Kuc, president and CEO of Complete Conference Coordinators Inc., a 10-person event-planning company in Naperville, Ill. In the past, Kuc always spread equipment spending over several years in an effort to stay below the old threshold of $24,000. In 2003, she moved her company into larger digs and invested in new furniture, computer systems, and telephones--all at once. "We were not hampered by that [lower] threshold," she says. "We were able to make the purchases we needed."
2. Bonus Depreciation
Enhanced expensing works great if you spend $100,000 or less on equipment--you can simply subtract the entire amount from your taxable income. For those who spend more than $100,000, there is another tax-saving option: bonus depreciation. Under this new rule, the IRS permits you to deduct 50% of the cost of equipment in the first year that you own it, and then depreciate the rest. That compares with a 30% deduction before the change. (There is a catch: The higher deduction only applies to purchases made after May 5, 2003. Anything bought before that date is subject to the old limits.) And unlike enhanced expensing, the new depreciation rules only apply to purchases of new equipment.
But if your purchases qualify, the two tactics can work together. Say you spent between $100,000 and $399,999 on equipment in the last six months of the year--purchasing, for example, $300,000 worth of new technology. Your first move would be to take advantage of the new enhanced expensing provision, deducting $100,000. That would leave you with equipment costs of $200,000. But thanks to bonus depreciation, you could lop off another 50%, or $100,000. Your total deduction: $200,000, and you'd depreciate the remaining $100,000.
Expenses between $400,000 and $499,999 are also eligible for both enhanced expensing and bonus depreciation, though the permitted deduction will be reduced by the dollar-for-dollar phaseout. So if you spent $450,000, you could deduct $50,000 under enhanced expensing and $200,000 under bonus depreciation. The remaining $200,000 would be depreciated. Companies that spend $500,000 or more on equipment are only eligible for bonus depreciation, but permitted to deduct 50% during the first year.
You can apply bonus depreciation to anything purchased after May 5, 2003, but before January 1, 2005. So if you didn't make a major expenditure on equipment last year, and you're thinking about doing it sometime soon, make sure you get it done before the end of 2004. "If you're planning to make an asset purchase in the near future, better to do it before these expire than after," says Sandra J. Dixon, associate in tax and estates and a CPA at Jackson Walker LLP in Dallas.
3. Regrets Permitted
Let's say your business income soars in 2004. Great news--though you'll probably feel a twinge of regret if you took full advantage of the new expensing rules in 2003. After all, with more income to report, you'll probably wish you had chosen to depreciate your equipment--instead of deducting the full amount--to offset your new, higher income.
Happily for you, the kinder, gentler IRS will countenance no such regrets. For a limited time, the agency will permit you to change your mind. So even if you've already filed your 2003 taxes and expensed an asset rather than depreciated it, you can now simply file an amended tax return, make the change, pay any additional taxes you owe, plus interest, and happily depreciate for years to come, says Dixon. This is a huge change: In the past, you had to apply to the IRS for specific permission to change your mind, and it was rarely granted, she says.
The new, amended returns, says Dixon, "allow you to use a little hindsight in tax planning." Still, she adds, the idea is not to encourage business owners to second-guess their decisions. Instead, the government is trying to encourage you to spend your money now rather than "sit around in December saying, 'Well, I think next year may be a better year, so maybe I should buy it then," Dixon says. This provision is good through 2005, but note that the IRS's forbearance has its limits: You're only allowed to change your mind once. "Once made, the revocation is irrevocable," the government warns.
4. Rethink Your Compensation
Here's one instance where the cut in the dividend tax can help business owners save money. In general, dividends are now taxed at a lower rate than income. So if your business is set up as a corporation, you can pay a portion of your own salary in dividends--and save a bunch in taxes. "Before, if a corporation paid dividends to shareholders, dividends were taxed at ordinary income tax rates, like 35%," explains Thomas L. Evans, partner at law firm Kirkland & Ellis LLP, in Washington, D.C. "After this tax legislation, if it's a dividend from most corporations, it's taxed at a maximum rate of 15%. If you have a small corporation, you can pay dividends out to yourself and get taxed at the lower rate. That could be a big savings." Bear in mind that the IRS has complicated rules regarding what constitutes "reasonable compensation"; a wholesale shift to dividends could raise a very bright red flag. So you'll need to spend time with your tax adviser to determine whether taking a portion of your compensation in dividends makes sense.
Alas, it's too late to make this change for your 2003 taxes. But even in an unpredictable world, there's one thing you can count on for 2004: You'll be paying--and trying to reduce--taxes again a year from now.