Hiring
Take advantage of special employment credits
The tax code is full of business credits for hiring people who have trouble getting work: welfare recipients, ex-felons, residents of empowerment zones, etc. If you have any such employees on your payroll, you may be eligible for one of the credits. The two biggest breaks are the work opportunity credit and the welfare-to-work credit.
You can't take both for the same employee, so look to the welfare-to-work credit first: It will lower your taxes by a maximum of $8,500 per employee over two years versus $2,400 for the work opportunity credit. That credit, however, covers a broader array of workers--including felons, youths, and others with high unemployment rates. What's more, as part of the Hurricane Katrina disaster relief program, you can also use it for hiring workers displaced by the hurricane. One caveat: Many of these credits expired at the end of 2005, so while you'll get to claim the credits on your taxes this year, unless Congress acts soon, and retroactively, they may not be available again. "They have been renewed year to year, but Congress is running late," says CCH's Gada. That uncertainty could make future planning tricky.
Employee Perks
Write off the fringe benefits
Employers provided an average of $18,358 in benefits per employee in 2003--largely for health, retirement, and paid time off--according to a recent survey by the U.S. Chamber of Commerce. That's an enormous expense, but the upside (at least at tax time) is that those costs will reduce your tax bill substantially. In addition to the usual write-offs for health insurance premiums, employer retirement contributions, and vacation pay, there are some often-overlooked benefits that can make your employees happy and lower your taxes, too. Lunches provided in the office to employees, for example, are 100 percent deductible, as are holiday parties and company picnics. But here's one place where there's an important difference between a C corp and an S corp. A corporation can write off those fringe benefits regardless of who gets them and the recipient doesn't have to pay taxes on them. But S corp owners or employees who own 2 percent or more of the enterprise will find most of their fringe benefits treated like taxable income.
R&D
Use the research tax credit
20% of R&D expenses can be written off. "The credit has saved us more than $50,000," says one entrepreneur.
The research tax credit isn't new (in fact, it dates back to the 1981 tax reform), but it can save you a bundle if you've spent heavily developing new technology or improving your product. In tax year 2001 (the most recent period for which data is available), 10,388 corporations--excluding S corps and other flow-through entities--claimed $6.4 billion in research tax credits. Calculating the tax break (reported on Form 6765) is complex, but you basically get a credit of 20 percent of the cost of your R&D, including the costs of labor. Daniel Thralow, chief executive of Thralow Inc., based in Proctor, Minnesota, rang up $20 million in revenue in 2005 from a slew of specialty online shops including Binoculars.com and Telescopes.com; he used the research credit to help offset the costs of developing customized software to run the company's various sites from the same warehouse and distribution center. "My accountant came to me and said, 'You are working on this database software and we think it falls into this tax-credit category, and you should hire someone to research it," Thralow says. So he hired a tax attorney, who wrote a formal memorandum on why Thralow would qualify--an important step, just in case the business is ever audited. "The cost of the attorneys was around $5,000," Thralow says. "But the credit has saved us more than $50,000 so far."
Capital Spending
Max out your expensing
Section 179 of the tax code, which allows businesses to expense rather than depreciate capital expenditures, is one of the biggest breaks available to businesses. For 2005, companies can expense up to $105,000, compared with $102,000 last year. By expensing capital outlays, you get the full tax benefit of that purchase today, rather than writing it off over many years. If you spent heavily in 2005 on new computers, for example, or on furniture for a new office, this could be a substantial sum. After all, if the business is set up as an S corp and you're in the 33 percent tax bracket, a $105,000 write-off could cut your tax bill by nearly $35,000.
The plane is a big expense, but I need one with how much I travel. " --Zak Brown, CEO, Just Marketing International
Zak Brown, a former racecar driver and now chief executive of Just Marketing International, an Indianapolis-based motor-sports marketing firm with $30 million in revenue, says he'll be Section 179-ing the purchase of a corporate jet. "The plane is a big expense, but I need one with how much I travel," Brown says. Some accountants consider that an aggressive move, as planes and cars tend to be looked at closely by the IRS. But it's perfectly legit as long as it's a true business expense.
State Returns
Don't forget local tax issues
You may not think of yourself as owing taxes outside your home state. But state authorities may have different ideas, depending on where your employees and facilities are located, where you conduct sales, and a variety of other factors. It's a thorny issue that you'll need a good accountant to help navigate.
Further complicating matters, states have increasingly decoupled from the federal tax system on key tax changes. Some states do not recognize Section 179 and QPAI deductions, for example. Say you've made some significant equipment purchases and take Section 179 expensing on your federal return. You may not be able to do that on your state return--or you may be limited in the amount you can expense. In other words, figuring out a tax strategy for your federal return may not do you much good at the state level. There is little you can do here except to consult with your accountant, keep close tabs on the rules of the states that you file in--and be prepared to crunch at least some of your numbers in multiple ways.
