Develop A Tax Strategy
1. See the Big Picture
All things being equal, accountants aim to record income and expenses in a way that lowers taxes in the current year, principally by deferring income and accelerating expenses. The time value of money is the reigning principle here -- the money you will later have to pay in taxes can be put to better use in the meantime. "If you put an 8 percent rate on it -- whether it's an interest rate or the opportunity cost of money -- that starts to add up fairly quickly," says Pullara.
The exceptions. But it's seldom so simple. For one thing, changes in tax law often remake tax strategy. If tax rates rise -- and top rates soon could -- then it may be smart to pay taxes on as much income as you can before they do. Often, there's also a business case for increasing current income -- you may, for instance, want to show bigger profits to persuade a bank to give you a loan. Finally, you have more than likely structured your company as a sole proprietorship, a partnership, or an S corporation -- all entities that pass the business's income through to your individual tax return. (Fewer than 20 percent of all small businesses are C corporations, which pay income tax themselves.) In that case, business income is just one piece of your personal income strategy: A business gain or loss could offset opposite results in another income stream, notes Gail Rosen, a CPA in Martinsville, New Jersey. There are limitations. A loss in an S corporation, for example, can't exceed your cash investment in the organization. But, adds Rosen, "sometimes you can inject cash into the business to shore up your basis."
Stay current. As a basic starting point, make sure your books are up to date. "At least 80 percent of the time, new clients don't have a current and accurate accounting system in place as of September or October," says Royal. If nothing else, staying on top of your books will give you a better sense of where you will stand next year, which is crucial for businesses with wide income swings. "It's really important to smooth your tax income," says Pullara. One year in a low tax bracket followed by a year in a high one could cost more than two years in the middle. "You're not trying to minimize taxes during any one year," he adds, "but over the business's life -- or at least over multiple years."
2. Income and Expenses
Your ability to schedule receipts and expenses depends on the accounting method your company uses for tax purposes. It's easiest to do under so-called cash accounting, in which income and expenses are recognized when you receive or make payments. The alternative is the accrual method, which records income and expenses at the time of sale. Any business with revenue of less than $1 million can use cash accounting. Above that amount, cash accounting is limited mostly to companies that provide services or don't carry inventory. But there can be a negative to cash accounting: If your company uses the accrual method to manage its business, basing taxes on cash accounting may require keeping a second set of books.
Income shifting. To defer income under cash accounting, wait until the last days of December or the first week of January before sending out invoices. (If you use the accrual method, you might encourage customers to hold off on taking delivery until after the first of the year, or delay your post-Christmas sale until after New Year's.) To accelerate income, bill clients as soon as the job is done -- or sooner. Lucretia Mattson, a CPA with LarsonAllen in Eau Claire, Wisconsin, suggests offering a slight discount for prepayment. That works under the accrual method, too, she adds -- in the case of a prepayment, you can claim the income when you receive it under either method.
Expense shifting. The same principles apply to expenses, the timing of which is easier to control. The easiest way to accelerate expenses, of course, is to buy supplies sooner rather than later -- in the fourth quarter of 2008, say, rather than the first of 2009 -- assuming the budget allows. If it doesn't, a credit card offers an easy solution in cash accounting, says Rosen. Provided it's not a store-issued card, you will generally recognize the expense when the charge is made, not when the bill is paid.
3. Take Advantage of 2008
This has been a very good tax year for deducting and depreciating, in part because the Economic Stimulus Act of 2008, which became law last winter, was designed to spark business spending. But several other valuable tax provisions happen to expire this year; unless Congress acts soon, they are use-it-or-lose-it opportunities.
Section 179 expensing. Section 179 is a provision of the tax code under which a business can immediately deduct certain kinds of property -- including vehicles, machinery, and computer software -- that would otherwise be depreciated over several years. For this year, Congress has doubled the allowable deduction to $250,000 and increased the eligibility limits for qualifying investments from $500,000 to $800,000. (That is, only companies that spend less than $800,000 on qualifying property can take full advantage. The deduction phases out as the investment reaches $1,050,000. The deduction can't exceed net income, often including the owner's salary, though the difference can be carried forward.) Businesses located in designated blighted neighborhoods (see "Help Out; Get Credit," next page) or the parts of the Gulf Coast afflicted by the recent hurricanes can deduct an additional $35,000.
Bonus depreciation. In 2008, any company can take a 50 percent special depreciation on new property -- chiefly items depreciated in 20 years or less -- bought and installed during the year. (Some equipment can be placed in service in 2009.) The bonus is on top of any depreciation elected under Section 179, as well as the standard first-year write-down. So, for example, if you buy machinery for $600,000, you can deduct $250,000 under Section 179 and then half of the balance, or $175,000, as a bonus. "The remaining $175,000 would be subject to normal depreciation," says accountant Gary McKinsey, of Modesto, California's Grimbleby Coleman. "This allows the business owner to deduct the majority of the cost in one year."
Energy-efficient commercial buildings deduction. Through 2008, you can deduct the cost of greening an existing building. The deduction was conceived as a way to make energy conservation cost-effective, but high energy prices are taking care of that, says Eric Trost, a CPA in the Milwaukee office of Suby, Von Haden & Associates. "It's something that you would start to do in the normal course of business, and you still get a deduction."
Help Out; Get Credit
The Work Opportunity Tax Credit targets high unemployment areas with an incentive: a percentage of a hire's first-year wages, up to $2,400.
Separate wage credits are also available for businesses located in one of 70 officially designated Renewal Communities and Empowerment Zones that hire local residents. Renewal Community credits are worth up to $1,500 per employee per year and Empowerment Zone credits up to $3,000 per employee per year. Participating in these programs need not change your hiring practices. It does require setting up programs to track employees, but this isn't difficult, says Trost. (Outsourcing the administrative function shouldn't cost more than 10 percent of the credit.) It's "absolutely worth it," he says. "At $1,500 per worker, if you have 10 or 15 workers, it adds up to real money." The credits are available for previous tax years, provided you have kept adequate records.
Renewal Community businesses can also take advantage of a Commercial Revitalization Deduction, an accelerated write-down of a new or rehabilitated building worth up to $10 million.
Finally, certain Empowerment Zone business owners may be able to exclude up to 60 percent of the gain when they sell stock in the business or postpone capital gains when they sell an asset.
Driving The Deduction
The Economic Stimulus Act has turned the tax status of car buying upside down. Usually, the tax code gives a bigger break for leasing, says Gail Rosen, because you can deduct most of the lease cost each year. For a luxury car, that can make the deduction for three years of leasing equal to about five years of write-offs on a purchase.
The bonus: But the bonus depreciation provision allows you to write down $10,960 on a car bought in 2008 and approximately another $11,300 over the next three years. That's about 50 percent more than would normally be allowed. SUVs over 6,000 pounds are eligible for a $25,000 deduction under Section 179 (unchanged by the stimulus package), on top of the maximum depreciation you can normally take, provided the vehicle is used at least half the time for business.
The paperwork: In all cases, you can deduct or depreciate a vehicle only in proportion to its business use. If you are ever audited, you will need contemporaneous records documenting that use.
The Internal Revenue Service (www.irs.gov) is the original source for tax information. There's a one-stop resource for small businesses under the site's Businesses tab.
The National Federation of Independent Business's site (nfib.com) has a wealth of tax articles and links to other useful sites in its Tools & Tips menu.
At smbiz.com, you will find updated links to tax news and forms and other resources.
Finally, Inc.com's Law & Taxation resources section compiles tax articles from Inc. and elsewhere. Vist www.inc.com/resources/tax.