It is hard these days for sole proprietorships, partnerships, and corporations to trim the amount of taxes they pay, but it is not impossible. The key is to act now, while there is still time to identify and capture the available tax breaks. Here are 12 tax saving strategies to consider:
1. Be miserly with your estimated tax payments. One key to saving money on your taxes is to pay the Internal Revenue Service enough to avoid penalties but not too much, according to Gerald L. Golub, managing partner, and Stuart Kessler, senior tax partner, of Goldstein Golub Kessler & Co., a New York City certified public accounting firm.
A similar point is made by Michael J. Costello, a partner in the Boston office of Laventhol & Horwath, another accounting firm. The safest way for smaller companies to do this is to make estimated tax payments in quarterly installments that add up to the previous year's total tax bill, Costello says. "It's much better to have a balance due the IRS on April 15 and have been able to use the cash in your business throughout the year. Cash is vital to a business. You don't want Uncle Sam sitting on it,"he notes.
2. Pay spouses for the work they do. Many small business owners and managers draw upon the talents of their spouses. Husbands, for instance, may help with the bookkeeping; wives may provide business advice, sometimes over a family dinner. Tax experts agree that spouses should be paid for their bona fide efforts, particularly if they are not otherwise employed. Consider this example: Your wife does not work outside the home, but in the past year she has helped you in the development of a marketing plan. For her advice, you pay her a $2,000 consulting fee. These earnings enable her to open an individual retirement account. She contributes the entire $2,000 to the account, sheltering the total amount she was paid from taxation.
3. Pay children for the tasks they perform. This tactic enables you to shift income from a high tax bracket (yours) to a low one (your children's). By compensating your offspring for the work they do for your business, you earn a deduction, and they earn spending money or cash to put away for college.
4. Contribute to retirement accounts. If you are doing business as a sole proprietor or partnership, it is to your advantage to make the largest possible contributions to tax-deferred Keogh plans and IRAs, suggest Carol Lefcourt, president of Lefcourt, Golub, Baer, Moneypenny Inc., a Palo Alto, Calif., financial planning firm, and Martin J. Satinsky, of the Philadelphia office of Coopers & Lybrand, the Big Eight accounting firm. It also makes sense to make your contributions to tax-deferred retirement accounts early in the year. For example, if you deposit $15,000 in a Keogh account on July 1, 1983 (assuming 10% interest compounded monthly), it will grow to $115,533 in 20 years -- $5,612 more than if the same amount of money were contributed on December 31, 1983.
The ceiling on Keogh contributions in 1983 is $15,000 or 15% of earned income from a sole proprietorship or partnership, whichever is less. In 1984, the 15% rule remains in place but the maximum contribution jumps to $30,000. The top annual individual contribution to an IRA is $2,000.
5. Use the Targeted Jobs Tax Credit (TJTC). This credit was adopted by Congress to encourage businesses to employ the economically disadvantaged, a group that includes welfare recipients, young people from poor families, certain Vietnam veterans, and ex-convicts. The credit equals 50% of the first $6,000 of wages paid to qualified employees (a maximum credit of $3,000 per worker). During the second year, the credit is 25% of the first $6,000 of wages paid (a maximum credit of $1,500). If your business can make use of this credit, contact your state employment service for more information. A representative of the employment service must certify that an individual qualifies for the TJTC -- or have the required papers "in process" -- before the employee starts work.
A word of warning about the TJTC: "Be very careful not to violate the discrimination laws in trying to seek out the types of people who fit into these categories," says Laventhol & Horwath's Costello. "It can be a discriminatory hiring practice if you ask questions on your job application that would lead to the answer of whether or not these people were eligible. You have to walk a fine line between the legal problems and trying to seek the desired result."
6. Squeeze tax savings from automobiles. You can deduct 20 cents a mile for work-related travel, or you can keep track pf the actual cost of operating a vehicle or business purposes, itemizing these expenses. Because of the high price of maintaining a car -- tires, oil changes, depreciation, insurance, interest on financing -- you will come out ahead if you itemize. Itemizing also qualifies your business to take an investment tax credit when it purchases a new car. If your company owns the car, be sure to keep track of your personal use of the vehicle and reimburse the business for that amount.
7. Deduct the cost of using your home for business. A home office does not have to be a separate room, but it must be space that is used regularly and exclusively for business. The IRS allows people with home offices to deduct all costs associated with the upkeep of that portion of the house -- utilities, maintenance, and so on. Take a home-office deduction if your house is your primary place of business, advises James D. McCarthy, vice-president of the tax services group of General Business Services Inc. in Rockville, Md. Your employees may also qualify for this deduction if you require them to maintain an office at home for regular meetings with customers, clients, or patients. 8. Use the research and development tax credit. Included in the 1981 Economic Recovery Tax Act was a new tax credit designed to encourage business to spend more money on R&D. The research and development credit is equal to 25% of a company's increased R&D expenditures. The law requires that companies use a specified period in figuring how much their research and development costs have climbed. This base period varies from one to three years, with the key being the year a company first took the credit. Here is an example of how it works:
In 1982 your company filed its 1981 return, taking the R&D credit for the first time. This means your base period is the previous year's expenditures. Subtract the base period number (expenditures for 1980) from the amount you spent on R&D in 1981. Multiply the answer times 25%. That is your credit. In 1983 your company files its 1982 return, taking the R&D credit for the second time. This means your base period is the previous two years.
There are two catches: The credit expires on January 1, 1986, and the amount you use to figure the credit (the increase in R&D expenditures) can't be more than 50% of research and development costs for the tax year. For example, say your company spent $1 million on R&D in 1980. In 1981 that figure climbed to $4 million, giving you an increase of $3 million. Under the rule, you could apply the 25% credit only to $2 million (50% of $4 million), rather than the actual increase of $3 million.
9. Capture depreciation deductions by speeding up planned purchases of equipment. Unfair as it may seem, the tax laws treat machinery and equipment acquired in December in the same manner as machinery and equipment purchased months earlier. "If you acquire property in December," says Costello "you are allowed a full six months' depreciation on that property. If you acquire property in January at the beginning of your taxable year, you're still only allowed six months' depreciation." The best tactic, then, is to accelerate equipment purchases to snare depreciation deductions this year rather than next year.
Another strategy is to write off a portion (the maximum is $5,000) of your capital expenditures, then depreciate the remaining amount. If your business purchases a new car for $10,000, the law allows you to deduct $5,000 just as you would any other ordinary business expense. The other $5,000 is depreciated.
10. Accelerate equipment purchases to earn investment tax credits. Tax credits are better than tax deductions because they are subtracted from your tax bill, not from your income. The investment tax credit equals 10% of the purchase price of equipment having a recovery of five years or more. "If you would ordinarily acquire equipment in January, February, or March, why not accelerate the delivery of the merchandise, have it placed in service in December, and reduce your taxes in April 1984, rather than in April 1985?" Costello asks.
Your personal computer is an item you may overlook when figuring your investment tax credits. If you are a sole proprietor or a co-owner of a partnership and use your machine for business, you are entitled to an investment tax credit. Be sure to figure the credit only on that portion of the time your PC is used for business. Say, for example, you use your PC 4 hours a week for business and 12 hours a week for pleasure. Your investment tax credit would be calculated by multiplying 10% (the amount of the credit) times 25% of the cost of the PC (the amount used for business). Corporations also can arn investment tax credits if they buy personal computers. In this case, the credit is figured using the entire purchase price. The assumption is that the machine -- as a business asset -- will not be used for pleasure.
11. Prepay expenses to boost your deductions. One simple way of accomplishing this, says Neil B. Godick, president of Godick & Co., a certified public accounting firm headquartered in Philadelphia, is to pay in December those bills normally due in early January. Good candidates are rent, utilities, and installment loans. Use this maneuver with caution, however. The IRS has taken businesses to task for prepaying too many expenses, arguing that they deliberately distorted their income. "If you paid six months rent in advance, the IRS could disallow the deduction," warns Costello.
12. Postpone income. Businesses can avoid paying taxes on some of their income by deferring receipt of that income until the following tax year. One strategy is to delay billings. Another way is to choose a fiscal year that ends in October or November. This enables you to push one to three months' worth of revenues from one year to the next. The IRS won't allow sole proprietors to make use of this option (they must be on a calendar year), but partnerships and corporations can take advantage of it -- if it doesn't result in the deferral of more than three months' income. "There are very few things you can do to avoid taxes," says Godick. "Think about postponing taxes rather than getting out of taxes."
Finally, seek outside advice and information. Federal tax regulations are complicated, and tax professionals can help you wade through them. The cost varies from $50 to $100 an hour and more. A good source of free help is the IRS itself. It publishes a variety of booklets helpful to small businesses, including Tax Guide for Small Business (ask for publication October, 1983October, 1983334), Travel, Entertainment and Gift Expenses (October, 1983October, 1983463), Accounting Periods and Methods (October, 1983October, 1983538), and Deductions for Bad Debts (October, 1983October, 1983548). You can order these by stopping by or calling your local IRS office.
YOUR CHANCES OF BEING AUDITED
% of returns audited
Gross receipts 1982 1981
Sole proprietors: Under $25,000 1.68 1.42
$25,000 to under 3.97 3.98
$100,000 $100,000 or 5.94
Partnerships 1.63 1.62
Corporations* Under $100,000 2.79 2.60
$100,000 to $1 million 4.49 5.42
$1 million to under 12.59 15.35
$10 million to 23.86 25.93
under $100 million
$100 million or more 66.73 80.52
*Based on assets
Source: Godick & Co., Philadelphia