A few months ago Brian Kickham bought eight new, white Chevy Impalas for his company. In total, the vehicles cost roughly $180,000 -- no cheap ride, even for a business as big as Northeast Security Inc., which supports 650 employees on revenue that CEO Kickham says is "over $17 million."
In truth, Northeast -- which provides security services (guards and systems) to property managers -- didn't need eight new vehicles. It didn't really need any new vehicles. "The oldest car in my fleet is four years old," says Kickham. So why did the CEO incur the expense?
Because his accountant encouraged him to. "We were alerted to the tax break and decided it would be worth our while to take advantage of it," says Kickham, whose company is based in Brookline, Mass.
The tax break to which Kickham refers is new and was signed into law last March by President Bush as part of a key piece of post-9/11 legislation meant as an economic-stimulus package. The bill, called the Job Creation and Worker Assistance Act of 2002, contains a number of provisions aimed at increasing corporate capital spending, including one that the IRS formally calls "the 30% first-year special-depreciation allowance." The law increases the amount of depreciation that business owners are allowed to claim for the year they acquire eligible property.
Eligible assets -- such as computers, other office equipment, office furniture, certain types of software, leasehold improvements, and vehicles used 50% or more for business -- must have been acquired after September 10, 2001, to qualify for the allowance.
Here's how the bonus depreciation works: Imagine that Company X purchased $100,000 worth of computer equipment in 2002. In accordance with the already existing Section 179 of the tax code, a flat deduction of up to $24,000 for business-related equipment purchases is permitted for 2002. (For 2003, the maximum Section 179 deduction rises to $25,000.) The company records $22,800 of first-year special depreciation (calculated by multiplying the remaining $76,000 by 30%). Furthermore, since computers can be depreciated over a five-year period, Company X is also permitted to record the expense using its regular depreciation method. Therefore, it is eligible for an additional 20% deduction of $10,640 calculated on the remaining $53,200 of the cost basis. For the next four years, the company would use $53,200 as the cost basis on which to calculate the depreciation of the computers.
Company X also has a second option: business owners may elect out of the first-year special-depreciation allowance. Why wouldn't the owner want to reduce his taxable income by claiming the 30% deduction? Two reasons: he has an about-to-expire net operating loss, or he anticipates being in a higher tax bracket in future years. So he prefers to record higher taxable income in the current year and lower income in future years.
Not a bad set of choices -- but how do you know which option is best for your business?
There's no simple answer, but the key factors to consider are how profitable you were last year and how profitable you expect to be in the next several years. Another significant item to consider is your state taxes. Does your state simply "piggyback" the federal tax code, meaning it conforms to federal rules? Several states, citing budget crises, have already "decoupled" themselves from the 30% bonus depreciation, mandating that residents add back the 30% special depreciation when computing their state taxes. Illinois, Pennsylvania, and Massachusetts are three states that have already decoupled, according to Marvin Kirsner, a partner at Greenberg Traurig in Miami.
But even if your state has decoupled, the federal bonus depreciation alone might still be a boon for your business. It was for Kickham's. And, in Kirsner's view, the bonus depreciation has had the desired effect of spurring capital spending during an economically sluggish year. "I've seen a spurt in companies' buying aircraft, and this has got to be a big reason for it," he says. It makes sense: buy a $3-million plane for your business and get $900,000 in additional first-year depreciation.
The Job Creation and Worker Assistance Act of 2002 also made a significant change to what certified public accountants refer to as the "carryback" rules. Companies that haven't fared well during the past two years get another break from the new legislation. The law allows business losses that were incurred in 2001 and 2002 to be "carried back" to tax returns from up to five years before the losses were incurred. That's three more years than the previously allowed two-year carryback period. For example, a company with a loss in 2002 can now carry back that loss to 1997, 1998, and 1999, in addition to 2000 and 2001, which formerly were the only years allowed.
The upshot is, any business that was in the red during 2001 or 2002 may be able to get a refund from Uncle Sam -- assuming that the company was profitable in any of the years from 1996 through 2000. Therefore, you may want to consider some tax planning. If you're reading this in December of 2002, it's not too late: if you wish, you can still delay closing some sales until 2003 begins. "Or you can accelerate some expenses, suggests CPA Nick Puniello of Boston's Puniello & Donohue. By either delaying income or incurring expenses in December, you stand to increase your 2002 loss, thereby yielding a bigger potential IRS refund from carrybacks.
Of course, you want to be certain that increasing your loss won't be a source of concern for any of your investors or lenders. "A bank is not going to be happy if your tax return shows a loss," says Puniello. But if you can convince your banker that the rough December will make you look better in March, you should give it a shot. "There's a feeling that if you're going to report a bad year, then it's desirable to get as much of that bad news into one year -- and then start January off with a bang," says Dan Mainzer, a senior tax manager in the Framingham, Mass., office of tax-consulting firm BDO Seidman.
Bear in mind that you don't have to use the five-year carryback period. You can use the two-year carryback period instead or forgo the carryback period altogether. Or you can elect to carry forward the loss for 20 years, using it to reduce future taxable income.
In addition to the carryback change and the bonus depreciation, Congress has been discussing several potential changes, many of which would apply to 2002. So check with your CPA -- today -- and see if you can get your company in better shape for tax time. You might just get a tax refund. Or a fleet of shiny, white Impalas.
Own an S Corp? Take Note
Having an ownership stake in certain types of business entities may put you on the fast track for an audit this year, especially if you bring home six figures or more, according to a recent Internal Revenue Service press release. In September the IRS announced it was changing its audit priorities as part of a broader initiative to revamp its tax-compliance programs. The IRS says its new system has been designed to red-flag those who hide their income in improper tax shelters and those who fall into the category of "high-risk, high-income taxpayers." Among the groups considered "high risk" are those who claim deductions from pass-through entities like S corporations. (Income from S corps is taxed only at the individual level, rather than at both the individual and the corporate levels.) "Audit priorities are cyclical," says Jackie Perlman, a senior tax research analyst at H&R Block. "For a while, having a sole proprietorship raised your chances of getting audited. Now it looks like the IRS might be focusing a bit more on S corps."
Perlman advises that owners of S corporations should make sure to draw a salary from their companies. The IRS will be checking up on S corp owners who use artificially low pay as a way to reduce their FICA taxes. And, as always, owners should document all their business expenditures, just in case. --Bobbie Gossage
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