Taxes for Business Owners

Taxes for Business Owners

Preparing the taxes for your business can be considerably more intricate than preparing your personal taxes. If you are involved in running your own business, are self-employed, or simply have an expensive hobby, there are multiple ways to reduce your tax liability. This article will highlight areas in which tax laws, regulations and information apply specifically to business owners. Areas in which specific strategies employed by business owners can result in savings include; business property purchasing strategies, the three in five test, income deferral, and social security.

As a property and business owner, it is important to know that for every $1,000 you can write off as a deductable expense, you decrease your income tax bill by $280, assuming you fall in the 28% tax bracket. If you are subject to the full self-employment tax, you can add an additional $153 to those savings. Obviously, the financial inducement for well-formed business strategies and savvy deducting is powerful. When managing your money outlay, it is important to be aware of which expenses are deductible and which are not. In addition, remembering that the bills for qualifying expenses that you pay before year-end are deductible on the current year's return, while those that you do not pay until after the first of the year are deductible only for the following year, can help you determine payment priority.

  1. Business Property Purchasing Strategies
    • The Midyear Convention and Year-End Purchasing

    One of the oldest tax-saving tricks in the book is to purchase the majority of your business property at year-end. However, employing this old trick can be both damaging and beneficial, so you should be aware of both aspects.

    Benefits

    Tax law allows you to claim as deductible 6 month's worth of the depreciation of your business property in the year you put the property into service, regardless of how late in the year you make the purchase. Therefore, buying property in late December (even that purchased on December 31 counts) can earn you a substantial depreciation write-off. I.E., you purchase two new snowplows for your road maintenance business in December. They do not truly reach the depreciated value of the snowplow until June of the next year, but you can write-off the full depreciated amount as tax deductible in January or February when you submit your return. Which means more money in your pocket, working for you. Of course, this mid-year convention of 6 months will work against you if you have to buy your property at the beginning of the year. A snowplow bought in February has still depreciated value by 10 months before year end, but you only get to write off six months of depreciate value.

    Problems

    The joke's on you if you buy too much business property at year-end. Uncle Sam started getting wise to this very old trick, and the current tax law states that if the cost of assets put into service during the final three months of the year exceeds 40% of the total cost of business property put into service throughout the entire year, the half-year convention will be replaced by a midquarter convention. What that means for you is that your depreciation will be calculated as if you put each purchased asset into service in the middle of the calendar quarter when it was first used. Which means that snowplow you bought in December only earns 6 weeks of depreciation, instead of six months.

    Based on your personal business needs, it is more than a good idea to track your purchases, and probable year end outlay, so that you can stay just under the 40% regulation. However, if you also have to purchase a lot of property at the start of the year, triggering the mid-quarter convention rule will boost your depreciation write-offs for all the property you put in service at the beginning of the year. For example, your January purchased snowplow will allow you to write-off 11 months of depreciation, instead of just six.

  2. Expensing
  3. Some business owners don't bother with the midyear or midquarter conventions, and prefer to manage their property purchasing write-offs by expensing. Expensing refers to a tax law provision that allows you to immediately write-off up to $500,000 of otherwise depreciable property, as long as it was put into service in 2010.

    Benefits

    If you choose to go the expensing route, it doesn't matter whether the item was purchased and put into service in January or December, you can still deduct the full cost of up to $500,000 according to Section 179 of the IRS Code. However, this does involve a ceiling limit of $2,000,000. This strategy is immensely helpful for businesses where property purchasing is difficult to structure and/or predict.

    Also for the year 2010, if you have purchased qualifying new property after September 8th, 2010, you get 100% bonus depreciation, so the entire thing can be written off, without meeting the ceiling requirements of section 179. If it was purchased prior to September 8th, you are eligible for a 50% write off.

    Problems

    The catch to expensing is that the type of property purchased must meet certain specific requirements. For example, you cannot deduct the full cost of a new business car immediately, the maximum allowable first year auto write-off is $2,960. However, if the new vehicle weighs between 6,000 and 14,000 pounds (including the maximum for passengers and cargo), you can write off $25,000 in the year of purchase. Therefore, if you are purchasing SUVs or snowplows, this can be a great strategy, for business cars, not as much.

    Like most things, good planning will pay off when structuring the property purchasing strategy for your business. Attending tax classes and/or consulting with a tax professional about which strategy is best for your business is both time and money well-spent.

  4. 2) Hobby or Business? The Three in Five Test

  5. Even if you are not self-employed, the time and money you spend on your hobby can qualify you for significant tax deductions, if it's done right.

    • The Three in Five Test

    • The very first qualification to meet is that you intend to make a profit, called a profit motive. The next, and most important, qualification to meet is that you must make a profit at least three years out of every five. If you meet that bar, the law presumes that you are trying to make money with it. So even if that's not what you intended by selling fudge every Christmas for $5 a box, if you turn a profit three years out of five, congratulations, you have a business (as far as your tax return is concerned). However, if you fail the three in five test, it is presumed that the activity is a hobby. So even if you are working 80 hours weeks desperately trying to make your hot-dog stand on Michigan Avenue a go, if you don't turn a profit three years of five, all you have is a hot dog hobby. This means you get NO business write-offs, deductions, tax breaks etc. If that happens, it is upon you to prove your profit motive by detailed documentation of hours, expenses, business model etc. If you can't satisfy Uncle Sam or a court of law, your deductions are strictly limited to the amount of income you report, and you can't claim a loss to reduce your tax liability.

    • Savvy Year-End Planning
    • You need to analyze both where you stand in the profit-or-loss front and how you're doing on the three in five year test. If you've got to show a profit this year to avoid having your business presumed a hobby, the last few months of the year mean it's time to turn into a track star. Collect everything that is owed to you (break knees if you have to), defer any payments possible, delay purchasing equipment and/or paying expenses, and otherwise do everything possible to make sure that by year end your books are up by at least 5 bucks.

    • 3) Social Security

    • Taking the time and putting forth the effort to trim your taxable business income not only can reduce your tax liability, you can double your savings by its affect on your Social Security taxes. Self-employment income is subject to a 15.3% Social Security tax, and this full tax applies to the first $102,000 of earnings from your salary, wages, and net self-employment income in 2010. Remember, for every $1,000 of extra business deductions, you can save $153 in Social Security taxes, in addition to what you will save in income taxes.

    • 4) Income Deferral

This tax-saving business strategy isn't rocket science. All income that you don't receive until after midnight on December 31 isn't taxed until the following year. So even if you'll be in the same tax bracket for the next year, its still usually a good idea to put off the tax bill for an entire year if you can, allowing the money you save to work for you for the next twelve months.

Income deferral works best as a tax strategy for those who are self-employed or do free-lance or consulting work in addition to their day-job. If you use the cash basis of accounting, then you have bit more leeway with your income at the end of the year. This is, of course, assuming that you don't need the money to put back into the business or to meet the three in five requirement. Some ways to defer your end of year income include:

  • Delaying your billings until late December, insuring that you do not receive payment until the new year.
  • Giving a grace period to overdue accounts, allowing them to delay paying you until after the first of the year.

Obviously not everyone can use this strategy. Employees can't really postpone salary and wage income by asking their boss not to give them their paycheck until January. And it doesn't work to just not cash your check yourself until after the first of the year either, because all income is taxable in the year it's "constructively received." In layman's terms, the year you could have had the money if you'd wanted it. This same provision applies to Christmas bonuses where your boss offers you a choice of having the money on your December or January paycheck. Since you have the choice of December, even if you did choose January, the IRS expects you to report and pay taxes on that income with your return for the tax year the offer was made in. (The only way to get out of the Christmas bonus tax is if your company's standard practice is to pay year-end bonuses the following year.) Income deferral is not an option open to everyone, but if you are self-employed and have the flexibility to use it, it's definitely a strategy worth looking into.

Article written by: Letty G.

Back to Articles =>