In this month's accounting and tax news, we touched on income tax planning for individuals. Now we want to discuss business tax planning. Businesses have far more variables to consider than typical individuals. While individual taxpayers are usually limited to one accounting method, a company's accounting methods and business processes have a significant influence on tax savings opportunities.
Before we discuss the variables involved in tax planning for a business, let's dispel one myth: not all deductions are good. Adhering to the belief that tax deductions are the only way to go sometimes causes taxpayers to spend money just to get a tax break. It makes no sense to spend $100 to reduce taxes by $40 or $50 -the taxpayer still ends up minus $50 or more. Only if there is a business reason for the expenditure and you have a choice between incurring an expense in 2009 or 2010, accelerating that outlay to 2009 might make sense.
This discussion assumes that any expenditure you consider has a business purpose.
Accounting methods fall into two major categories - cash and accrual. Cash-basis taxpayers must receive payment for their product or service in cash and make payment for their expenses in cash in order to generate taxable income or loss. Accrual-basis taxpayers need only have a legal right to receive payment for their services or products and a legal obligation to pay their expenses in order to generate taxable income or loss. While there are other nuances, this is the basic difference between the two accounting methods.
Just as with individuals, businesses typically try to defer taxable income to the following year. If you are a cash-basis taxpayer, the best way to accomplish this is to delay billing. Delaying billing to a point that your customer will be unable to send payment until early January 2010 will, in effect, reduce your taxable income.
An accrual-basis taxpayer does not have the ability to defer billing and minimize taxable income. As long as a product is shipped or service performed and your customer has an obligation to pay you - regardless of whether the bill has been sent - the income counts. If it causes no harm from a customer relations or liability standpoint, you might consider delaying performance of services or changing shipping terms to minimize year-end income.
Cash-basis businesses have the same opportunity as cash-basis individuals to pay expenses before year's end in order to take deductions. One important consideration is in the area of financing acquisitions. If you intend to deduct the full cost of a fixed-asset purchase, do not finance the acquisition with the dealer from whom you purchased the asset.
To illustrate this point, assume you purchase a forklift from XYZ Forklift Inc., a Best Company Forklift dealer. As part of the transaction, you can pay cash, take out a loan from your bank or the Best Forklift Financing Corp. or pay XYZ over the next three years. As a cash-basis taxpayer, the IRS will treat the purchase as a cash-basis purchase if you pay cash or borrow the money from the bank or the Best Forklift Financing Corp. On the other hand, paying XYZ Forklift Inc. over the next three years is not a cash-basis purchase.
Accrual-basis taxpayers do not have this limit. Accordingly, if you need to reduce income by increasing expenses, make your purchases before year's end. However, remember that if you are purchasing equipment, it must be placed in service before yearÂ’s end to take advantage of depreciation or Section 179 expensing provisions.
Retirement plans are another avenue of tax savings for small businesses. Depending on the size of your company and the makeup of your staff, there are several ways to go. If you have a relatively young workforce with a stable and older ownership group, you might want a plan that provides a specified benefit to employees upon retirement. When you have an ownership group that is older and a fairly young and fluid employee group, you can fund the plan aggressively with most of the benefits going to the owner group. On the other hand, a defined contribution plan will work better when the reverse is true. The point is that you are not precluded from instituting a plan that will work for you this year - you just need to establish that plan now.
Don't forget that higher expensing limits are also still available for 2009 equipment purchases. For additions placed in service in 2009, you can expense up to $250,000 in equipment purchases. The amount you can expense begins to be phased out if you add more than $800,000 in qualifying expenditures in 2009. When you take the added bonus depreciation available for 2009 additions, you can realize significant tax savings if you purchase equipment and place it in service before Dec. 31, 2009.
Let's look at an example. Assume you buy an $800,000 loom and it's up and running by year's end. You will be able to immediately expense $250,000. You will get an additional bonus depreciation amount of $275,000. Finally, assuming the property has a five-year life, you get regular depreciation of $55,000. In total, you can deduct $580,000 of your purchase in year one. Even if you are limited by the mid-quarter convention in the tax code, you still get a deduction of $531,875 on your $800,000 purchase. This translates into savings of between $186,000 and $203,000 if you are in the 35 percent tax bracket. If you are interested in running the numbers, try the calculator at Section 179.org.
Depending on your circumstances, there could be a number of techniques available to help minimize your business taxes. If you are interested in retaining more of what you bring in, give us a call. That is our mission Â– to help you keep what you earn.
Have a terrific Thanksgiving holiday.