The end of the year is usually a hectic time for business owners like me, who are scrambling to wrap up activities while planning ahead for the new year. This December is particularly challenging because of continuing tax uncertainty. As a small-business owner and tax expert, I’ve decided to focus on what is known rather than on what is not known about tax rules and to take year-end actions that are helpful regardless of possible changes to tax rules.
Here are five steps that I recommend taking before the year’s end.
1. Bring your books up-to-date. Before any tax planning can be done, it’s vital to know whether your company made or lost money for the year. To do this, accounting records must be up-to-date. Some business owners I know let this task slide for months and, unfortunately, may not be prepared to think about year-end tax planning at this time.
2. Consider a retirement plan. Profits can be sheltered in qualified retirement plans, and the 2010 rules remain relatively unchanged from 2009. For example, a corporate owner or self-employed person whose salary or net earnings are sufficient can contribute a maximum of $49,000 to a SEP (Simplified Employee Pension) plan, scoring a tax deduction while saving for one’s golden years. Owners who don’t yet have qualified retirement plans for their companies need to complete the paperwork (provided by their financial institution or mutual fund) by Dec. 31. Then they’ll have until the extended due date of their 2010 return to make their contributions for the year.
It’s wise to discuss the wide range of plan options with a CPA or other financial adviser. Keep in mind, if you do miss the Dec. 31 for setting up a qualified retirement plan, you still have one plan option – the SEP – which can be set and funded as late as the extended due date of the return.
3. Don’t forget health coverage. Owners (other than those with a C corporation) who pay for their health coverage can deduct it, but only as a personal expense rather than as a business expense. However, for 2010, if you are self-employed you can use the premiums to offset the number of net earnings used to calculate self-employment taxes (which cover mandatory Social Security and Medicare contributions). Because of the tax savings, owners may want to reduce their estimated taxes. The last payment for 2010 is due on Jan. 18, 2011.
Those who use the cash-basis accounting method might also want to pre-pay their 2011 premiums to boost their write-off for 2010 while saving on self-employment taxes.
If the insurance qualifies as a high-deductible health plan, then you’re allowed a tax-deductible contribution to a Health Savings Account, or HSA, for 2010. (To be considered “high deductible” in 2010, the policy’s deductible must be at least $1,200 for individuals and $2,400 for families and meet certain other tests.) While the HSA 2010 contribution can be made as late as April 18, 2011, the sooner it is made, the more earnings you can build upon a tax-advantageous basis. Earnings will never be taxed if withdrawn to pay qualified medical costs.
4. Donate to charity. Business owners who have had a good year can share their good fortune with charities. The donations are tax-deductible within the limits allowed by law. For example, if you own a C corp, your charitable deductions are limited to 10% of taxable income.
For owners who record business income on personal tax returns (such as sole proprietors, or owners of S corporations or limited liability companies), it’s helpful to note a change for 2010: There’s no phase-out of itemized deductions for high-income taxpayers. That’s a shift from prior years when contributors lost part of their charitable deductions when income exceeded a threshold amount. If you’re unsure whether an organization qualifies for tax-deductible contributions, check IRS Publication 78.
5. Upgrade equipment. If you need to invest in new business equipment or upgrade old machines, now is a great time to act. I’m buying a new smartphone and other business owners I know have made similar buying plans. Whether the business is profitable or not, there is a tax break to help.
—If the business is profitable, elect first-year expensing for the cost of equipment up to $500,000. (This dollar limit is up from $250,000 in 2009). If the cost is more than the dollar limit, you can also use 50% bonus depreciation and a regular depreciation allowance to effectively write off most of the cost of the purchase. The bonus depreciation option is set to expire on Dec. 31.
—If the business is not profitable, rely on 50% bonus depreciation to write off half the cost (plus a regular depreciation allowance on the other half). This write-off can create or increase a net operating loss, which can result in a carryback that can generate a cash refund.
While first-year expensing can be used for new or pre-owned equipment, bonus depreciation is limited to new equipment. However, the purchase of equipment for both first-year expensing and bonus depreciation can be financed in whole or in part without any impact on the tax write-off.
A final word: I’m waiting to see what Congress does with taxes—the extension to 2010 of provisions that expired in 2009, as well as the possible extension for 2011 of Bush-era tax cuts—before making any dramatic tax moves, such as deferring income and accelerating deductions. Hopefully, there will still be enough time to act.