Year-End Tax Planning

December, Two Thoushand-two
By: Heidi Rafferty

Well's Fargo's December Small Business Roundup Newsletter

Year-End Tax Planning
Eight steps your company can take to reduce its tax liability.

Certain tactics will save you money and affect your finances not only in the current tax year but also in years to come. Here are some top considerations for smaller enterprises.

It may sound like common sense, but your accounting should be current, says Danielle Hewitt, a CPA and president of the Invisible Accountant Inc. in Irvine, Calif. "All kinds of things can skew the numbers," she says. "It's so important to keep it accurate throughout the year. So many business owners run their businesses from their checkbooks. The balance doesn't necessarily reflect what the tax liability is going to be."

Once your books are in shape, you should control the expenses you deduct and the income you take in, says Robert Houskeeper, owner of Encinitas, Calif.-based Robert Houskeeper CPA. If you pay outstanding bills, you can deduct those expenses. You can also send out invoices to receive payment in 2003 if you wish to defer income.

"If I do work for you in December, there is flexibility," says Houskeeper, who teaches managerial accounting at San Diego State University, tax and cost accounting classes at National University in San Diego and works with the Center for Entrepreneurship at National University. "As a general rule, I can report the income next year versus this year if I issue the bill in January."

But be careful: If your client offers payment before 2002 ends, you cannot decline to accept it under law, he warns. "You don't have the luxury of manipulation."

Consider making last-minute equipment purchases, Hewitt says. You can deduct up to $24,000 in 2002 for items such as computers, office furniture and other equipment under Internal Revenue Code section 179 if you buy and place the item into service before Dec. 31. If the purchase exceeds the Section 179 amount any excess is eligible for annual depreciation deductions you take over the life of the property.

Hewitt says many small businesses are unaware of a new tax law that took effect as result of Sept. 11. The IRS said that for a period of three years [from Sept. 11, 2001, to Sept. 10, 2004], any equipment placed into service will get an additional 30% over and above the regular depreciation. For example, if you bought a $175,000 computer system, you first would deduct the allowed $24,000, leaving you with $151,000. Thirty percent of that figure is $45,300, leaving you with $105,700 subject to regular first year depreciation of 20%—for computers not subject to the mid-quarter convention—or $21,140. This scenario, Hewitt says, gives you a total first-year write-off of $90,440 ($24,000 + $45,300+ $21,140 = $90,440).

Even in a down market, set up your retirement plan, Houskeeper says. If the plan documents are signed by Dec. 31, you can make contributions at any time up to the due date—including extensions—of the business's tax return. Houskeeper says a Keogh plan is a good option, but it has to be formally established by year-end. Another alternative is a SEP IRA, which is a low-maintenance plan, he says. "Typically, you can put 15 percent of earnings into the SEP."

The IRS has provided additional incentives for small companies to establish retirement plans, including letting small businesses claim as a tax credit up to $500 per year for the first three years of the plan to cover administration costs as well as higher so-called "catch-up" contributions for participants age 50 or older.

The rules are getting better every year for the self-employed when it comes to health coverage, Houskeeper says. "Congress has been gradually allowing the self-employed to deduct health insurance coverage above the line," he says.

For 2002, taxpayers are allowed to deduct 70% of health insurance costs. That will grow to 100% in 2003 and beyond, Houskeeper says. "If a self-employed individual is paying for themselves and their family, we can get a dollar-for-dollar deduction for them."

Meanwhile, you should make plans to handle any expected premium increases for 2003. You can shift some of the cost to employees through higher co-payments and deductibles and take steps to enable them to pay their share on a pretax basis.

If you can afford it, pay cash bonuses, says Leland J. Reicher, a partner at the law firm Reish, Luftman, McDaniel & Reicher in Los Angeles. Reicher represents professional firms and closely held and family-owned businesses.

"Bonuses are very important because that's basically how you zero out the corporation and get rid of the income," Reicher says.

Therefore it's critical to keep tabs on any large payments coming in from clients late in the year, he adds.

You should also consider changing your business organization if it no longer suits your needs, Reicher says. If you're a sole proprietor, you may want to incorporate or form a limited liability company for personal liability protection. Talk it over with your lawyer, but Reicher advises smaller businesses to be S corporations rather than C corporations.

"You avoid the potential double tax [with the S corp.]," he says. "It used to be that there were good tax benefits in a C, or they were unavailable for an S. And that's not true anymore. Those have been equalized, and for most small businesses, S is the way to go."

Make charitable contributions to tax-exempt organizations if you operate as an accrual method C corp., says Kathy Womack, president of Arlington, Texas-based Income Tax Consultants. You can charge last-minute donations in 2002 to a credit card and take the deduction even if you pay the bill in 2003. If you make the donation by check and the charity doesn't receive the money until 2003, you can still take the deduction for 2002 if you mailed the check by Dec. 31. Make sure you put all of this information in your minutes, too.

Womack notes that charity donations made by sole proprietors or S corporations don't apply to the business—the deductions are passed through to individual owners and reported as an itemized deduction on the individual's return. "That's one thing that [business owners] have a misunderstanding about."

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