Year End Tax Planning Strategies for Small Business
December 22, 2014 by Stephanie Potash
The Small Business Administration reports that small businesses pay average effective tax rates that range from about 13.3 percent for sole proprietorships to 26.9 percent for S corporations. The effective tax rate is the amount of taxes paid by a company as a percent of its net income. Proactive business owners can make some last-minute strategic moves to significantly reduce the amount of taxes they’ll owe next spring. Here are four simple ideas to consider during the fourth quarter of 2014.
Idea #1: Buy a “Heavy” SUV, Pickup or Van
Buying a gas-guzzling SUV, pickup or van may be frowned upon for environmental reasons. But these vehicles can be useful if your business needs to haul people, materials, inventory or equipment around. They also have major tax advantages for businesses:
Thanks to the Section 179 deduction privilege, you can immediately write off up to $25,000 of the cost of a new or used heavy SUV, pickup or van that is placed in service by the end of your business tax year beginning in 2014 and used over 50 percent for business.
You may be able to write off more if Congress decides to restore the expanded Section 179 or 50 percent first-year bonus depreciation deductions for 2014. Last year, the Section 179 limit was $500,000 for qualifying assets, including heavy long-bed pickups and vans with no seating behind the driver’s seat and no body section protruding more than 30 inches ahead of the leading edge of the windshield.
After taking advantage of any first-year tax breaks, you can follow the “regular” tax depreciation rules to write off whatever is left of the business portion of the heavy SUV’s cost over six years, starting with 2014.To cash in on this favorable tax treatment, you must buy a “heavy” vehicle, which means one with a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. First-year depreciation deductions for lighter SUVs, light trucks, light vans, and passenger cars are much skimpier. You can usually find a vehicle’s GVWR specification on a label on the inside edge of the driver’s side door where the hinges meet the frame.
|Example 1: New SUV vs. New Sedan
Your business uses the calendar year for tax purposes. You buy a new $65,000 Cadillac Escalade and use it 100 percent for business between now and December 31. On your 2014 business tax return or form, you can write off $25,000 of the cost thanks to the Section 179 deduction. If Congress restores the 50 percent bonus depreciation deduction, you can write off another $20,000 (half the remaining cost of $40,000 after subtracting the Section 179 deduction).
You can follow the regular depreciation rules to depreciate the remaining cost of $20,000. This is the amount of the original purchase price that’s left after subtracting the Section 179 deduction and the 50 percent bonus depreciation deduction. Regular depreciation would typically result in an additional $4,000 deduction (20 percent times $20,000). So your first-year depreciation write-off equals $49,000 ($25,000 plus $20,000 plus $4,000) — a whopping 75.4 percent of the vehicle’s original cost.
In contrast, suppose you spend the same $65,000 on a new sedan that you use 100 percent for business between now and year end. Because the sedan is covered by the so-called luxury auto depreciation limits, your 2014 depreciation write-off will be only $3,160. If Congress restores the first-year bonus depreciation tax break, you will be able to deduct $11,160, however.
|Example 2: Used SUV vs. Used Passenger Car
Your business uses the calendar year for tax purposes. You buy a used $40,000 Cadillac Escalade and use it 100 percent for business between now and December 31. On your 2014 business tax return or form, you can write off $25,000 thanks to the Section 179 deduction privilege.
You can also follow the regular depreciation rules to depreciate the remaining cost of $15,000. Regular depreciation would typically result in an additional $3,000 deduction (20 percent times $15,000). So your first-year depreciation deductions add up to $28,000 ($25,000 plus $3,000).
In contrast, if you spend the same $40,000 on a used passenger car, your maximum 2014 depreciation write-off will be only $3,160.
Important Note: Section 179 can’t be claimed if it will create (or increase) an overall business tax loss. If your business is already expected to have a tax loss for the year (or close to it), purchasing a heavy vehicle at year end may not reduce your 2014 tax bill. This is the so-called business taxable income limitation. Contact your tax adviser if you think it might be an issue for your business.
Idea #2: Juggle Income and Deductible Expenditures through Year End
Pass-through entities. If you run your operation as a so-called “pass-through entity” — sole proprietorship, S corporation, limited liability company or partnership — your share of the enterprise’s net income will be reported on your Form 1040 and taxed at your personal rates. The 2015 individual federal income tax rate brackets are scheduled to be about the same as this year’s, with only modest bumps for inflation, so they will remain relatively taxpayer friendly.
Therefore, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in about the same or lower tax bracket next year. In that case, deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2014 until 2015.
On the other hand, if your business is thriving, and you expect to be in a significantly higher tax bracket in 2015 (say, 35 percent versus 28 percent), take the opposite approach. If possible, accelerate income into this year and postpone deductible expenditures until 2015. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.
C corporations. If you run your business as a traditional C corporation, the 2015 corporate tax rates are scheduled to be the same as in 2014. So if you expect your corporation to pay the same or lower rate in 2015, postpone income into next year while accelerating deductible expenditures into this year. If you expect the opposite, try to accelerate income into this year while postponing deductible expenditures until next year.
|Juggling Lessons for Cash-Basis Entities
Juggling year end income and deductions is fairly simple, if your small business is eligible to use the cash method of accounting for tax purposes. The cash method gives you flexibility to manage your 2014 and 2015 taxable income to minimize taxes over a 2-year period. Here are some specific cash method strategies if you expect business income to be taxed at the same or lower rate next year.
Before year end, charge recurring expenses that you would otherwise pay early next year on credit cards. You can claim 2014 deductions even though the credit card bills won’t be paid until next year. However, this favorable treatment doesn’t apply to store revolving charge accounts. For example, you can’t deduct business expenses charged to your retail store account until you actually pay the bill.
Pay expenses with checks and mail them a few days before year end. The tax rules say you can deduct the expenses in the year you mail the checks, even though they won’t be cashed or deposited until early next year. For big-ticket expenses, send checks via registered or certified mail to prove they were mailed this year.
Prepay some expenses for next year. This is allowed as long as the economic benefit from the prepayment doesn’t extend beyond the earlier of: (1) 12 months after the first date on which your business realizes the benefit or (2) the end of 2015 (the tax year following the year in which the payment is made). For example, this rule allows you to claim 2014 deductions for prepaying the first three months of next year’s office rent or prepaying the premium for property insurance coverage for the first half of next year.
On the income side, the general rule is that cash-basis taxpayers don’t have to report income until the year they receive cash or checks in hand or through the mail. To take advantage of this rule, put off sending out some invoices so you don’t get paid until early next year. Of course, you should never do this if it increases the risk of not collecting the money.If you expect to pay a significantly higher tax rate on next year’s business income, try to reverse these strategies to raise this year’s taxable income and lower next year’s. For example, a cash-basis taxpayer might ship before year end (and invoice) products scheduled for delivery in early January and hold off on sending checks to vendors until after January 1.
Idea #3: Take Advantage of NOLs
With the exception of the Section 179 depreciation deduction, the business tax planning strategies discussed here can be used to create (or increase) a 2014 net operating loss (NOL). This occurs when a business’s expenses exceed its income. You can then choose to carry a 2014 NOL back for up to two years in order to recover taxes paid in earlier years. Or you can choose to carry the NOL forward for up to 20 years, if you think your business tax rates will go up.
Idea #4: Talk to Your Tax Pro Now
Your tax adviser can evaluate your small business’s year-to-date financial performance to help determine how much you are likely to owe next March 15 (or April 15 for pass-through entities), as well as whether you’ve paid enough estimated taxes for 2014. The strategies discussed here only scratch the surface of proactive tax planning moves. Business owners who assess matters before year end have many more tax-reduction strategies at their disposal than those who wait