Year-End Tax-Planning Moves for Small Businesses

Some savvy moves over the next few weeks could dramatically reduce Uncle Sam's tab.

Attention small-business owners: By combining some new tax maneuvers with some time-honored strategies that still work, you can shrink your 2003 tax bill considerably. And you've got from now until the end of the year to take action.

So assuming you like the idea of kicking off 2004 with a bit more cash in the coffers, read on.

Buy Equipment and Software Before Year-End
As you've probably heard, new and pre-owned "heavy" SUVs, pickups, and vans used over 50% in your business qualify for the $100,000 "Section 179" instant depreciation write-off. (The 2003 Act increased the maximum Section 179 deduction from a mere $25,000 to the current $100,000 amount.) This break is so juicy, it seems almost too good to be true.

Say you spend $60,000 on a new Cadillac Escalade that's used 100% in your business. Provided you make the purchase before year-end, you can probably deduct the entire $60,000 cost on this year's return. (This assumes your business is unaffected by the limitations outlined in Section 179 Rules.)

Just make sure you buy a heavy-enough SUV, pickup or van. That means a machine with a manufacturer's gross vehicle weight rating (GVWR) above 6,000 pounds. Only these heavy vehicles qualify for the ultragenerous $100,000 Section 179 instant deduction privilege. (First-year depreciation deductions for lighter vehicles are much skimpier.) Fortunately, it's pretty easy to find attractive machines with GVWRs above 6,000 pounds. Most that look big enough to qualify do qualify. You can verify the GVWR specification by checking the label on the inside edge of the driver's side door.

Thanks to the 2003 tax cut, you can also use your $100,000 Section 179 instant-deduction privilege to immediately write off the cost of new business software purchased between now and year-end. Under the previous rule, you had to depreciate most software costs over 36 months.

After buying that heavy SUV and loading up on new software, you may still have plenty of room left under your $100,000 Section 179 tax shelter. Folks, this is a use-it-or-lose-it deal. By that I mean you can't carry over any unused Section 179 allowance to next year. But you need not get too carried away. Why? Because you'll start off on Jan. 1, 2004, with a brand-new $102,000 Section 179 allowance, thanks to the annual inflation adjustment.

Section 179 Rules
A taxpayer's annual Section 179 deduction can't exceed that year's aggregate net business taxable income from all sources (calculated before the Section 179 write-off). With the huge new $100,000 Section 179 allowance, this little-known rule will now affect many more taxpayers than ever before. But there is some good news. When you conduct your business as a sole proprietorship — or as a single-member LLC treated as such for federal tax purposes — you're allowed to count any salary, wages and tips that you may earn as an employee as additional net business taxable income. If you're married and file jointly, you can also count your spouse's earnings from employment as well as any net self-employment income from business activities in which he or she actively participates. These taxpayer-friendly loopholes greatly reduce the odds that you'll be adversely affected by the net business income limitation.

If you run your shop as a partnership, multimember LLC or S corporation, please consult your tax pro about how to take full advantage of the expanded Section 179 write-off. Why? Because the $100,000 deduction maximum and the net business income limitation apply at both the entity level and at your personal level. This means some careful planning may be required in order for you to collect the expected tax savings from your heavy SUV, pickup or van.

Obey Stricter Section 179 Rules for Corporate-Owned Vehicles

When the heavy SUV, pickup or van is owned by your C or S corporation, it must be used over 50% for actual corporate business activities (based on mileage) to qualify for the Section 179 write-off. Unfortunately, personal use by an employee who's also a more-than-5% shareholder (this means you) doesn't count as corporate business use for this purpose, even though the personal-use value is properly reported as additional taxable compensation on your Form W-2. The same restriction holds true for other corporate employees who are related to a more-than-5% shareholder. When the over-50% business-use test is failed, your corporation must depreciate the vehicle using the straight-line method over a total of six years.

Diversify Your Wealth With Low-Taxed Stock Redemption Deal
Do you have too much of your total wealth tied up in your solely owned C corporation? This is a fairly common scenario in the small-business world. Fortunately, I have a tax-saving idea especially for folks in your shoes. Here goes. Have your corporation buy back some of your shares. In tax lingo, this is called a partial redemption. The payment you receive from the company in exchange for the redeemed shares will generally be a qualified dividend that gets taxed at no more than 15% (plus the state income-tax hit, if any). Depending on some complicated rules, part of the redemption payment may simply reduce the basis of your shares, which means totally tax-free treatment for that part. Bottom line: You pay no more than 15% to the U.S. Treasury (maybe less), and you retain ownership of all the outstanding stock in your corporation (assuming you owned 100% in the first place). The big change is that you now have lots of cash to invest in a diversified portfolio of publicly traded securities. So you'll sleep better. Best of all, you can pull this off at an extremely low tax cost.

While I'm certainly not a political pundit, I recommend doing big tax-saving deals like this sooner rather than later in order to lock in today's favorable federal tax rates. So I think getting your stock-redemption transaction done before the end of this year would be very prudent. I absolutely guarantee the current ultrafavorable federal tax rates won't be changed for this year. I don't make the same guarantee for 2004 and beyond (although I'll be quite surprised if anything happens next year).

Set Up Your Retirement Plan Now
Recent tax-law changes give small-business owners better retirement-plan options than ever before. But you gain no advantage until you actually set up a plan. Shame on you if you haven't! But you can still get into the game before year-end. Here's how, in a nutshell.

  • Establish a simplified-employee-pension (SEP) plan and potentially contribute and deduct up to $40,000. Actually, you can do this after the end of this year, because a SEP can be opened as late as the extended due date of your 2003 return. You can make your contribution as late as that date and still claim a 2003 tax deduction. But why procrastinate? Do it before year-end, and you'll rest easier knowing you've started the ball rolling.
  • For a one-person business, establish a solo 401(k) plan. This arrangement may allow you to contribute and deduct considerably more than other types of plans. However, to claim any deduction on your 2003 return, you must establish the plan by Dec. 31, 2003. You can defer part of the actual contribution until the extended due date of your 2003 return. (See our story for more on this.)
  • Set up a defined-benefit pension plan and potentially contribute and deduct even more. The exact amount depends on various factors, including your age and earnings. Defined-benefit plans generally work best for high earners age 50 and older. To claim a deduction on your 2003 return, you must establish the plan by Dec. 31, 2003. You can defer the actual contribution until the extended due date of your 2003 return.

Warning: If your business has other employees, you may have to make contributions to their accounts as well as your own. In this case, please consult a retirement-plan pro before taking any action. If you decide to go ahead, doing so before year-end still makes sense.

Defer Receipts and Accelerate Deductible Expenses
After the 2003 Act, you can forget about the strategy of deferring taxable income into future years and accelerating deductible expenses into the current year purely to take advantage of lower individual federal income-tax rates scheduled to take effect in future years. Individual rates have probably bottomed out. Don't expect them to go lower anytime soon.

Even so, it's still a tax-smart move to defer income into next year and accelerate deductible expenditures into this year if you expect to be in the same or lower tax bracket next year. Here's the drill assuming your business uses the cash method of accounting for tax purposes (as most small businesses do).

  • Charge deductible business expenses on credit cards before year-end. That way, you'll create 2003 tax write-offs even though the actual credit-card bills won't be paid until 2004. Beware: This taxpayer-friendly rule doesn't apply to store revolving charge accounts. So if you charge expenses on your Home Depot card, you can't claim any deductions until you actually pay the bill.
  • Cut checks before year-end to pay other deductible expenses. You can claim 2003 deductions even though the checks may not be cashed or deposited until early next year. To failsafe your write-offs against IRS challenge, I recommend sending large year-end checks via registered or certified mail. That proves you shipped the checks off this year.
  • On the income side of the equation, consider deferring some of your billings until right at the end of the year. That way, you'll be paid — and taxed — next year instead of this year. Of course, you should never defer billings when there's any chance that it would increase the odds of not collecting your money.
Tax Planning Info. for 2004
Single Joint HOH
10% tax bracket $0-7,150 $0-14,300 $0-10,200
Beginning of 15% bracket 7,151 14,301 10,201
Beginning of 25% bracket 29,051 58,101 38,901
Beginning of 28% bracket 70,351 117,251 100,501
Beginning of 33% bracket 146,751 178,651 162,701
Beginning of 35% bracket 319,101 319,101 319,101
Standard deduction $4,850 9,700 7,150
Personal exemptions $3,100 3,100 3,100
Beginning/end of personal exemption phase-out range (based on AGI):
$142,700/265,200 214,050/336,550 178,350/300,850
Beginning of itemized deduction phase-out range (based on AGI):
$142,700 142,700 142,700
Maximum salary deferral contribution to 401(k): $13,000
Maximum 401(k) contribution if age 50 or older: $16,000
Maximum deductible contribution to SEP account: $41,000
Maximum contribution to profit-sharing plan: $41,000