Once more it’s time to play another deep game of chess with the IRS. Are you ready?
2015 is coming to an end but there is still time for business owners to make smart decisions now that will minimize the taxes they will owe next year. Here in this article I discuss several major tax planning strategies and considerations.
Get a Tax Projection
You can’t improve your position if you don’t know where you’re at right now. The starting point is to request a tax projection from your accountant based on income and expenses through November. This projection will specifically quantify the taxes you are likely to owe by April 15th next year. A tax projection prevents a nasty “April Surprise” and will also identify opportunities to minimize taxes before 2015 comes to an end.
If you don’t like the results predicted by a tax projection then one of the things you can do is ‘buy deductions.’ The first major deduction available to small business is depreciable assets. If your business has a legitimate need for equipment or vehicles then now is the time to buy. Section 179 allows businesses to expense the statutory amount of the cost of an asset (every December Congress usually engages in a last minute scramble to change the law and keep the maximum Section 179 deduction at its historical limit of $500,000.)
Vehicles also qualify for Section 179 expensing. Weight matters. Vehicles with a Gross Vehicle Weight Rating “GVWR” of 6,000 pounds or more qualify for more generous deductions than smaller vehicles. Confirm the GVWR with your dealer before you buy a business vehicle.
It doesn’t matter if you buy assets for cash or finance them with a loan. As long as legal title to an asset transfers to you or your business by December 31, 2015 then you will be able to claim depreciation (including Section 179 expensing) on the asset in 2015.
Another important deduction is contributions to a pension plan. There are approximately 21 different types of pension plans available including IRA’s, Roth IRA’s, SEP plans, Keogh Plans and SIMPLE pension plans. In many cases a business owner can fund these plans after year‐end, and in some cases as late as the extended due date of a tax return.
Pensions are a ‘pay to play’ system because the amount that can be funded is usually linked to compensation. In order to maximize the amount of pension funding you must maximize your taxable compensation (salary or wages.) Compensation is subject to a 15.3% social security tax.
You must pay this tax in order to obtain the privilege of funding many types of pension plans. Math matters when trying to decide if it’s worth it. If your average effective income tax rate is, say, 25% (federal plus Maine) then it would indeed be worth it to increase your compensation, pay the additional 15.3% social security tax, and enjoy a 25% income tax benefit. In this simplified example you would be ahead of the game approximately ten cents for each dollar.
Anti-discrimination rules apply to most pension plans, which means a business owner may have to offer the same pension plan to qualifying employees.
Defer Income and Accelerate Deductions
This is a classic tax planning strategy frequently used by many business owners. If 2015 was a great year for you it may indeed make sense to slow down in December and push projects (and taxable income) into the next year. Our income tax system has progressive tax rates. The more you make the higher the tax rate that will apply.
The ability to accelerate deductions depends on what type of accounting method your business uses. Those of you using the cash method of accounting can generally claim a deduction when a bill is paid (there are exceptions though.) Under the ‘mailbox rule’ an expense is deductible when you put a check in a mailbox or hand it to a Post Office carrier. Unmailed checks dated December 31 that are not sent out until January won’t be deductible until January.
It gets trickier if your business uses the accrual method of accounting, where expenses are (usually) deducted when a bill is incurred, regardless of when it is paid. Important tax rules such as the “all events test” and the “recurring item exception” clarify if and when an accrued expense is deductible for tax purposes. Consult with your accountant for further information on this.
Shift Taxable Income to Others
If your business is organized as an S corporation, partnership or LLC it may be possible for you to shift income to someone else. This is a more sophisticated tax planning strategy that may be feasible depending on your family circumstances. Here is a simplified illustration:
Let’s say you have a nephew who is not your dependent and is age 24 or older. Your nephew has just started his career and is paying federal income tax at the bottom rate of 10%.
Your business is extremely profitable and you are paying federal income tax at 35%.
Assuming you and your nephew come to an agreement, you could gift non-voting stock in an S corporation or LLC to your nephew. Let’s say that after the gift your nephew owns 10% of your business as a passive investor. Because S corporations and LLC’s are ‘pass-through’ entities that means your nephew will be taxed on 10% of any business profit. You have just shifted income that would have been taxed to you to your nephew.
Of course your nephew will ask to be reimbursed for the taxes he will owe on income taxed to him. You would be delighted to do this because he is paying tax at a 10% rate while you would have paid tax at a 35% rate. You save on the differential while remaining in control of the business.
This tax planning strategy assumes there is a legitimate, legally binding agreement between you and your nephew where all the requirements for making a valid gift of an equity interest in a company are respected. Further, there are significant implications to giving partial ownership of a company to someone else, especially if and when a business is sold or liquidated. Careful attention should be paid to these issues prior to implementing this type of strategy.
Pay As You Go
Our income tax system wants taxpayers to ‘pay as you go.’ Quarterly estimated tax payments are required by Maine and the IRS if you owe either of them $1,000 or more. A variety of methods exist to estimate current income taxes. Both the IRS and Maine charge a penalty, called Underpayment of Estimated Tax, when insufficient estimated taxes are paid in during the year.
In effect this is another tax planning strategy that will help you avoid this penalty while also avoiding the financial burden of owing a substantial amount of taxes by April 15th.
The best strategy of all is to think ahead, plan ahead and act ahead.
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339
©2015 Copyright George Adams CPA MBA. All Rights Reserved.