Holiday List: Last-Minute Tax Moves

There's still time to make changes that will cut 2005 taxes

Are you looking for last-minute ways to reduce your 2005 taxes? You still have an opportunity to take some steps before the end of the year. There are also some moves you can make up until the April 15 deadline—and even beyond, if you file for an extension.

BIG FAT CAVEAT

Every business owner’s situation is different. The information that follows is from sources considered reliable, but as always, you must consult your tax advisor to ensure you are taking the correct actions for your circumstances.

The information that follows is intended primarily for cash basis “S” Corporations rather than “C” Corporations or accrual-basis businesses, but in many cases the information applies to all businesses. There are several major areas in which to look for potential tax savings, reductions, refunds, or even credits:

• Setting up certain retirement plans
• Buying and deducting certain equipment or depreciable assets
• Revisiting previous years’ deductions, especially depreciation, to make sure deductions weren’t overlooked
• Pre-paying selected business expenses
• Reassessing whether your business should be a “S,” “C” or other business entity
• Paying bonuses at the “right” time

Retirement Plans

Most company-sponsored retirement plans had to be established no later than October 1st for 2005. However, if you did not set up a plan, or haven’t fully funded the one you have, all is not lost. If you are making contributions on behalf of your employees [using SIMPLE Individual Retirement Account (IRA), Simplified Employee Pension (SEP) Plan IRA, 401(k), profit sharing, or similar plans] you have until your tax filing date, plus extensions, to make these contributions. If your cash flow will support making maximum contributions you can reduce your taxable income and benefit your employees at the same time.

If you are willing to make contributions for your employees you can still set up and fund SEP IRAs for yourself and your employees—up until the day you file your business tax return, including all extensions. For many business owners (for sole proprietors, the rules are slightly different) that means you can contribute 25% of your earnings and the earnings of eligible employees (the lesser of 25% or $42,000), thereby avoiding or deferring significant taxes, well into 2006.

Also, you may be able to take a tax credit for $500 (or up to one-half, whichever is less) of the set-up and employee education costs for a SEP IRA, SIMPLE IRA/401(k), or other qualified plans. Even better, you may be able to take this credit for up to three years.

Buying Equipment, Vehicles, or Real Property

Under Section 179 of the Internal Revenue Code, you can deduct and/or depreciate certain business assets purchased by December 31st, even if you use credit and don’t make any payments until 2006. Whether you want to do this or not depends on the shape of your business. If you’re doing well and need to shave the tax bill, this might be an excellent time to buy computers, software, furniture, etc. and take a deduction in 2005; If business is not so hot, defer these purchases to when you need tax relief.

Note that while the total allowable Section 179 expense is $105,000 in 2005, this is a cumulative number. So, if you have multiple subchapter S businesses, you can’t take $105,000 per business. In addition, if taking the deduction(s) would put the business into a break-even or loss status, you may be able to add back in owners’ compensation and deduct the amount above breakeven as a 179 expense.

The Ghost of Depreciation Past

According to Richard A Thompson, a Tax Partner with Sikich Gardner & Co, LLP, one of the most frequent mistakes business owners make is the way in which they depreciate their business property. Specifically, in many instances the entire building, including business personal property, is depreciated according to the 39-year schedule. This can substantially defer the allowable depreciation amount because business personal property is depreciated over a much shorter period (generally five to seven years, or in come cases 15 years) so the cost of the property can be recovered much more quickly than over 39 years. Thompson recommends going back over past years’ returns to identify incorrectly depreciated business personal property. Some examples of mis-categorized property could include cubicles, alarm and fire suppression systems, carpeting and other floor and wall coverings, and kitchen equipment. Any depreciation not properly claimed in prior years can all be claimed in the current year, often substantially reducing your current year tax liability.

The difference in business real property and business personal property is pretty simple—land is neither, structures are real, and anything added to the building that could be removed is usually personal. Talk to your accountant to get an actual breakout for your situation.

Pre-Paying Certain 2006 Business Expenses

Cash-basis businesses may deduct certain prepaid expenses in the year paid under specific conditions. Expenses that involve interest payments (such as mortgage payments) generally can’t be pre-paid, but rent, utilities, and employee benefits usually can be. If, for example, you heat your building with propane, you might pre-pay for 1,000 gallons to get the deduction in 2005. On the other hand, if you paid a fee to secure a lease, and now pay monthly rent, the fee must be amortized over the term of the lease (a capital expense).

Changing Between “S” and “C” Entities

You may be able to save taxes by switching from “C” Corporation to a subchapter “S” Corporation, provided you are a cash-basis taxpayer. This could save you significant “double” taxation immediately, because the income from the company flows tax-free to the owners, who declare it as personal income. S status can also help when you go to sell your business. If you are eligible to make this election, and the change makes sense, you need to file the election form by March 15th 2006. We will have more on this in a future article.

Paying Bonuses

Here’s one for you accrual-basis business owners. If you are going to pay bonuses, do so by March 15th 2006 so you can take the deduction for 2005. Cash basis businesses need to pay the bonuses by the 31st of December or you lose the deduction for 2005.

The end of the tax year doesn’t mean the end of tax deductions; prior planning and consulting with a tax professional can reduce stress and increase the chances nothing is overlooked.