Year-End Tax Planning Moves for Businesses

As the end of the year approaches, many are looking for ways to reduce their business profits before year's end. Here are some possible moves that might apply to your situation.

Self-employed Retirement Plans - If you are self-employed and haven't done so yet, you may wish to establish a self-employed retirement plan. Certain types of plans must be established before the end of the year to make you eligible to deduct contributions made to the plan for 2012, even if the contributions aren't made until 2013. You may also qualify for the pension start-up credit.

Increase Basis - If you own an interest in a partnership or S corporation that is going to show a loss in 2012, you may need to increase your basis in the entity so you can deduct the loss, which is limited to your basis in the entity.

Hire Veterans - If you are considering hiring some new employees between now and the end of the year, you might consider hiring a qualifying veteran so that you can qualify for the work opportunity tax credit (WOTC). The WOTC for hiring veterans in 2012 ranges from $2,400 to $9,600, depending on a variety of factors (such as the veteran's period of unemployment and whether he or she has a service-connected disability).

Purchase Equipment - If you are in the market for new business equipment and machinery and you place them in service before year-end, you will qualify for the 50% bonus first-year depreciation allowance. Or, you can elect to expense up to $139,000 of the newly acquired items using the Sec 179 expensing allowance. The $139,000 expense limit is reduced by one dollar for every dollar in excess of the $560,000 annual investment limit.

Purchase an SUV for Business - If you are in the market for a business car, and your taste runs to large, heavy SUVs (those built on a truck chassis and rated at more than 6,000 pounds gross [loaded] vehicle weight), consider buying in 2012. Due to a combination of favorable depreciation and expensing rules, and depending on the percentage of business use, you may be able to write off most of the cost of the heavy SUV this year.

These are just some of the year-end steps that can be taken to save taxes. Please contact this office so we can tailor a plan to your particular needs.

DECEMBER 2010 TAX BRIEFING

401(k) Distribution to Disabled Spouse:
In the Fall 2010 edition of the Retirement News for Employers , the IRS stated that a distributable event in a 401(k) plan includes an employee's disability, but not a spouse's or dependent's disability. However, the 401(k) plan may allow a hardship distribution based on an immediate and heavy financial need of the employee or the employee's spouse, dependents, or beneficiaries. The distribution can be no more than necessary to satisfy the financial need, but can include amounts needed to pay taxes resulting from the distribution. The plan's terms will define "immediate and heavy financial need,"which may cover disability-related medical expenses for the employee's spouse.

Real Estate Dealer or Investor:
The Tax Court held that a couple who bought and sold real estate recognized ordinary income instead of capital gains. In finding that the real estate transactions were conducted in the ordinary course of a trade or business and not for investment, the Tax Court noted that (1) taxpayers' objective in purchasing and selling real estate was to recognize the maximum gain within a short period (most sales occurred within four months after they purchased the property); (2) the real estate transactions were entered into regularly and resulted in significant gains; (3) taxpayers engaged in at least 15 sales over three years, and (4) they did not rely on the services of a real estate agent or broker to select, promote, or sell their properties. Wendell Garrison , TC Memo 2010-261 (Tax Ct).

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How the Bush Tax Cuts Affect Tax-Saving Strategies

Each November, we like to look at the steps you can take to reduce your tax bill. This year, it's a little ambiguous, because the Bush tax cuts and credits are set to expire at the end of 2010. If they do expire, a lot of folks will experience a significant adjustment to their tax situation.

The "Bush tax cuts" refers to legislation enacted in 2001 and 2003. The cuts lowered tax rates on income, dividends, and capital gains; eliminated the estate tax; lowered burdens on married couples, parents, and the working poor; and increased tax credits for education and retirement savings.

Both Republicans and Democrats favor an extension of the tax cuts for the middle class. Where they differ is whether to extend the cuts for Americans in the top 2% of taxpayers.

With this in mind, we're looking at year-end measures separately for these two groups: the middle class - those making less than $200,000 for singles / $250,000 for married filers - and the higher income taxpayers - those making more than $200,000 / $250,000.

But first, let's take a quick look at what's at stake.

If All the Bush Tax Cuts Expire...
Among other things, if the Bush tax cuts were allowed to expire, the following would take place:
1. Tax brackets would change, from 10%, 15%, 25%, 28%, 33%, and 35% to 15%, 28%, 31%, 36%, and 39.6%.
2. Long-term capital gain tax rates would rise from 15% to a maximum of 20%.
3. The child tax credit would be lowered.
4. The alternative minimum tax would cease to be indexed for inflation.
5. The marriage penalty would be reinstated.

Middle-Income Taxpayers
We don't expect Congress to allow the tax cuts to expire for this group. That means middle-income taxpayers can take the same measures this year they have in previous years to reduce their tax burden for 2010.

We recommend the following steps to save on taxes this year: defer income, accelerate your deductions, and plan out your capital gains.

Defer Income
If you are planning to sell an investment on which you have a gain, it may be best to wait until the new year. This will defer payment of the taxes for another year (subject to estimated tax requirements).
• If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. Again, this can defer the payment of taxes (other than the portion withheld) for another year. (Note that deferral of tax generally won't work where the bonus is contractually due in 2010.)
• If your company grants stock options, it may be wise to wait until next year to exercise the option or sell stock acquired by the exercise of an option. (Exercise of the option is often a taxable event; sale of the stock is almost always a taxable event.)
• If you're self-employed, and you can afford the delay in cash inflow, defer sending invoices to clients until the end of December.

Accelerate Deductions
Pay a state estimated tax installment in December instead of at the January due date. Just make sure the payment is based on a reasonable estimate of your state tax.
• Pay your entire property tax bill, including installments due in 2011, by year-end. (This is not applicable to mortgage escrow accounts.)
• Try to bunch threshold expenses, such as medical expenses and miscellaneous itemized deductions. (Threshold expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income.) By bunching these expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing your deduction. For example, you might pay medical bills and dues and subscriptions in whichever year they would do you the most tax good.

Caution: In most cases, credit card charges are considered paid in the year of the charge regardless of when you pay on the card. But this does not apply to store revolving credit cards. If you charge expenses on a Wal-Mart store credit card, for example, the deduction cannot be claimed until the bill is paid.

Some tax benefits are phased out if you have more than a certain level of adjusted gross income. In these cases, a strategy of deferring income and accelerating deductions may also allow you to claim larger deductions, credits, and other tax breaks for 2010.

Tip: Deferring income into 2011 is an especially good idea for taxpayers who anticipate being in a lower tax bracket next year, either because of much-reduced income or much-increased deductible expenses.

Minimize Taxes on Investments
Judiciously match your capital gains and losses to reduce your tax burden for 2010. Where appropriate, try to avoid short-term gains, which are usually taxed at a much higher tax rate (up to 35%) than long-term gains (15%). You might consider, where feasible, trying to reduce all capital gains and generate short-term capital losses of up to $3,000.

Tip: If you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses are deductible up to the amount of your capital gains plus $3,000.

High-Income Taxpayers
Depending on what Congress decides in this legislative session, individuals making more than $200,000 filing singly or $250,000 filing married in 2010 will owe more tax than they have since the 2001 Bush tax cuts were passed. What does this mean for end-of-year tax planning?

Don't Defer Income
If tax cuts for the richest Americans are allowed to expire at the end of the year, then many in the current 33% tax bracket will find themselves in the 36% bracket, and those currently taxed at the 36% rate will be taxed at 39.6%.

For these taxpayers, it makes sense to bump up 2010 income, to take advantage of the current lower rates. Grab that year-end bonus; sell stock acquired by the exercise of a company stock option; bill clients for as much work as possible if you're self-employed.

Take Capital Gains Now
Capital gains and qualified dividends for those in the higher tax brackets would be affected if the tax cuts are allowed to expire for the richest Americans. The capital gains rate would revert to a maximum of 20% for higher income filers (from 15% currently), and qualified dividends would resume being taxed at the regular tax rate of the filer, or as high as 39.6%.

This indicates that now is a good time to take any capital gains or qualified dividends. Selling assets now as opposed to 2011 could have positive tax consequences for higher income filers.

Let Us Help You
As you can see, this is a complicated year for tax planning. Please don't hesitate to come in and meet with us about your situation. There's still a lot we can do to minimize your tax burden for 2010.

Please note, to comply with IRS regulations, we need to advise that any discussion of federal tax issues in this blog is not intended or written to be used, and cannot be used by you, (i) to avoid any penalties imposed under the Internal Revenue Code or (ii) to promote, market or recommend to another party any transaction or matter addressed herein. For more information please go to http://www.lw.com/docs/irs.pdf

THE TAX COURT DISALLOWS THE EXCLUSION OF THE SALE OF HOME

In a tax court decision [David A. Gates and Christine A Gates, Petitioners v. Commissioner of the IRS, Respondent], held that taxpayers, who voluntarily demolished and constructed a new house on their property in order to enlarge and remodel their home, couldn't exclude the gain on the sale of the new house under the Code Sec. 121 exclusion for the sale of a principal residence. Although the taxpayers owned and used their old house as a principal residence for at least two of the five years before the sale, the Code Sec. 121 exclusion did not apply because they never lived in the new house and it was never used as their principal residence.

The Code Sec. 121 exclusion allows a taxpayer to exclude from income up to $250,000 of gain from the sale of a home owned and used by the taxpayer as a principal residence for at least two of the five years before the sale. The full exclusion does not apply if, within the two-year period ending on the sale date, the exclusion applied to another home sale by the taxpayer. Married taxpayers filing jointly for the year of sale may exclude up to $500,000 of home sale gain if (1) either spouse owned the home for at least two of the five years before the sale, (2) both spouses used the home as a principal residence for at least two of the five years before the sale, and (3) neither spouse is ineligible for the full exclusion because of the once-every-two-year limit.

If you want more information or need assistance, please call our office