Small Business Tax Saving Strategies for the 2012 Filing Season*
INTRODUCTION
1: Welcome
2: Advice for Small Businesses from CPAs
It is my pleasure to present to you a few of the important tax issues that may have an impact on your 2011 tax returns.
Whether it’s the economic uncertainty that many of you continue to face as small business owners or the complexities of new tax laws that affect your business, there rarely has been a time when meeting your tax responsibilities has been more challenging.
Understanding these laws, and correctly applying them when preparing your tax return, can be overwhelming, especially when new demands on your business and the growing competition seem to consume more and more of your time and resources. However, the proper application of these rules can help the business owner finance the asset purchases by conserving earnings that can be used to finance growth.
Below I will present tax law provisions dealing with expenses, employees, reporting requirements and planning opportunities. These discussions will offer some of the latest information and practical strategies you can use to minimize your tax bill.
However, I’d like to remind you that tax planning and the timing of your tax decisions are critical, and that tax issues may change throughout the year. I therefore recommend that you regularly monitor your financial situation and consult with your CPA at least quarterly if you believe your business may be affected by any tax-law changes or other circumstance.
By taking the necessary responsive steps when the need arises, rather than delaying action until the end of your tax year, you can better protect the financial interests of your business.
It is impossible to predict what Congress might ultimately decide to do next year with the uncertainties in the world economies and as pressure on tax and spending changes grow. So stay in touch with your CPA.
*Information is current as of Dec. 12, 2011.
SELECT 2011 TAX PROVISIONS
3: Section 179 Expense Deduction
I’d like to start with a discussion of the special rules available to small businesses for purchasing capital assets. The Section 179 expense deduction is an expensing provision that applies to tangible business property placed in service during the tax year. By claiming it, you can deduct the full cost of newly purchased equipment in the year of purchase and, in the process, you receive a larger tax benefit, improve cash flow and have additional capital to invest.
Regardless of whether you made the purchase with cash or credit, the maximum write-off on a per-taxpayer basis is:
* $500,000 in 2011
* $139,000 in 2012
You are eligible for the deduction on a wide range of property purchases, from computer software to office equipment. For 2011, the deduction also is available for qualified restaurant, leasehold and retail improvement property. This expansion is not available in 2012, unfortunately.
You need to keep in mind that the deduction is reduced by every dollar more than $2 million. So, for example, if you spend $2.5 million or more on eligible property, your Section 179 expense deduction will be zero. Normal depreciation rules will then apply. In 2012, the $2 million dollar limit decreased to $560,000, and the deduction reaches zero for amounts more than $699,000.
The Section 179 expense deduction is limited and cannot be greater than your business’s taxable income and it does not apply to property you inherited or initially purchased for personal use, even if you later change it to a business use.
4: Bonus Depreciation
An additional depreciation that was implemented to encourage asset purchases is the provision for bonus depreciation. You can use the bonus depreciation rules to write off the entire cost of certain business property you first placed in use in 2011. This rule, known as first-year bonus depreciation, allows you to write off 100 percent of your costs in 2011. For property placed in service in 2012, the bonus depreciation allowance is decreased to 50 percent of the property’s cost. Any remaining cost not fully deducted under the bonus depreciation rules is subject to the regular depreciation rules. Thus, it must be deducted over a period of several years.
The allowance generally applies to tangible personal property, including property with a recovery period of 20 years or fewer, office equipment, computer software and certain leasehold improvements. The property must be new, it can’t be used.
By providing immediate tax relief, improving cash flow and providing additional capital for reinvestment in the business, this rule delivers a number of benefits to small business owners. It is important to properly coordinate between using the Section 179 rules versus the bonus depreciation rules as there can be tax consequences to each choice.
5: Start-up and Organizational Expenses
As a small business owner, you typically incur a wide range of costs in the launch of your business. However, relief is available to you. The tax law allows you to deduct some of those costs in the year that you started the business, and others must be amortized, or deducted, over the course of succeeding years.
These start-up costs include expenses incurred when investigating whether to start or buy a business and which business to start or buy. Costs can range from market analysis and feasibility studies to advertising and consultant fees.
In 2011, you may elect to deduct up to $5,000 of start-up expenses incurred during the tax year, down from $10,000 in 2010. The balance must be amortized over 180 months, beginning in the month the business was launched.
However, the deduction phases out dollar-for-dollar in 2011 if costs are greater than $50,000, with no immediate deduction available when start-up costs are greater than $60,000. In that case, all of the costs must be amortized over 180 months.
Also, you can deduct certain organizational costs (up to $5,000, subject to a dollar-for-dollar phaseout if your costs are greater than $50,000) incurred in the setup of a C or S corporation or a partnership, under the same rules for business start-up costs. Organizational costs include legal and accounting fees relating to the creation of the entity.
These rules help small business owners by promoting entrepreneurship and making additional capital available to business owners that can be used for other purposes.
6: Federal Unemployment Tax Act (FUTA)
Generally, all employers pay FUTA tax to support federal and state programs that pay benefits to unemployed workers. The amount of FUTA tax owed by an employer is a percentage of the total amount of wages paid by the employer during the year, limited to the first $7,000 of wages paid to each employee during the year. The FUTA tax rate was set at 6.2 percent for many years, but it was reduced to 6 percent as of July 1, 2011.
If you were required to pay unemployment tax in 2011 for a state unemployment program, you will be allowed a credit against your FUTA tax. The credit is limited to 5.4 percent of wages, producing an effective FUTA tax rate of only 0.6 percent in 2011 – for all of 2011, not just as of July 1.
7: Deduction for Health Insurance When Computing Self-Employment Tax
If you’re self-employed as a sole proprietor, partner or LLC member, you must pay self-employment tax on business earnings. The tax is based on your net earnings from self-employment and generally is equal to 15.3 percent. However, in 2011, the tax was temporarily decreased by two percentage points, to 13.3 percent, consisting of a Social Security tax rate of 10.4 percent and a Medicare insurance tax rate of 2.9 percent.
When you determined your net earnings from self-employment in 2010, you could deduct health insurance costs incurred for yourself, your spouse, your dependents and any of your children who had not reached age 27. This deduction is not available in 2011, but under a separate provision, you can continue to deduct these health insurance costs from your gross income when determining your income tax.
8: Worker Retention Credit and Credit for Hiring Unemployed Veterans
You may take an additional general business tax credit for each formerly unemployed worker you hired after March 18, 2010, and before Jan. 1, 2011, and who you keep on the job for at least one year. Although the credit is available for employees hired in 2010, the credit cannot be claimed until 2011.
If you hired new employees in 2010 with the intention of claiming this credit, don’t forget about it when filing your 2011 returns. The credit is equal to the lesser of $1,000 or 6.2 percent of the wages the taxpayer paid to the retained worker during the one-year period.
9: Credit for Hiring Unemployed Veterans
In late 2011, Congress and the White House created the Returning Heroes Tax Credit and Wounded Warriors Tax Credit to give an additional incentive for employers to hire unemployed veterans. The credit is a component of the work opportunity credit, which is available to employers who hire a specifically targeted individual, such as individuals receiving welfare assistance, ex-felons and summer youth.
The credit is worth up to $5,600 for hiring a long-term unemployed veteran, $2,400 for hiring short-term unemployed veteran and $9,600 for hiring an unemployed veteran with a service-related disability. It is available for the first year you hire each unemployed veteran after Nov. 11, 2011, and before Jan. 1, 2013.
10: Certain Form 1099-MISC Reporting Repealed
If you were engaged in a trade or business in 2011 and made payments of $600 or more to an individual or business in the form of wages, interest, rent or other similar payments, you must provide the payee with a Form 1099-MISC and send a copy to the IRS.
Historically, you have not been required to send a 1099-MISC to corporations, other than with respect to the payment of legal fees or medical or health-care services that are otherwise reportable, but a requirement was enacted in 2010 to report such payments after Dec. 31, 2011. Similarly, a provision was enacted that would have required individuals receiving rental income from real estate to file information returns for payments made after Dec. 31, 2010.
These two new reporting requirements were eliminated before they could come into full effect thanks to the efforts of the business community, the AICPA, and others. Thus, corporate payments and an individual’s rental income generally remain excepted from the information reporting requirements. However, all other requirements remain in effect and, as I will discuss in a minute, the penalties for not reporting as required have gone up.
11: Credit Card Transactions
Beginning with Jan. 31, 2012, by Jan. 31 of each year, merchants conducting credit card, debit card or gift card transactions may receive a Form 1099-K from the card processing company reporting the gross amount paid to the merchant during the prior year. Payments made through a third-party settlement network, such as PayPal or eBay, will be reported only if the payee receives more than $20,000 in aggregate and the total number of payment transactions exceeds 200.
Form 1099-K is a new form for the 2012 tax year, implemented to ensure that businesses, especially small businesses, pay tax on their credit and debit card income, especially from online sales. Even merchants who already properly report their credit and debit card income are affected by this new requirement because they must establish new accounting procedures. This is because Form 1099-K will report the gross amount received through payment cards, and therefore you must reconcile the form with your own records to take into account fees, returned items, cash back and other similar amounts.
Pay attention to requests for filing W-9 forms from your credit card vendors as the card processing company may be required to institute backup withholding on your credit card transactions if you do not provide them with a correct taxpayer identification number, such as an EIN. The IRS has delayed this requirement until after 2012, however. The IRS also has provided that for payments made to a third party settlement network, backup withholding will not apply to payees who receive fewer than 200 payment transactions, even if they receive more than $20,000 in payments.
12: Information Reporting Penalties
A penalty may be imposed if you fail to file any correct and timely information statement with the IRS, or if you fail to furnish a correct and timely information statement to the payee. The amounts of these penalties have increased in 2011.
Both penalties are now $100 per return, reduced to $30 for returns fewer than 30 days late and to $60 for returns 30 or more days late that are filed before Aug. 1. The penalties are capped at a certain amount, depending on the amount of the per-return penalty and the gross receipts of the business. The penalties may be waived for reasonable cause or increased in cases of intentional disregard.
In summary: (1) the new information reporting requirements enacted in 2010 are not gone, as if they never existed, (2) the IRS will now receive more information about merchants who accept credit cards and (3) higher penalties will apply to businesses that do not correctly and in a timely manner file information statements.
13: Corporation Built-in Gains
If you converted a C corporation to an S corporation, the built-in-gains tax applies to certain property held by the S corporation at the time of the conversion. If you sell the property after the conversion, you may need to pay tax on the gain, known as net recognized built-in gain, equal to 35 percent, the highest corporate tax rate.
This tax generally applies to property sold within 10 years of the conversion to an S corporation, but in 2011, that time frame is decreased to 5 years. So a built-in gain on a property sold in 2011 is not subject to the built-in gains tax if the conversion to an S corporation occurred more than five years before the date of the sale.
This rule lowers your tax burden and may provide additional capital for business investment.
14: Planning for 2012 and Beyond
Potentially, 2013 could be a momentous year for tax, and planning for it should begin in 2012.
First, in addition to the normal 2.9 percent Medicare tax, a new Medicare tax of 0.9 percent will apply to certain wages. Businesses will be required to withhold additional amounts from the paychecks of their employees, and the new tax may cause some business owners to rethink their own compensation planning.
Second, a new Medicare tax of 3.8 percent will apply to certain investment income, including pass-through income from a passive trade or business such as a partnership or S corporation. You may want to rethink their business structure to accommodate this new tax.
However, these two Medicare taxes will only apply to amounts in excess of $200,000, although this limit is increased to $250,000 for joint returns and is decreased to $125,000 in the case of married taxpayers filing separate returns.
Third, the Bush-era tax cuts may expire. The expiration of these tax cuts would, among other things:
* increase the tax rates on regular income, capital gains and dividends
* increase the number of individuals subject to the Alternative Minimum Tax (AMT)
The bulk of these changes will affect individuals, but they will also have a major impact on businesses. In particular, the highest tax rate on individuals will increase to 39.6% percent, which is 4.6 percentage points higher than the highest tax rate on corporations. Therefore, although there has been a move in recent years toward pass-through entities, such as LLCs, the C corporation may again come back into favor as individual rates are increased.
As part of the expiration of the Bush-era tax cuts at the end of 2012, capital gain tax rates generally will increase from 15% to 20%, or 0% to 10% for taxpayers in lower-income tax brackets. This increase affects all taxpayers, including small businesses, other than C corporations, for which special rules apply. As a side note, a separate increase occurred at the end of 2011 that affects the sale of qualified stock in a small business that is a C corporation. Special rules, such as a five-year holding period, must be met for a stock to meet the requirements of qualified small business stock, but if it does, some of the gain on the sale of the stock can be excluded from income. In 2011, all of the gain could be excluded, but in 2012 and beyond, half of the gain can be excluded.
15: Planning for Net Operating Losses
When a business’s deductions exceed its income, a net operating loss, or NOL, arises, which may be carried either back or forward to offset gain in past or future years. Generally, NOLs are carried back to offset gain in the two prior tax years, and any unabsorbed NOLs are then carried forward up to 20 years. Any NOLs left after the 20-year period disappear. This may sound simple, but significant planning is required to maximize an NOL. Factors that must be taken into account include the business’s tax liability in past years, anticipated gains in future years, the expected tax rates in future years, whether the entire NOL will be used before it expires in 20 years, and whether the business is, or will be, subject to the Alternative Minimum Tax (AMT).
Additionally, you may need to decide whether it would be better to generate an NOL or to take the Section 179 expense deduction. The Section 179 deduction cannot create an NOL and cannot be carried back to prior years, so, if there is gain in a prior year that you’d like to erase, it may be advantageous to depreciate the relevant cost and create an NOL carryback.
Also, the presence of an NOL may affect the decision of whether to claim bonus depreciation. If an NOL carryforward is about to expire, you may be better off giving up the bonus depreciation to instead claim a combination of regular depreciation and the NOL carryforward.
An NOL offers significant tax advantages, but also requires significant planning. In past years a longer carryback period was permitted and, as the business moves forward, it must be sure to reconcile any unused losses that must be carried forward.
This should be discussed with your CPA.
16: Planning for Retirement
It’s never too early to think about retirement. Business owners have several options when it comes to choosing a retirement plan, including:
* A 401(k) plan, which allows employee salary deferrals and/or employee contributions, may be a good option for businesses seeking flexibility and room to grow.
* A Savings Incentive Match Plan, or SIMPLE, is specifically designed for small employers. The SIMPLE comes in two versions, allowing contributions to either a 401(k) or an IRA. Both the employer and employee may make contributions to the IRA or a 401(k). Unlike with the normal 401(k) plan, the SIMPLE 401(k) requires employers to contribute a certain amount to their employees’ retirement accounts.
* A Simplified Employee Pension Plan, or SEP, is a simple, inexpensive plan that allows you to contribute up to 25 percent of the employee’s compensation to an IRA each year.
If you are self-employed, the simplest and most flexible options are the same: a solo-401(k), a SIMPLE IRA or a SEP IRA.
17: Planning for Business Succession
Most business owners believe that business succession planning is only important as one of the principal owners or partners are nearing retirement. That is unwise.
Succession planning is critical not just for retirement but from the outset because the unexpected can occur at any time and any age. Consider the impact on your business if a principal owner or partner suddenly died or was forced to retire due to an illness. Failing to plan for this is a critical mistake.
For business owners nearing retirement, having a plan in place is essential to ensure the business continues to function. Luckily, several strategies can help ease the transition between business owners. To finance a transition, a plan may rely on life insurance, a buy-sell agreement, a grantor trust or a family-limited partnership, among other options. The best succession plan for you depends on your particular needs and wishes, and may depend on the structure of the company, such as whether it is a sole proprietorship or partnership, and whether the business will be handed over to a family member or to a third party. Especially with the constantly changing estate tax rules, an appropriate plan that meets your needs should be a part of your annual discussions with your CPA.
CLOSING
18: Key Takeaways
As I conclude my presentation, I would like to leave you with three important takeaways.
First, remember that your CPA can be your valuable partner when helping to keep your tax bill to a minimum.
Second, don’t be afraid to ask questions to make sure you understand the advice you’re considering.
Third, don’t wait until the end of the year to implement these and other tax-planning strategies because, by then, it will be too late. Be sure to plan for tax savings throughout the year.
If you need help to keep your tax bill to a minimum, please contact us at BmK360CPA & Associates, PC
19: Thank You
