With only about six weeks left in 2003, small business owners should be doing some serious year-end tax planning.
The procrastinators who haven’t set up qualified retirement plans for their employees have until Dec. 31 to get it done. And companies that have put off buying new equipment should consider making those purchases by Dec. 31 to take advantage of more liberal deductions.
Owners of small corporations also have to do some planning in light of the changes in tax laws this year.
But before you start making decisions, you should keep in mind that year-end planning should be done with a long-term perspective.
"Tax planning is looking at this year and probably the next two after that," said Gregg Wind, a certified public accountant in Marina Del Rey, Calif.
You also need to make your decisions in the overall context of your business, not just because they’ll save some money on your tax bill. Equipment purchases are a key area where businesses can save money on taxes.
This year saw a dramatic increase in what’s known as the Section 179 deduction, which allows small businesses to deduct upfront a maximum of $100,000 for new equipment bought and put into service during the calendar year. Congress increased the deduction, named for an Internal Revenue Code provision, from $25,000.
But business owners need to know the rules about the kinds of equipment that qualify for the deduction. You can deduct equipment used in the course of business — office furniture, computers or manufacturing machinery, for example. You can’t deduct a building or equipment like air-conditioning or heating units that are structural components of a building.
And you can only deduct equipment placed into service by Dec. 31. If you ordered a machine that won’t arrive until January, you can’t take the Section 179 deduction.
If the deduction isn’t available for equipment you’d like to buy, it might qualify for depreciation, and new rules allow businesses to depreciate up to 50 percent of the cost of equipment purchased in a given year. You could use this bonus depreciation, as it’s known, for the cost of equipment above the $100,000 threshold for the Section 179 deduction.
Let’s say you bought several pieces of equipment totaling $106,000. You can deduct $100,000 and depreciate the remaining $6,000.
As you examine your options for deducting or depreciating equipment, keep in mind Wind’s advice on long-term planning: Your decisions need to be based not only on this year’s tax bill, but also on what you’re expecting in the future. For example, while you might want to deduct an equipment purchase upfront for 2003, if you’re expecting your income to soar in 2004 and beyond, you might be better off using depreciation to lower tax bills for those years.
If you’ve been meaning to set up a retirement plan for yourself and your employees, you need to get one in place by year’s end. But many business owners might not feel that they have the money to contribute to the plan.
Wind said that’s not a problem. To qualify for the 2003 tax year, you only have to create the plan by Dec. 31; you can take a deduction on contributions made until April 15 (or Aug. 15 if you get a four-month filing extension).
Owners of small corporations have some decisions to make by the end of the year, too. Janet Korins, a tax partner at the law firm Proskauer Rose LLP in New York, noted that with the lower tax rate on dividends, company owners might want to consider taking some of their compensation as dividends.
Before Congress passed the federal tax cut this year, dividends were taxed as ordinary income. Now, the top rate on dividends is 15 percent.
"It may be beneficial for owners of closely held corporations to get dividends as opposed to compensation," Korins said. "You have to think about things differently in terms of your planning objectives after this change."
But be careful. You can’t take your entire salary, or even a large chunk of it, as dividends. The IRS is on the lookout for small corporations that try to use alternative forms of compensation as a way to avoid paying employment taxes.
As with many other issues in your business, it’s a good idea to seek the advice of a professional — a tax lawyer or a CPA — as you make your tax decisions. You can get more information about how to handle equipment costs, retirement plans and other areas of the tax law at the IRS Web site, www.irs.gov.
Small Business is a weekly column on the topic by The Associated Press.
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