'Tis the season—“opportunity” season, that is. In the certified-public-accountant world, there is a time period from Jan. 1 to April 15 typically labeled as tax season; however, I like to refer to this time, and actually the entire year, as opportunity season because it provides opportunity to start your year-end tax planning.
Tax breaks, deductions and credits typically are reserved for those generating taxable income. Many of the items mentioned will have limitations based upon income. Rather than spelling out all the limitations and regulations of the tax law, I will focus on providing ideas from the Small Business Jobs Act of 2010, concepts related to entity planning and tax elections, as well as a few specialty items. Keep in mind that tax planning is a process that may require a little time and research, but ideas are free and should be explored to determine whether there are potential benefits to you and your entity.
Small Business Jobs Act of 2010
On Sept. 27, President Obama signed the Small Business Jobs Act of 2010 into law. It has several provisions that give small-business owners tax breaks and better access to credit.
Enhanced Code Section 179 Expensing: Eligible taxpayers may deduct the entire cost of qualified property, such as machinery, equipment and furniture, placed in service in 2010, rather than depreciating the assets over time. The maximum deduction is $500,000 with a phase out starting when more than $2 million in qualified property is placed in service. For example, a taxpayer with sufficient taxable income places bidding software that cost $10,000 in service. The taxpayer can deduct the entire $10,000 in the current taxable year, rather than depreciating the asset during the typical three years.
Extended Bonus Depreciation: Bonus depreciation allows taxpayers to deduct 50 percent of the cost of qualified property placed in service in 2010. Unlike Section 179 expensing, bonus depreciation is not subject to limits based on the amount of property placed in service nor is it limited to taxable income. For instance, a taxpayer who purchases a $60,000 truck is eligible for $25,000 of Section 179 expense (the maximum Section 179 expense for a truck or van with a gross vehicle weight between 6,000 and 14,000 pounds). The remaining cost basis of the vehicle then is eligible for 50 percent bonus depreciation ($17,500) in the current year.
New Deduction for Health-insurance Costs: Prior to passage of this law, self-employed taxpayers only could deduct health-insurance costs for income-tax purposes. The new rule states self-employed taxpayers can deduct the cost of health insurance for themselves and their family members when calculating self-employment taxes.
Small-business Lending Fund: The bill established a $30 billion Small Business Lending Fund that provides low-cost capital to small community banks if they go above and beyond 2009 small-business-lending levels. This will not decrease a taxpayer's taxable income, but it can provide financing for the purchase of new machinery so the taxpayer can take advantage of depreciation rules.
Increase in Maximum Small Business Administration Loans: The law permanently increases the maximum loan size for SBA loan programs 7(a) and 504 to $5 million, as well as raises the maximum 504 manufacturing-related loan to $5.5 million. The 7(a) loan helps start-up and existing small businesses obtain financing when they may not be eligible for business loans through normal lending channels. The 504 loan provides small businesses with long-term, fixed-rate financing to acquire major fixed assets for expansion or modernization. Visit sba.gov for more information about these loans.
Times have changed and you must change your approach when reviewing your entity and its needs. In some instances, this can be an opportunity to go back to the basics and rediscover what your business really needs. Although the following questions may seem rudimentary, oftentimes they are overlooked. Here are a few areas to evaluate:
Cash vs. Accrual: Review your current accounting method to ensure it fits your type of business and provides you with the best planning options. If you are an entity that receives cash after completion of a job, you may be more likely to benefit from a cash-basis election. On the other hand, if you are invoicing your customers and collecting cash prior to completion of your project, you are more likely to file on an accrual basis. The issue here is the timing of your cash collections in relation to the timing of your cash disbursements.
Passive vs. Active: Do you typically incur a large amount of passive-activity losses that are accumulating without the appropriate tax benefits? A passive activity may be an investment in an LLC where you are not part of the daily operations. Rental real-estate activities are treated as passive regardless of the taxpayer's participation. There are special rules that may allow a taxpayer to deduct up to $25,000 of passive rental activity losses from nonpassive income.
If a taxpayer can qualify as a real-estate professional, he or she may be able to treat rental real-estate activities as nonpassive. The taxpayer can deduct rental real-estate losses from other nonpassive income; the $25,000 special loss allowance does not apply.
There are several specialty items, such as depreciation and energy deductions, you should consider when doing your tax planning.
Cost-segregation Studies: Cost-segregation studies distinguish personal property, such as fixtures and equipment, from real property, such as commercial buildings and rental units. This allows a taxpayer to categorize assets for accelerated depreciation, thus reducing taxable income in the early years of building ownership.
For example, a commercial building is typically depreciated during 39.5 years. A cost-segregation study will reclassify some of the property to five-, seven- or 15-year life property, accelerating depreciation and realizing less taxable income in the early years. It is important to note this does not increase the total depreciation that can be claimed for the property; rather, it accelerates the depreciation deduction to earlier years. As such, the benefit stems from considering the time value of money—a deduction now is worth more than a deduction in the future.
Section 179D Energy Deductions: Taxpayers owning or constructing buildings meeting certain energy requirements may be eligible for up to $1.80 per square foot as an upfront tax deduction. To qualify, the property must reduce total energy and power costs of interior lighting, heating, cooling, ventilation and hot-water systems by 50 percent or more compared to ASHRAE 90.1-2001 minimum requirements. Partial deductions may be eligible for the lighting component. For government-owned buildings, there is a rule allowing for the deductions to be transferred to those involved in the design process.
As you venture into the holiday season, remember there are many potential tax-planning opportunities of which you can take advantage. More effort spent on continuous tax planning will allow you to be in the best position to take advantage of tax breaks. Meet with your CPA and evaluate all your options to determine what the best plan is for you and your business today, tomorrow and in the future.