What tax law changes do small businesses need to be aware of this year? For example, how will the American Jobs Creation Act signed last year impact them?
The AJCA was enacted in October 2004 and contained a provision known as the "domestic production activities deduction." When fully phased-in, taxpayers will receive a deduction equal to 9 percent of the lesser of qualified production activity income or taxable income. The applicable percentage is 3 percent for 2005.
QPAI is defined as domestic production gross receipts less cost of goods sold, costs directly allocable to the receipts and a ratable portion of indirect costs. The calculation of QPAI will be important for companies that have multiple business activities in the same entity.
For most small businesses, the deduction will be the appropriate percentage (3 percent for 2005) of taxable income. It should also be noted that the deduction is limited to 50 percent of the W-2 wages of the taxpayer for the taxable year. This could be an issue for small businesses that do not have employees such as a sole proprietorship. All small businesses should be reviewing this provision to make sure they maximize their deduction. The IRS was scheduled to issue regulations in September but these have been postponed due to Hurricane Katrina. The regulations were expected to be issued in October.
Many small businesses have taken advantage of the bonus first-year depreciation allowance that existed for the past few years. This provision expired Dec. 31, 2004. This will have an impact on the amount of tax depreciation expense that may be available for 2005. Proper planning can help mitigate the impact of this expired provision.
Are there any changes scheduled for 2006 and beyond that small businesses should take into consideration?
Thus far in 2005 we have had the Energy Tax Incentives Act of 2005 and the Safe Transportation Equity Act of 2005. For business owners, new provisions will provide tax incentives for energy-efficient improvements to new or existing buildings. If you are anticipating improvements to an existing building or constructing a new home, review these provisions to see if tax incentives are available. I also mention that on Sept. 9, 2005 the IRS increased the standard mileage rate to 48.5 cents per mile. This could provide enhanced deductions for vehicles for the latter part of 2005.
What steps can small businesses take to lower their taxes before the end of the year?
Small businesses should review their method of accounting periodically to make sure they are minimizing tax. The construction industry has unique accounting method issues. Small businesses have a wide range of methods to choose from. Review your method with your tax adviser. If a change is beneficial, action may be needed before year-end. Otherwise, review income and expense items as you approach year-end. Properly deferring income or accelerating expenses may reduce the tax bite for 2005.
Equipment acquisitions should be reviewed. Each year a taxpayer is allowed to write off a certain amount of equipment purchases. This write-off eliminates the need to depreciate the asset. For 2005 the amount that can be written off is $105,000. Part of year-end planning should include a review of this provision to determine if additional equipment purchases could reduce taxable income for 2005. A change in the tax law last year limits the benefits of this provision to $25,000 for certain SUVs.
What are some common tax mistakes small businesses make?
Review payments to independent contractors. The IRS reviews these payments to make sure the individuals receiving payments are not employees. How workers are classified for tax purposes has major tax consequences. You need to look at the degree of control the company has over the worker. If the company can control what will be done and how it will be done, the worker may be classified as an employee.
Many of our readers have home offices. What steps must they take to make sure they are eligible for the home office deduction?
A deduction for a home office is available if it is used on a regular and exclusive basis for business. Review with your tax advisor whether the "regular and exclusive" test is met. Also calculate the potential benefit before deciding to claim the deduction. This deduction would include depreciation expense on the home. Taxpayers should consider that this depreciation will be taxable if the home is sold later. This is a legitimate deduction and often is overlooked.
As our readers look to next year, what can they do throughout the year to lighten their tax burden?
Tax planning that is done for 2005 should consider the tax picture for 2006. For example, if taxable income is expected to be large in 2006, it actually may be beneficial to accelerate income into 2005 and pay tax at a lower tax rate. The same strategy applies for deductions and equipment purchases.
Why should small businesses work with a professional tax adviser?
The tax adviser will assist in interpreting the many tax provisions that will impact the contractor's tax liability. The adviser also should provide valuable planning in areas such as the type of entity for the business, and succession planning.
When choosing a tax advisor, what should a small business owner look for?
The advisor should be focused on the residential construction industry. The advisor that specializes in the residential construction industry is better equipped to advise on the tax issues that relate to the industry. Additionally, choose an advisor that you are comfortable with. Talk with people in your industry to see who they use.
Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.