Remodelers are likely to feel the bite of this year’s tax law changes more sharply than small business taxpayers in other industries. The bad news is many of the 2011 breaks we used to save money during the past few years are gone, and most of the 2012 changes are intended to increase your tax bill. Business owners who take the time to explore tax strategies now may uncover potential savings to help offset the expected tax increase. Early year tax planning typically helps owners identify savings possibilities without actually requiring a decision or management commitment at this time.
Small business tax planning can be tackled with a simplified three-step approach. First, review the list of tax changes and consider which items may apply to your business. Second, do some number-crunching by marking up last year’s tax return and make a rough estimate of the cost/benefit of the changes and any options available. Finally, if this year’s tax bill will increase significantly, consider how to make up the additional amount. In some cases it will be possible to offset an increase in one type of tax with a savings in another area.
Expiring Tax Breaks
A wide range of tax benefits designed to stimulate the economy during the recession expired at the end of 2011. Business owners who took advantage of one or more of these items will feel the direct effect of the expiration. The list of expiring benefits includes liberal deductions for business start-ups, bonus depreciation for purchases, tax credits for hiring youth and veterans, empowerment zone tax breaks and credits for energy-efficient home improvements.
A list of 51 tax law changes that may affect small business owners in 2012 is available at tonynovak.com/article/Tax-laws-changing-for-2012.htm. After identifying the issues that might have a significant impact on your tax bill, read more about these issues at www.IRS.gov on the news and small business pages.
Cost of Living Adjustments
Many of this year’s changes involve the indexing of dollar amounts and thresholds for a broad range of tax items. Normally the impact of indexing is minimal because the Treasury Department makes small adjustments each year. But the Treasury Department chose to skip the tax adjustments in 2010 and 2011 because of the recession, so the changes for 2012 are larger than we’ve seen in other years. In effect, we will feel the impact of three years' worth of price increases all at once. While most of the indexing changes serve to decrease taxes, it is inevitable that some individuals and businesses will be adversely affected. One of my clients, for example, whose income was on the borderline of qualification for some tax credits, learned that the changes this year would likely cause her to be ineligible for some education credits she took in 2010.
The impact of the changes may not be immediately reflected in employees' paychecks, according to Christian Hoyt of PayUSA.com, a professional payroll company. Employers and their payroll processors are moving slowly to adapt the new rules because of uncertainties about the details of the changes, as well as the new requirements for employee-benefit-plan reporting requirements under the Affordable Care Act of 2010. By March, professional payroll companies should have the glitches worked out and the impact of indexing will be apparent to salaried workers. Business owners may want to consult a tax professional (usually at the same time they prepare 2011 tax returns) to prepare a tax projection for 2012 that incorporates the new indexing amounts.
Employee Benefit Changes
Changes to small business health plans and all 401(k) plans take effect in 2012. The passage of federal health-reform law in 2010 made it easier for employers to save money on health-insurance costs through the use of a SIMPLE cafeteria plan. A cafeteria plan allows employers to predetermine a budget for employee health benefits and then the employees choose among several options that provide the most value on an individual basis. When this flexible benefit plan design is combined with the small business tax credit of up to 35 percent of the cost of insurance we expect more contractors will be able to provide employee health benefits this year. Yet contractors in some states may still find challenges. As states wrestle with federal health-reform implementation for 2012 (and probably 2013) business owners will find some of the health plans that are most attractive in one state are considered illegal in another. These differences will disappear by 2014 as health-reform laws are fully implemented.
New 401(k) disclosure requirements kick in at the beginning of 2012 focusing on plan fees. These disclosures are likely to reveal the wide variation in fees that different contractors pay for their retirement plan providers. They may learn for the first time, for example, that these fees are as low as 0.5 percent of assets or as high as 5 percent of assets per year. That difference in fees translates to a substantial difference in long-term investment performance and the ultimate financial welfare of the plan participants. Contractors who discover fees in the higher end of the range are wise to consider lower cost 401(k) options.
The IRS knows 30 percent of small businesses misclassify employees as subcontractors to avoid collection of wage taxes. Even more disturbing is that the IRS considers 80 percent of all subcontractors to be incorrectly classified and asserts they should be taxed as employees. Enforcement of independent contractor misclassification has become a high priority item for the IRS. Reports about contractors nabbed by the IRS are sobering. The cost of defending a wage tax audit and the potential tax adjustments (plus interest and penalties) represent a major financial risk to any small businesses that use independent contractors.
Fortunately there is some good news: If your business is among those vulnerable to wage tax audits for this reason, then you may want to consider the new offer by IRS to voluntarily settle the issue in 2012. In September 2011 the IRS announced details of the Voluntary Classification Settlement Program. In short, the program allows taxpayers to settle the issue with a payment of 10 percent of the wage taxes and completely avoid interest and penalties.
"The Voluntary Disclosure Settlement Program provides an unprecedented opportunity to eliminate tax risk for wages improperly classified as nonemployee compensation,” explains Ronald M. Warren, a tax attorney with Kulzer & DiPadova PA, Haddonfield, N.J. “This is a great chance to become compliant at a minimal cost. If a taxpayer believes he may become the target of an audit, this program requires immediate consideration".
A separate self-help resource about employee issues is available at www.irs.gov/businesses/small/article/0,,id=99921,00.html.
Fresh Start Program
The IRS recognizes some well-intentioned and honest business owners ran into trouble paying their taxes during the recession. When money is tight the tax bill is often the last item to be paid. A record number of small businesses now have unpaid tax debts, according to the U.S. Treasury Department. A lingering tax debt can cause emotional stress on the business owners, hurt the company’s credit reputation and increase the cost of borrowing. The IRS recently introduced a generous new program called “Fresh Start” to allow business owners to relieve this burden and get back onto a productive course.
Self-employed taxpayers with gross receipts less than $500,000 and net income less than $100,000 are now eligible for a streamlined offer to settle tax bills under $50,000 when the entire amount of tax due cannot be paid. The IRS looks at the taxpayer's assets and income to determine whether all or part of the tax can be paid as a lump sum or in installments. Settlement of an outstanding tax debt through a compromise offer allows a business owner to move forward with a new start without the financial and emotional burdens of a looming tax problem. It is always smart to work with a professional tax adviser on the Fresh Start program. An adviser can negotiate on your behalf while minimizing the required disclosures of personal and business finances.
The threshold for filing tax liens against taxpayers is now higher; in most cases a business owner is now safe from liens if the unpaid tax balance is less than $10,000. Previously the threshold was $5,000. This change in procedure is important because a significant portion of small business tax delinquencies fall in the $5,000 to $10,000 range.
If a tax lien has been placed, the taxpayer now stands a better chance of having the lien removed to help restore business credit. Paid liens will be withdrawn at the taxpayer's written request under an expedited program. Unpaid liens can still be withdrawn if the taxpayer agrees to a direct debit payment plan.
“This willingness of the IRS to issue a lien withdrawal (and not just a lien release) is a substantial departure from the prior longstanding policy,” Warren explains. “A taxpayer can repair his record and his credit score immediately. If you recently satisfied a filed tax lien, or if you’ve made arrangements to satisfy an existing tax lien, please consult your tax professional to see whether you qualify for an immediate lien withdrawal."
The tangible business benefits of settling a tax debt can be gigantic in comparison to the manageable cost of a tax installment payment plan.
Financial and Estate Planning
Conventional advice indicates that estate tax strategies are no longer necessary for most small business owners. The risk in this statement is that business owners may be tempted to abandon tax strategies that are already in place. A smarter approach is to cautiously consider changes and not abandon trusts and estate planning tools that are already completed. While there may not be any need to spend time or money on estate planning this year, the issue is likely to resurface in the future. Past efforts to preserve family wealth may prove valuable in the future.
The slowly improving economy is expected to present remodelers with an opportunity to improve cash flow and return to profitability during 2012. The IRS is showing a willingness to cooperate with business owners in this regard while rebuilding the Treasury’s own tax revenues from small-business taxpayers. Overall, the time-tested fundamentals of business planning, accurate accounting and conservative financial management will serve contractors well in managing tax expenses during the year.
Tony Novak is a compensation planner based in the Philadelphia area. He served on the board of directors of the National Association of the Remodeling Industry and as president of the Bucks/Mont NARI chapter in 2000.