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Listen in! Pick up some expert advice to a reader's question that we selected from CyberSchmooz.

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Featured Biz Question

What can I do to help reduce my tax burden next April?

Answer from our Guest Expert Peter Soh of AdviseInc.com

Year-End Tax Saving Advice

As the year winds down, it's a good idea to review your tax situation. With several new provisions in effect, there are plenty of deductions and deferrals to take advantage of.

1) Consider deferring income and increasing expenses. Since income tax rates are declining for individuals, owners of passthrough entities like S corporations, LLC’s, sole proprietors, and partnerships should defer income to the next year (2003) and accelerate expenses to this year (2002). Each year the individual income tax rates are decreasing by roughly a half percentage point. If you are an accrual basis taxpayer, consider billing your December invoices in January for your customers and asking your vendors to supply you invoices in December. If you are a cash basis taxpayer, pay your bills in December rather than next year or utilize a credit card, and bill your customers in January rather than December.

2) Take advantage of Section 179. You can expense up to $24,000 in 2002 for new equipment (like computers, furniture, office stuff), $25,000 in 2003. The $24,000 is reduced for new equipment in excess of $200,000 though and you must have taxable income of at least that amount to utilize Section 179.

3) Also, in addition to Section 179, you can utlize “Bonus Depreciation” of an additional 30% if you are qualified small business and you have purchased equipment in a specified period (starting after 9/11/01). This new law benefit allows businesses to claim greater first-year write-offs for purchases of computers, machinery and other equipment. Businesses are eligible to claim an additional first-year depreciation deduction equal to 30 percent of the cost of the equipment. This "bonus depreciation" applies to most types of business property – except for real estate – purchased between Sept. 11, 2001 and Sept. 10, 2004.

The Joint Tax Committee gave the example of a business that acquired $1 million in equipment in 2002. The business would be allowed an additional first-year depreciation deduction of $300,000. The remaining $700,000 of the adjusted basis would be recovered in 2002 and subsequent years under the usual depreciation rules.

To enable taxpayers to reap the benefit of the 30 percent bonus depreciation for new purchases of cars used for business, the new law temporarily raises the ceiling on first-year depreciation for passenger autos from $3,060 to $7,660.

Because the depreciation provision was made retroactive to purchases since Sept. 11, 2001, many businesses who purchased equipment late last year will be eligible for extra tax deductions on their 2001 income tax returns. Those who already filed their 2001 return will be able to take advantage of the new law benefit by filing an amended tax return. Most states also have this rule to conincide with IRS guidelines.

4) Consider donating excess inventory to qualified nonprofit organizations. You'll benefit the organizations and, by removing the items from your shelves, generate a tax deduction as well. How your business is organized affects the write-offs you can claim.

For pass-through entities (partnerships, limited liability companies and S corporations) the owner's share of the charitable contribution deduction passes through and is claimed on the owner's personal tax return (assuming the owner itemizes deductions). The amount of the deduction passed through is the owner's share of the deduction figured at the entity level. The deduction is based on the property's fair market value on the date of the contribution, reduced by any gain that would have been realized if it had been sold instead of donating it. For example, the business paid $12 for an item now worth $10. A donation would generate a deduction of $10 ($10 current value less 0 gain since a sale in this example would have generated a loss).

For C corporations, the corporation deducts charitable contributions up to 10% of taxable income. Donations of inventory to special charities (schools, needy, and the ill) can result in enhanced write-offs. The write-off for inventory can be increased by 50% of the difference between the property's basis and its fair market value. But in no event may the write-off exceed 200% of the property's basis. Similar enhanced write-offs apply to the donation of scientific property used for research and certain computer equipment to schools or libraries.

After donating the items, be sure to remove them from your opening inventory account. If the inventory was manufactured by you (instead of purchased by you), also remove from the cost of goods sold your materials, labor, and other indirect costs that were included in the cost of production.

5) Net Operating Losses for individuals and corporations can now be carried back over 5 years instead of 2 years if the losses originate in 2001 and 2002.

6) SEP IRA’s allow for a 25% contribution to your retirement plan instead of 15%. Employers can now contibute up to 25% of the employee’s salary into the plan in 2002. You can setup a SEP IRA by April 15, 2003 for the 2002 tax year and get the tax deduction for the contribution for 2002.

7) Max out on contributions to your qualified employer retirement plan and IRA. Contributions to your 401(k), 457 or 403(b) reduce your taxable income and may have the added bonus of an employer match. Contributions to your traditional IRA may be tax deductible in many cases. What's more, money in these accounts grows tax deferred, so it has a chance to compound faster. Employer plan contributions must be made before the end of the year, but you have until April 15, 2003 to make your 2002 IRA contribution. And don't forget to contribute the additional catch-up allowance if you're 50 or older.

2002 contribution limits for 401(k)s and IRAs
  Limit Catch-up allowance for people 50 or older
401(k)s and other qualified retirement plans $11,000 $1,000
Traditional and Roth IRAs $3,000 or earned income, whichever is less $500

8) Taxpayers with inventory can utilize the “Cash Basis” method if they have average gross receipts of less than $1MM. This allows for certain accrual basis taxpayers to see if the cash basis method of accounting is better than the accrual basis (usually if Accounts Receivable is greater than Accounts Payable) and the cash basis is a much more simpler method of accounting.

9) Consider offshore planning with controlled foreign corporations (CFC’s). If you business has foreign sales (outside the US). Consider incorporating a subsidiary in a low tax jurisdiction to source these foreign sales and pay less US taxes on the profits of those foreign sales. Taxes will be paid once those earnings are repatriated back to the US but the deferral of these taxes can be enormous.

10) Consider setting up qualified defined benefit plans. These plans have been around for awhile. Allows for you to fund a retirement plan with life insurance contracts without the limitations of qualified defined contribution plans. Allows the owner to move business assets in a tax deferred vehicle to fund the retirement of owners. Only consider if owner is relatively close to retirement and for companies with a low amount of employees. The funding requirements are typically higher than defined contribution plans also.

So take time to digest these tasty morsels and always contact your tax advisor if you are considering these tax planning techniques.

Happy Tax-Savings!

Peter Soh, CPA and CEO of AdviseInc.com

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About the Expert

Peter C. Soh
Owner of AdviseInc.com
Peter is a savvy certified public accountant dedicated to helping startups. He is a small business advisor for the U.S. Small Business Administration and teaches "How to Start Your Business" seminars. more

 

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