Smart Year-End Tax Moves For Business Owners

Year-End Planning Considerations

Defer taxes. Deferring tax is a traditional cornerstone of good tax planning. Generally this means you want to accelerate deductions into the current year and defer income into next year. There are plenty of income items and expenses you may be able to control. Consider deferring bonuses, consulting income, property sales or self-employment income. On the deduction side, you may be able to accelerate charitable contributions, state and local income taxes, real estate taxes and interest payments. But be careful; the alternative minimum tax could affect timing strategies, and it’s possible for tax rates to go up.

Bunch your itemized deductions. Many expenses can be deducted only to the extent they exceed a certain percentage of adjusted gross income (AGI). Bunching itemized deductible expenses into one year can help you get over these AGI floors — such as the 7.5% AGI floor for medical expenses and 2% AGI floor for miscellaneous expenses. Miscellaneous expenses you may be able to accelerate and pay now include unreimbursed employee business expenses (travel, meals, entertainment, vehicle costs and publications), investment advisory fees, custodial fees, investment publications, and professional fees for things such as tax planning, accounting and legal advice. Bunching medical expenses can be even easier. Consider scheduling your nonurgent medical procedures and other controllable expenses into one year to take advantage of the deductions.

Maximize above-the-line deductions. Some of the best tax benefits in the code phase out for high-income individuals, and nearly all of these phaseouts are tied to AGI. That’s one reason above-the-line deductions are so valuable. They reduce AGI. Most other deductions and credits reduce taxable income or tax without affecting AGI. And above-the-line deductions aren’t reduced by AGI floors as many itemized deductions are.

Common above-the-line deductions include traditional Individual Retirement Account (IRA) and Health Savings Account (HSA) contributions, moving expenses, self-employed health insurance costs and alimony payments. When possible, put the maximum amount allowed into your HSA and IRA. And don’t forget that if you’re self-employed, the cost of the high-deductible health plan tied to your HSA is also an above-the-line deduction.

Make up a tax shortfall with increased withholding. Although you don’t actually file your return until after the end of the year, remember that you must pay tax throughout the year with estimated tax payments or withholding. You will be penalized if you haven’t paid enough.

Check your withholding and estimated tax payments now while you have time to identify and fix a problem. Taxpayers with more than $150,000 of AGI in 2008 need to pay either 110% of last year’s tax liability or 90% of this year’s. (Taxpayers with less than $150,000 AGI need to pay only 100% of last year’s liability, and certain taxpayers with AGI of less than $500,000 in 2008 and at least half their income from a small business need to pay just 90%.)

If you’re in danger of being penalized, try to make up the shortfall through increased withholding on your salary or bonuses. Paying the shortfall through an increase in your last quarterly estimated tax payment can still leave you exposed to penalties for underpayments in previous quarters. Withholding is considered to have been paid ratably throughout the year.

Watch out for the AMT. The AMT is essentially a separate tax system with its own set of rules. Each year you must calculate your tax liability under the regular income tax system and the AMT, and then pay the higher amount. Many deductions and credits are not allowed under the AMT, so taxpayers with substantial deductions that are reduced or not allowed under the AMT are the ones stuck paying. Common AMT triggers include state and local income and sales taxes, real estate or personal property taxes, investment advisory fees, employee business expenses, incentive stock options, and interest on a home equity loan not used to build or improve your residence.

Proper planning can help you mitigate, or even eliminate, the impact of the AMT. In years you’ll be subject to the AMT, you may want to defer deductions that are erased by the AMT and consider accelerating income to take advantage of the lower AMT rate.

Leverage retirement account tax savings. Most people know to contribute as much as possible to retirement accounts such as 401(k)s and IRAs to maximize tax savings, but keep in mind that “Roth” versions of these accounts also provide a good opportunity. You don’t get a tax break when you put money into a Roth account, but the money grows tax-free and is never taxed again if distributions are made properly. As a business owner or a self-employed individual, you may have even better options. Consider setting up your own retirement plan to maximize how much you’re allowed to contribute. Both a profit sharing plan and simplified employee pension allow contributions of up to a generous $49,000 in 2009 (not counting catch-up contributions). Your personal contribution limit will be a function of your income.

Special Consideration For Business Owners

As a business owner, you have important tax considerations that most people don’t have to worry about.

Business Structure.. Business structures are generally grouped into two categories: C-corporations and pass-through entities. Pass-through entities “pass through” taxation to individual owners, so the business income is taxed only at the individual level.

Some pass-through entities — such as S-corporations and limited-liability partnerships and companies — offer the same liability protection as a C-corporation, so tax treatment should be a factor when deciding on a structure. Unlike pass-throughs, C-corporations endure two levels of taxation. A C-corporation’s income is taxed first at the corporate level and then again at the individual level when it is distributed to shareholders as dividends.

Although this factor is significant, there are many other important differences in the tax rules, deductions and credits for each business structure. The choice of business structure can also affect the ability to finance the business and may determine what exit strategies will be available. You always want to assess the impact of state and local taxes where your company does business, and owners who are also employees have several other unique considerations.

Corporate employee-shareholders. If you are an owner of a corporation who works in the business, you need to consider employment taxes in your salary structure. The 2.9% Medicare tax is not capped and will be levied against all income received as salary. So S-corporation shareholder-employees may want to keep their salaries reasonably low and increase their distributions of company income to avoid the Medicare tax. But C-corporation owners may prefer to take more salary (which is deductible at the corporate level), because the Medicare tax rate is typically lower than the 15% tax rate they would pay on dividends. Tread carefully, however. You must take a reasonable salary to avoid potential back taxes and penalties, and the IRS is cracking down on misclassification of corporate payments to shareholder-employees.

Protecting Your Assets. The end of the year is always a good time for business owners to review and update their estate plan. Estate planning should be an ongoing process. Check your plan regularly to ensure it fits in with any changes in tax law or in your circumstances. Family changes such as marriages, divorces, births, adoptions, disabilities and deaths can all lead to the need for estate plan modifications. Geographic moves also matter. Different states have different estate planning regulations. Stay mindful of increases in income and net worth. What may have been an appropriate estate plan when your income and net worth were much lower may no longer be effective today.

Using your gift tax exclusion. .Make sure to take advantage of the annual gift tax exclusion before the year is over. Gifts of up to $13,000 per donee ($26,000 for married couples) are generally excluded from gift tax in 2009 and will be permanently removed from your estate. You can use this exclusion on as many different donees as you want.

Leverage your gift tax exclusion with your business. As business owner, you may be able leverage your gift tax exclusion by gifting ownership interests that are eligible for valuation discounts. Structures such as family limited partnerships (FLPs) and limited-liability companies can also provide valuation discounts when interests are transferred.

For example, you can transfer assets — such as rental property or investments to an FLP — and then gift FLP interests to family members. The valuation discount, combined with careful timing of the gifts, may enable you to transfer substantial value free from gift tax. But be careful because the IRS can challenge the value of assets or the FLP itself. The IRS has had success challenging FLPs in which the donor retains the actual or implied right to enjoy the FLP assets. Independent and professional appraisals are highly recommended.