With the government shutdown and debt-ceiling issues resolved—at least temporarily—it’s time for small business owners and the self-employed to take stock of their finances and do year-end tax planning. Things are much more clear-cut now than they were in the fourth quarter of 2012, when the country faced massive uncertainty around tax cuts and the so-called fiscal cliff.
Patrick Cox, an attorney specializing in taxation and small business in the New York office of law firm Withers Bergman, says he sometimes feels as if he’s crying wolf when he warns clients about looming tax changes at year’s end. “All you want, as a business owner or a tax planner, is the ability to forecast what’s coming next. But for the past five or six years, I’ve been telling people to hurry up because everything is going to change—and then Congress eventually reaches an agreement to extend tax rates, sometimes even retroactively,” he says.
Then came 2012, when the tax cuts put in place by President George W. Bush expired for high earners and new taxes tied to Obamacare went into effect on the wealthy, including many clients whose small businesses are organized as flow-through entities such as S-corps and LLCs. “I felt bad for them because I could not convince some of them to dispose of assets to take advantage of the lower rates and then they got caught,” he says.
This year, things aren’t so dire. Still, it’s a good time to meet with your accountant or financial adviser to see what you can do to minimize the taxes you and your business will owe for 2013. Typically, that means deciding whether to accelerate or defer income before the end of the calendar year, plus taking stock of expiring tax provisions to see whether you should take advantage of any before they disappear.
Here’s some guidance on how to approach your invoicing, purchasing, and giving decisions for the next couple of months.
Take stock of your income. Start by adding up your 2013 business or self-employment income to date and determine if you’re likely to be in the same tax bracket this year as you were in 2012. Then think about 2014 and whether you are likely to have less income then—or additional income that could bump you into a higher tax bracket.
If you expect to be in a lower tax bracket next year, it’s best to defer as much income as possible until after year-end, accelerating any deductions you plan to take, anyway. Similarly, if you have new clients or contracts lined up now that are likely to push you into a higher tax bracket next year, it’s better to bring in more income now and pay taxes on it at the lower rate.
What if you determine that nothing much will change? “If a taxpayer’s overall tax rate is the same in both years, accelerating deductions achieves tax savings this year rather than waiting for those tax savings to materialize next year,” Rick Rodgers, a certified financial planner and president of Rodgers & Associates in Lancaster, Pa., writes in an e-mail.
If you’d like to defer income, ask clients to pay you in January, rather than December. And put off taking distributions from your retirement accounts, unless they are required minimum distributions. In order to accelerate deductions, make your planned charitable contributions now rather than in 2014.
If you can pay medical bills in December, you may become eligible for the medical expense deduction on your tax return. Be aware that the Affordable Care Act raised the income threshold for that deduction to 10 percent of adjusted gross income from the previous threshold of 7.5 percent. (Taxpayers 65 and over are still subject to the 7.5 percent threshold.). “You may need to prepay or defer medical bills to lump expenses into a single year to get the deduction,” Rodgers writes.
Make retirement contributions. Self-employed individuals not covered by a retirement plan can put money into their IRAs or other retirement accounts to reduce their taxable income for 2013. If you want to accelerate income this year so as to avoid paying at a higher rate next year, you can convert a traditional IRA to a Roth IRA. And you don’t have to decide what to do immediately: You can make IRA contributions for 2013 as late as next April, when your federal income tax return is due.
Determine where you are on the self-employment tax. If you make quarterly estimated payments on your self-employment income, take a look to see whether you have overpaid or underpaid, now that the year in nearly gone. If you’ve overpaid and estimate that you’ll be getting a large refund next April, you can reduce your final payment due in January 2014—keeping some money in your pocket now, rather than waiting for that refund check. If you’ve underpaid, talk to your accountant about increasing the January check, so you don’t wind up owing taxes on your 2013 income.
Take advantage of capital expenditures. During the recession, a series of stimulus bills raised the Section 179 deduction threshold for the purchase of new and used equipment, including such things as computers and office furniture. The provision, named after an IRS tax code, allows a business to deduct the full purchase price of new and used equipment in the year it is purchased, financed, or leased and put into service, rather than having to depreciate it over time.
“We always hear about increased Section 179 limits expiring, but so far, Congress has extended them every year,” says Barbara Bel, a CPA and tax partner in the New York office of O’Connor Davies, an accounting and consulting firm. Rather than recover the cost of the expenditure with tax deductions over its useful lifetime, Section 179 provides an opportunity to expense the entire amount in the year of purchase. “If your business will be profitable in 2013, and you’re thinking about making a large purchase anyway, you might look at this as an option. Generally, you cannot take this deduction if it puts your business into a loss situation.”
For 2013, the deduction cannot exceed $500,000, with a maximum purchase amount of qualifying property of $2 million before the deduction to your company begins to be reduced. The deduction is set to revert to $25,000 in 2014 unless the more generous deduction threshold is extended. “This might apply to someone like a restaurant owner who is looking to buy a second restaurant and will need to outfit it with a lot of expensive equipment,” Cox says.
And take advantage of bonus depreciation. This is another tax provision that is perennially on the chopping block. Also tied to the stimulus provisions enacted during the recession, a one-time bonus depreciation of 50 percent is available in 2013. Unlike the Section 179 deduction, the bonus depreciation can only be taken on new equipment and it can be taken by businesses that have net operating losses in 2013. Certain states, including New York, do not allow for this bonus depreciation, Bel says. “That’s another reason to consider the Section 179 deduction.”
Every year, multiple tax breaks, including the two I’ve described above, are set to expire on Dec. 31 unless Congress extends them. While it’s difficult to know whether those breaks will be extended retroactively in 2014, being aware of these tax provisions may help you with purchasing decisions, Cox says.