Cuts included in this year's tax-relief legislation are allowing Americans to keep an extra $350 billion of the money they worked so hard to earn. The accelerated reduction of tax rates will also benefit small-business owners, especially those who operate as sole proprietors or partnerships and pay taxes on their business income at the now-lower individual tax rates.
As we edge into the last part of 2003, small-business owners should start thinking about how they can best take advantage of the new tax laws, says Robert Siegel, senior tax manager at Rothstein, Kass & Co., http://www.rkco.com/home.cfm, a public accounting firm in Roseland, N.J. Siegel and Rothstein's tax manager, Cheryl Pimlott, recently gave some end-of-the-year advice to Smart Answers' Karen@KarenEKlein.com. Edited excerpts of their conversation follow.
Q: Small-business owners who operate on cash-basis, calendar-year accounting systems are always urged to accelerate expenses and defer income this time of year in order to minimize their tax liability. What are some specific things they can do to capitalize on the 2003 tax cuts?
Siegel: There's a new provision this year, especially designed for small businesses, that allows them to expense up to $100,000 worth of equipment that they put into service in their company. For instance, we're talking about new computer systems, furniture, fixtures, manufacturing equipment, that kind of thing.
So, if you know that you're going to need $100,00 worth of equipment reasonably soon, but you've only purchased $20,000 so far, buy the rest of it before the end of the year so you can take the full expense deduction in the 2003 tax year. Or, you might want to delay some purchases if you're already at $100,000 and save them for 2004, so you can get the full deduction next year. You can't deduct so much that it puts your company into an overall loss for the year, but you can try to zero out your profits or reduce them, and thus reduce your tax liability.
Pimlott: By the way, you can get the expense deduction on purchases you make up to Dec. 31, 2003. Even if you charge the equipment on a credit card or buy it with the proceeds of a loan, as long as you're on a cash-basis accounting system, it's still deductible. And you can also deduct credit-card interest you're paying related to a business purchase.
Q: Sounds like entrepreneurs need to start shopping! Is there anything special they can or can't buy?
Siegel: There's an interesting loophole that some people may want to jump on quickly, before it closes. Vehicles with gross weights over 6,000 pounds are not treated as passenger vehicles in the tax code. This is interesting because if you buy a passenger vehicle for your business, there are limitations on the deductions you can take for the car. But, if you buy certain SUVs that are over 6,000 pounds, and you use them 100% for your business, you can deduct the cost as a business expense without any limitations. There are about two dozen luxury SUVs that exceed that 6,000-lb. limit, including the Hummer, the Cadillac Escalade, Chevy Suburban, Lexus, and Land Rover.
Pimlott: There's another reason to make business purchases this year, and that's "bonus depreciation." In 2002, legislation was enacted allowing you to take an immediate 30% depreciation deduction for the cost of any equipment purchase. They increased that amount to 50% this year, and there's no limit on the dollar amount you claim. Of course, the remaining 50% is depreciated over the life of the equipment, based on a tax schedule. These are small things, by the way, but sometimes the only way to get ahead is to take advantage of the small things and, eventually, it adds up.
Q: What about some of the other things company owners can do?
Pimlott: If you're a cash-basis taxpayer, you want to prepay as many bills as possible by Dec. 31, 2003. Don't wait until Jan. 2, 2004, to pay your bills, or you won't be able to claim those expenses until 2004. And you can defer some income as well. Why not notify your clients in December that, as a holiday benefit, you are extending their credit terms from 30 days to 60 days? It's a way to do something nice for your customers and not make any deposits in December.
Siegel: You can also donate things like unused office equipment or cars to charitable entities by Dec. 31 and claim them as donations for 2003. The fall is a very good time to do inventory and get rid of merchandise or equipment that is obsolete, not selling, or damaged. Instead of letting it sit around, hoping it will sell eventually and letting it cost you money to keep it, get rid of it now. Keep track of what you do with bad inventory, because it may be deductible as a business loss or a charitable donation. Just make sure to check with your accountant, because sometimes you have to pay "use tax" on donated merchandise, particularly if you bought it using a resale certificate.
Q: What about some of the provisions Congress has set up to encourage employers to establish pension plans for their employees?
Siegel: The government really is doing everything it can to make it attractive to contribute to your pension or set up a new pension plan for your company -- and it would behoove people to take advantage of that. One nice thing is a tax credit you can get for establishing a pension plan for your company by the end of 2003. You can deduct up to 50% of the cost of setting up the plan, up to $500. If it costs you more than that, whatever you can't deduct in 2003, you can carry over on your tax returns for the next three years. This is applicable to businesses that have never offered a pension plan before.
Another big thing for 2003 is that annual contribution limits have gone way up. Remember, if you employ your spouse in your company, you can both make contributions and reduce your business income. And if you have certain kinds of plans, such as SEPs, you don't have to actually fund the contribution for 2003 until you file your return, including extensions.
Pimlott: So, if you know you'll have major receivables coming in next year, you can take the deduction for 2003 but make the payment in 2004.
Q: Many of the current tax provisions are going to expire, at least theoretically, in upcoming years. What should entrepreneurs know about those deadlines?
Siegel: The 2003 Tax Act is particularly challenging because there are so many details and so many provisions expiring on various dates. The $100,000 equipment-expense deduction expires in 2005, for example. Some of the other provisions expire in 2010. So it's always best to talk to your CPA personally about timing of things like expenditures and donations. Great ideas this year -- like deferring income because tax rates should stay low in 2004 -- may be disastrous in other years when the tax rates go up.