After reading the 1997 Taxpayer Relief Act, Susan Ginsberg and Gene Myers decided that 1998 was the year for their small Chicago CPA firm to splurge on two new, automatic feed-and-sort photocopy machines. "It's a luxury we had always done without, but we decided to treat ourselves," Ginsberg says.
The purchase lets Ginsberg Myers & Associates take advantage of an $18,500 tax deduction for office equipment bought in 1998, up from $18,000 last year. More important, it helps them hold their individual incomes under $100,000 in 1998. In turn, this makes them eligible to convert their tax-deferred IRAs into Roth IRAs--which is worth thousands of dollars in tax savings. Says Ginsberg: "Spending on office equipment is a way to have our cake and eat it, too."
That's the kind of ingenuity it takes to squeeze a break from the tax rules that take effect this year. "The law tinkers with everything, but doesn't make major changes," says David Diesslin, a Fort Worth financial planner who specializes in helping small businesses. Some of the breaks targeted for smaller companies don't do much in reality, Diesslin adds.
Some gems have emerged, however, especially from innovations that weren't specifically designed with small businesses in mind. One example is the Roth IRA, which unlike the conventional IRA doesn't impose a tax on withdrawals. Because business owners have more control over their income than ordinary wage earners do, they have more of an opportunity to slip under the income limits and thus reap the benefits.
Even minor changes such as the $500 increase in the equipment-expense deduction are welcome at a time when computers seem to become obsolete the day after they're delivered. Truly creative owners can maximize the benefit by taking out a loan to finance the purchase as late as Dec. 31. Even though you haven't laid out a dime yet, the law lets you take the full $18,500 deduction in 1998--a classic case of deduct now, pay later.
Want another double play? Read carefully between the lines on health insurance. This year, the premiums are 45% deductible for the self-employed. That's up from 40% in 1997--a deduction that inches up to 100% by 2007.
If you don't want to wait, say tax experts, hire your spouse. Sole proprietors can't fully deduct their own policy, but they can deduct the full cost of an employee's policy--and as an employee, your spouse can cover the entire family, including you.
There's also a break on capital gains for serial business owners--those who sell off one venture and roll the money into another. Instead of shelling out the standard taxes on your profit, you can defer them from the sale of small-business stock if you use the money within 60 days to buy stock in another small business. There are some conditions, though, says James Caskey, an Indianapolis tax accountant: You must have acquired the stock at original issue, held it for at least five years, and sold after Aug. 5, 1997.
DON'T BOTHER. Most of the other ballyhooed small-business breaks are likely to disappoint, despite the fanfare when they passed. How about the new $1.3 million estate tax exemption for small family-owned businesses and farms? It's a nonstarter, says John Dadakis, an estate-law expert at Rogers & Wells in New York, because the burdensome rules outweigh any benefit. Besides, Dadakis adds, the exemption is worth less each year; it's offset by the standard estate tax exemption, now at $625,000, which is increasing in stages to $1 million by 2007.
Similarly, the new law exempts small companies from the Alternative Minimum Tax if their average annual gross receipts were $5 million or less in 1995, 1996, and 1997. But practitioners say such businesses seldom paid the AMT anyway. "I've never seen it happen," says Ed Slott, a tax accountant in Rockville Centre, N.Y. A new charitable deduction for corporations that donate computers to schools won't be of much practical value either, says Kyra Hollowell Morris, a tax planner in Mt. Pleasant, S.C., because you have to have some tax basis left in the equipment--not very likely, she says, since small businesses tend to write the equipment off quickly.
The experts are more interested in some of the more general changes that could benefit small-business owners disproportionately. For instance, the dramatic cut in capital-gains tax rates for individuals--they'll drop to as low as 8% by 2005--is an excellent reason to give company stock to your children and grandchildren now instead of risking federal inheritance taxes that run as high as 55%, plus any state levies. And the Roth IRA is practically made to order for small-business owners, who have many ways to lower and defer income.
Just don't get too creative. Deferring income and accelerating expenses to squeeze under the $100,000 limit this year will raise your 1999 income--and 25% of the amount you withdrew from tax-deferred IRAs to finance the Roth IRA will be added to your 1999 income. "Your 1999 tax bracket could go from 28% to 36% as a result," Caskey says, so you will wind up paying more. Worse still, if the IRS later disallows some of your deductions as too aggressive, it might retroactively push your 1998 income over $100,000, warns Slott--and that would disqualify you for a Roth IRA.
Speaking of legal problems, don't rush to open a Roth if you've any reason to worry about lawsuits. Most state laws protect IRAs from creditors, but the statutes refer specifically to tax-deferred IRAs, not Roth IRAs. Advises Seymour Goldberg, a Garden City (N.Y.) tax lawyer and pension specialist: Wait until your state updates its laws. Otherwise, the Taxpayer Relief Act may turn into another headache, and you can bet the aspirin won't be deductible.