My previous column, "Yearend Business Checkup, Part I" (BusinessWeek.com, 11/26/07), included some recommendations for a general business and personal financial checkup for small business owners. Today's column raises some items to discuss in a yearend tax planning meeting with your accountant or chief financial officer.
Make sure that your business is primed to take advantage of the same tax deductions you took last year, if they're still applicable. Explore any regulations that may have changed, and whether you now qualify for new deductions or no longer qualify for a deduction your business took in the past. A life or business change, such as a change in your business structure or in your marital status, can alter what's in your best interest this tax year.
Think about giving yearend bonuses to your employees, particularly if your company operates using the accrual method of accounting. Accrual-method firms can deduct yearend bonuses in 2007 but have until two and a half months into 2008 to actually pay them out. "This is a good tax outcome both for the employees, who don't pick up the extra income until '08, and the company, which still gets the '07 deduction," says Brittney Saks, partner with PricewaterhouseCoopers Private Company Services Practice. The tax benefit does not apply to companies using the cash method of accounting or to bonuses given to a company's owners or majority shareholders.
The election limit for small business expenses, known as the Section 179 expense election, has been increased in 2007 to a maximum deduction of $125,000. This means that business owners can list as immediate business expenses the purchase of business assets and equipment they made in 2007 up to $125,000, rather than depreciating that property over many years for tax purposes. The equipment must be put into service in your company before the end of the year in order to be deductible, says Lorin Luchs, tax partner in the Washington (D.C.) office of BDO Seidman.
Related to this increase, the maximum deduction for business assets (known as the "asset phase-out") for qualified business equipment has also been increased to $500,000. The Section 179 expense deductions are only useful for companies that are declaring a profit, says Saks. "If you're in a loss situation, you can't increase your loss by declaring these equipment expenses."
Your company does not have to take advantage of this expense election, she notes. You can choose to depreciate your business equipment as you would have in the past. "This is one of those items that can go either way. You can use the expensing election and deduct more, or take the longer depreciation method and reduce your deductions. It all depends on where your company is falling toward the year end," Saks says.
Be aware of your potential exposure to the Alternative Minimum Tax, a complicated tax that requires many items on a tax return to be refigured in a way that reduces the tax benefit for several deductions. This tax is scheduled to affect a record number of taxpayers in 2007 if it is not changed or repealed by Congress. Small business owners who operate pass-through entities such as sole proprietorships and S-corps are particularly at risk for being hit by the Alternative Minimum Tax, Luchs says.
C-corps are exempt from this tax if their annual average gross receipts for the previous three-year period are $7.5 million or less, Saks says. "If you're getting close to reaching this $7.5 million number, you might consider the impact and see if there is acceleration or deferral of income or expenses that would help your corporation stay below that threshold," she advises.
Evaluate whether you can reap tax benefits if you adjust the wages of owners and top executives before Dec. 31. "S-corp owners may want to take lower wages and C-corps may want to do the opposite," Luchs says. Proceed cautiously: If the wages paid to an owner or executive of an S-corp are considered too low, or wages paid to a C-corp executive are too high, the IRS may challenge them.
Small businesses may want to defer income from 2007 into 2008 by holding off on closing sales until January and delaying December billing. "Depending on income tax rates, deferral is often helpful for sole proprietors, partnerships, S-corps, and LLCs," Luchs says.
Take a look at your inventory. If inventory your company is holding has declined in value, you may be able to take a deduction for the loss. The loss must be documented before Dec. 31, however.
If your business was affected by the recent California wildfires (BusinessWeek.com, 10/26/07), you may be eligible for extended tax filing and payment deadlines. Victims in seven California counties affected by the fires have until Jan. 31, 2008 to meet tax deadlines previously scheduled between Oct. 21, 2007 and Jan. 31, 2008. This includes quarterly estimated tax payments for small business owners.