Another year goes by, and based on what I read and hear, it was probably a good year for most of you. But as always, with good years there is some bad news along the lines of sharing your hard-earned profits with Uncle Sam.
Just remember, you only have an obligation to pay what you owe, and you have every right to make that amount as low as possible. The problem is keeping track of what you owe and the related tax laws to calculate your obligation. We all realize how much the tax code changes. Hopefully, you all have professional help that can provide you with a summary of those changes so you can take the maximum advantage to which you are entitled.
There were some important changes in 2004 that can affect 2005, as well as subsequent years. Based on what we hear coming out of Washington, they're not through yet. So please take the time to scan any industry-specific tax summaries to get a feel of what is going on and what, if anything, it is going to cost you.
are coming due
The last two years provided opportunities for you to really reduce your tax obligation via equipment purchased and bonus depreciation. That was great, but remember that you "robbed Peter to pay Paul", and 2005 is the year you start paying for being aggressive in 2003 and 2004. So chances are the deductions you expect for 2005 may not be there because they were already used in the previous two years.
If you have been keeping a running total of your taxable income, and have appropriate estimated tax payments or set-aside funds to cover your tax liability, you can sleep nights. On the other hand, if you paid little or no tax last year, even if you made estimated tax payments for 2005, you may have a large, unexpected tax liability to pay on March or April 15th, 2006, along with related estimated tax payments for the remainder of the year. In short, it's a double dip — you pay the tax in March or April and pay it again during the balance of 2006.
The point of all this is to know where you stand, especially if you used bonus depreciation in 2003 and 2004.
Locating additional deductions
What can you do if you find yourself with a major tax liability you would like to reduce? Or said another way, how can you create deductions for your business operations without just transferring them to your personal tax situation?
1. Find ways to defer income. Make sure accounting for recording income for tax purposes has been properly noted. Has the income been earned or is it still work in process? Make sure you are adhering to your contracts and not billing anything before the income is earned.
2. Find ways to accelerate expenses. Chase down your vendors or subs to make sure you have all invoices in the proper year. If you are on a cash basis, you can take advantage by paying those that apply for tax purposes. Some new rules actually allow you to expense certain prepaid expenses that otherwise would appear on your balance sheet.
3. Buy equipment. Purchase any needed units before year end and put them to use by December 31, 2005. Would I do this just to reduce a tax liability? No. But if you were thinking about some new equipment, and can get it by the end of the year, you can depreciate 20% of it or take the 179 deduction, which allows a write-off of $105,000 for 2005 as long as you keep your fixed asset additions to below $420,000.
4. Defer gains. If you buy new equipment and trade in older units, you wind up with a lower tax basis and, in turn, less depreciation to use. If you sell the older units outright, you pick up a gain, which produces the same result. The trick is to sell the equipment after year end or, if this isn't feasible, do a tax-free exchange if the cost of doing so warrants it.
5. Review deferred compensation rules. With proper planning, a business owner can establish a 401K or profit-sharing plan where they get the bulk of the contribution, and at the same time get a 2005 deduction without any personal tax liability. New tax rules regarding deferred compensation were enacted in October 2005, so it pays to review these rules very carefully before you do anything. All of the old rules are out the window, so don't just do what you did last year because you may be surprised.
6. Check into the deduction for qualified production activities. Believe it or not, your operations may qualify under this new law. Construction is listed as one of the qualified activities. It is a 3% deduction of "qualified production activities income", which increases to 9% in 2009. This is a big deal if you qualify. I would make it my business to find out what is required to do so.
The trick to good tax planning is just that — planning. You should know where you're at by March of any year. Do you have tax to pay? If so, do you have the cash to pay it? Are there any losses you can use? Are there new rules to take advantage of?
Planning takes time and it is tough to accomplish if you start doing it on December 15th. Take advantage of what is available to you, and don't run your business from a tax perspective only — it seldom pays off.
Garry Bartecki is director of dealer/distributor services at BDO Seidman, LLP of Chicago, as well as a consultant to the AED. He can be reached at (312) 616-4677 or firstname.lastname@example.org.