Smart Year-End Tax Moves

It’s been a tough couple of years for many businesses. When the economy struggles, companies are tempted to put taxes on the back burner while they concentrate on other business concerns. This is a big mistake. You can’t bury your head in the sand and pray that everything works out when April 15 rolls around. Managing your business and individual tax burden becomes even more important in a difficult business environment. You can’t afford to miss out on tax incentives that can boost your bottom line. Your competitors won’t.

Lawmakers have aggressively used the tax code to try to get the economy back on track, and there are now more ways than ever to reduce your tax liability. But all of them take planning. You need to understand your opportunities and leverage the tax breaks available to you and your business. Business owners and managers have more tax concerns to worry about than most people. Don’t act first and think about taxes later. A little foresight can go a long way.

Although the year is winding down, it’s not too late to act. Below are several year-end tax strategies that may help you leverage new incentives or avoid a tax headache. But keep in mind that these strategies won’t work for everyone. Whether or not they help you will depend on your situation. The strategies also involve just a fraction of all the new tax incentives available for businesses and individuals. Make sure you talk to a tax professional to discuss your own situation and to uncover all the tax breaks that can help your business.

Expense business investments

In an effort to jumpstart business investment, lawmakers have expanded the ability of taxpayers to immediately deduct the cost of many types of investments in their businesses.

Legislation enacted in 2010 doubles a bonus depreciation tax benefit for property your business places in service before the end of the year. Under this provision, you can fully deduct the cost of eligible equipment on this year’s return if you place it in service by December 31. To qualify for bonus depreciation, the property you place in service must be new and generally have a useful life of 20 years or less under the modified accelerated cost recovery system (MACRS).

This tax benefit is generally only available for property placed in service before the end of the year (there are different rules for certain property with long production periods and most airplanes), but Congress could extend it. If no legislation is enacted, property placed in service in 2012 will qualify for regular bonus depreciation, which allows you to deduct half of the cost of the property while the rest is depreciated using normal rules.

Get your self-employment taxes right

Employees that earn wages generally split payroll taxes with their employers and these taxes are automatically deducted from their paychecks. Self-employed taxpayers instead pay their own payroll taxes as “self-employment tax,” which is levied against self-employment income. Self-employed taxpayers may then deduct half the cost of this tax (what’s normally considered the “employer” half) for income tax purposes.

Lawmakers provided a partial payroll tax holiday in 2011 that reduces the employee share of Social Security taxes from 6.2% to 4.2%. This rate cut also applies to the self-employment tax, lowering the combined rate from 15.3% to 13.3% for 2011 self-employment income under the $106,800 Social Security wage cap. This rate cut is considered to come from the employee’s share of employment taxes, so it does not reduce your above-the-line income tax deduction for self-employment tax. This deduction is still calculated as one-half of 15.3% of self-employment income, or 7.65%.

Become a “qualified small business”

Lawmakers have focused many new tax incentives on small businesses. Legislation enacted in 2010 presents a unique opportunity for companies that are considered a “qualified small business” (QSB) under tax rules. A QSB must be organized as a C corporation for tax purposes (and meet several other tests) and cannot have more than $50 million in assets.

Original issue QSB stock purchased before the end of 2011 will receive a full exclusion from capital gain. That means taxpayers who purchase this stock before the end of the year will never pay tax on any gain on the stock as long as they hold it for five years and follow all the rules. You can normally exclude only half of the gain on QSB stock held. The full exclusion offers an excellent opportunity for eligible enterprises to raise capital at a reasonable rate or provide owners with a tax efficient growth opportunity. And it’s not only for C corporations. Under QSB tax rules, partnerships may perform a conversion into a C corporation in which the converted partnership interests are treated as stock acquisitions that can qualify for the QSB stock gain exclusion. But be careful, because there are lots of other tax implications to consider when deciding on your business structure.

Smartly set your corporate employee-shareholder salary

If you own a corporation and work in the business, you need to think carefully about your salary structure. Your tax treatment will vary depending on how high you set your salary and whether your business is organized as a traditional C corporation, or an S corporation (in which corporation income is “passed through” and taxed at the individual level).

Payroll taxes that are levied against salary income include a 2.9% Medicare tax (1.45% for the employee and 1.45% for the employer). Distributions of corporate income are generally not subject to this tax. That means if your business is an S corporation, you will pay Medicare tax only on business income received as salary, not income received as a distribution. C corporations are different. C corporation distributions also escape Medicare tax, but are subject to a 15% dividend tax rate (even though the income is already taxed at the corporate level). So many C corporation owners will pay less overall tax on income received as salary (which is deducible at the corporate level).

But remember to tread carefully. You must take a reasonable salary to avoid potential back taxes and penalties, and the IRS is cracking down on misclassification of corporate payments to shareholder-employees.

Make up estimated tax shortfall with increased withholding

Although you don’t file your return until after the end of the year, it’s important to remember that you must pay tax throughout the year with estimated tax payments or withholding. People paid in wages generally don’t have to worry as long as their employer is withholding enough. But business owners or executives with other types of income often need to make estimated tax payments. You will be penalized if you haven’t paid enough.

If your adjusted gross income is over $150,000 in 2011, you generally can avoid penalties by paying at least 90% of your 2011 tax liability or 110% of your 2010 liability through withholding and estimated taxes. If you’re in danger of being penalized for not paying enough tax throughout the year, try to make up the shortfall through increased withholding on your salary or bonuses.

Paying the shortfall through an increase in your last quarterly estimated tax payment can still leave you exposed to penalties for underpayments in previous quarters. But withholding is considered to have been paid ratably throughout the year. So a big bump in withholding on high year-end wages can save you in penalties when a similar increase in an estimated tax payment might not.