As an individual taxpayer, you understand how important it is to maximize every deduction and tax credit to lower your overall tax bill. The same holds true for your business. To pay as little tax as possible you must take advantage of every deduction that the law allows.
New Equipment Costs
Business equipment and furniture can be depreciated over several years, or the full cost can be deducted in the year of purchase as a Section 179 expense. To qualify for the full-cost deduction, which is limited to $108,000 in 2006, $125,000 in 2007, and $125,000 + COLA for 2008 through 2011 as updated for 2007 Iraq War Funding Law. If your purchases total more than $430,000 in 2006 or $500,000 in 2007, your maximum deduction is reduced dollar for dollar. Therefore, you can no longer deduct this expense once your applicable purchases reach $625,000. You may choose each year whether to depreciate or deduct equipment purchases, and you can expense all or some. Under the old law once you file, you cannot change the treatment of a purchase. Under the new 2007 Iraq War Funding Law law taxpayers may make the 179 election to expenses on amended 2004 through 2011 tax returns.
By planning qualifying purchases before the end of the year, you can maximize your depreciation deduction and avoid the "mid-quarter convention." This occurs when more than 40% of the total basis of all personal property placed in service during the year is placed in service in the last 3 months of that tax year. However, any purchases fully deducted as a Section 179 expense are removed from the mid-quarter convention computation.
Finally, to maximize your depreciation deduction, consider a cost segregation study. By identifying and pricing separately the nonstructural items and land improvements from your building, it's possible to accelerate depreciation. These items have much shorter depreciable lives than the assigned 39-year life for nonresidential real property. Landscaping, site fencing, parking lots, and security equipment are some examples of assets eligible for reclassification.
On March 9, 2002 President Bush signed into law the Job Creation and Worker Assistance Act of 2002 (The 2002 Act). The Act contains many tax and economic incentives one of which is a 30% Additional Bonus Depreciation for qualifying property acquired after September 10, 2001 and Before September 11, 2004.
General: The act provides for an additional first-year depreciation deduction equal to 30% of the adjusted basis of qualified property. This additional depreciation is allowed for both regular tax and AMT purposes. Taxpayers may elect not to take the additional depreciation if they wish.
Interaction of 179 Deduction and 30% Depreciation Deduction: For purposes of the 30% deduction, the adjusted basis subject to the 30% deduction is the basis of the property after being reduced for any 179 depreciation deduction allowed for the year.
Qualifying Property: Generally to qualify for the new 30% deduction an asset must be property subject to the Modified Cost Recovery System (MACRS) depreciation rules with an applicable recovery period of 20 years or less. This includes MACRS property this is 3-year, 5-year, 7-year, 10-year, 15-year or 20-year property. Additionally, Computer Software depreciated under section 167(f)(1) over 36 months, along with certain leasehold improvement property defined under section 168(k)(3) [certain interior improvements to leased commercial property.
Cost of Used Property: Unfortunately cost of used property does not qualify for the 30% bonus depreciation deduction. The Act requires ?Original Use? and is further defined as the first use of the property by the taxpayer. Therefore, it appears that the purchase of used property will not qualify but improvements to used property should qualify.
Except for your commute to and from your primary job, you can deduct all business travel expenses, including travel from one job site to another; travel to a temporary assignment outside your general area of residence; travel between primary and secondary jobs; and all other cab, bus, train, airline, and automobile expenses.
You may deduct expenses for an automobile you own in one of two ways. Either record and deduct your actual expenses, including depreciation; or record your mileage and deduct a standard amount per mile of travel, plus parking and toll fees. The standard mileage rate for 2006 is 44.5 cents per mile for business miles driven.
If expenses include accelerated depreciation, deducting actual expenses may at first provide a larger deduction. But, keep in mind that you may not switch to the standard mileage rate in later years when it provides the larger deduction. If you lease a vehicle, you must deduct actual expenses. Detailed record keeping is important to substantiate your deduction.
If your employer reimburses you for business travel, the reimbursement is not usually included in your income, and you can't deduct expenses. Travel expenses for which you are not reimbursed are deductible as miscellaneous itemized deductions subject to the 2% of AGI limitation.
"S" corporation shareholders should reimburse business related auto expenses on a monthly basis.
Expense Reimbursement Plans
Companies can institute "accountable" or "nonaccountable" expense reimbursement plans, with the former better serving both the employer and employee.
Under accountable plans, employees submit mileage logs or actual expense receipts for which they are reimbursed at the standard mileage rate or for actual expenses. The company can deduct the reimbursements in full, while employees do not report them as income or deduct related expenses.
Under nonaccountable plans, employees do not submit expenses to the employer, but instead receive flat expense allowances. The employee must declare the allowance as income, while expenses are taken as miscellaneous itemized deductions, subject to percentage limitations. The employer may also owe FICA on the allowances, so both parties lose.
Business Vehicle Purchases
If you purchase vehicles for business, the IRS has classified certain vehicles as luxury items, and will limit the amount of depreciation taken based on the year the car is placed in service. In general, cars priced at more than $25,000 are subject to the limitations.
If you buy a car in 2005, the annual depreciation limit (including Section 179 expenses) will be $2,960 in 2005; $4,700 in 2006; $2,850 in 2007, and $1,675 in later years.
Note that the limitation doesn't apply to vehicles with gross weight ratings of more than 6,000 pounds, which might include large pickup trucks, vans, and sport utility vehicles. Many sport utility vehicles weigh less than 6,000 pounds. So, if you plan to purchase one, be sure to ask how much it weights.
Low annual depreciation limits apply to newly acquired automobiles. So, if you need a car, consider leasing to increase your write-offs and conserve cash.
Travel & Entertainment
In general, you cannot deduct travel, meal, and entertainment expenses unless you can establish that the expense was directly related to a business activity or discussion. Plus, you can only deduct 50% of your business meal and entertainment expenses, and most club dues cannot be deducted. To ensure that you receive the deductions to which you are entitled, think through your expenses:
- Are gifts incorrectly recorded as entertainment?
- Are subscriptions incorrectly recorded as dues?
- Are fully deductible expenses, such as employee recreation or holiday parties, incorrectly recorded as entertainment?
Corporations often find themselves with excess inventory that would be greatly appreciated by a charitable organization. Congress has made this act of giving fairly painless for those businesses. For example, if you contribute food or medical supplies to a charity that provides for the homeless, you may deduct not only the cost of the goods, but half of the lost profit (not to exceed twice the cost) as well.
For 2002 and 2003, C corporations may also reap similar tax advantages for donations of some computers, software, or peripheral equipment to primary or secondary schools. The donation must occur no later than 2 years after the date the corporation acquired the property. Corporate contribution deductions are limited to 10% of the C corporation's taxable income before considering the donation.
Employing your Children
If you own a business and can legitimately employ your children, you will realize several tax advantages. First, your child's wages are fully deductible as a business expense. And, if you are a sole proprietor, you won't have to pay FICA on those wages if the child is under age 18, nor will you have to pay employment insurance if the child is under age 21. Also, your child's wages may be subject to a lower tax rate than if you were to retain the same money as business earnings. Children age 14 and older pay a modest 15% tax rate on earned and unearned income up to $29,700 in 2005.
Finally, a child with earned income receives a standard deduction of up to $5,000 for 2005, and qualifies for an IRA deduction of $4,000 - totaling $9,000 free from federal income tax. Children may also be partners in partnerships or shareholders in S corporations, which will reduce the overall family tax burden through use of the child's lower tax bracket.