Year-end tax planning strategies for small businesses
November 21, 2013
Set aside some time in the midst of the upcoming holiday bustle to examine the tax situation of your business. With a few maneuvers, you can reduce the amount of money your business owes for 2013. This might involve purchasing a new vehicle that comes with significant tax incentives, making eligible real property improvements, and taking other tax-saving steps before Tuesday, December 31.
It’s not too late. You can still take steps to significantly reduce your 2013 business income tax bill.
Here’s a rundown of the best small business year-end tax-saving moves.
1. Buy a Heavy SUV, Pickup, or Van
While buying a big SUV, pickup, or van for your business may not be seen as politically correct because of the gas the vehicles use, the fact is they are useful if you need to haul people, equipment and materials around. They also have major tax advantages.
Thanks to the Section 179 deduction privilege, you can immediately write off up to $25,000 of the cost of a new or used heavy SUV that is placed in service by the end of your business tax year beginning in 2013 and used over 50 percent for business.
For a heavy long-bed pickup (one with a cargo area that is at least six feet in interior length), the $25,000 Section 179 deduction limit does not apply. Instead, the “regular” Section 179 deduction limit of up to $500,000 applies, as explained later in this article. The same is true for a heavy van that has no seating behind the driver’s seat and no body section protruding more than 30 inches ahead of the leading edge of the windshield.
Thanks to the 50 percent first-year bonus depreciation privilege (more on that later), you can write off half of the business-use portion of the cost of a new (not used) “heavy” SUV, pickup, or van that is placed in service by December 31, 2013 and used more than 50 percent for business.
After taking advantage of the preceding two breaks, you can follow the “regular” depreciation rules to deduct whatever is left of the business portion of the vehicle’s cost over six years, starting with 2013.
To cash in on this favorable tax treatment, you must buy a “heavy” vehicle — one with a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. First-year depreciation deductions for lighter SUVs, light trucks, light vans, and passenger cars, are much less. You can usually find a vehicle’s weight rating on a label on the inside edge of the driver side door where the hinges meet the frame.
Example 1: Your business uses the calendar year for tax purposes. You buy a new $65,000 Cadillac Escalade and use it 100 percent for business between now and December 31. On your 2013 business tax return or form, you can write off $25,000 of the cost thanks to a Section 179 deduction. Then, you can use the 50 percent first-year bonus depreciation break to write off another $20,000 (half the remaining cost of $40,000 after subtracting the Section 179 deduction).
Finally, you can follow the regular depreciation rules to depreciate the remaining cost of $20,000 (the amount left after subtracting the Section 179 deduction and the 50 percent bonus depreciation deduction), which will generally result in a $4,000 deduction for 2013 (20 percent times $20,000). Overall, your first-year depreciation write-offs amount to $49,000 ($25,000 plus $20,000 plus $4,000), which represents a whopping 75.4 percent of the vehicle’s cost.
In contrast, if you spend the same $65,000 on a new sedan that you use 100 percent for business between now and year end, your 2013 depreciation write-off will be only $11,160.
Example 2: You operate a calendar year business for tax purposes. You buy a used $40,000 Cadillac Escalade and use it 100 percent for business between now and December 31. With a Section 179 deduction on your 2013 business tax return or form, you can write off $25,000. Then, you can generally deduct another $3,000 under the normal depreciation rules [20 percent times ($40,000 minus $25,000) equals $3,000]. Your first-year depreciation deductions add up to $28,000 ($25,000 plus $3,000). In contrast, if you spend the same $40,000 on a used light SUV or a used regular passenger car, your maximum 2013 depreciation write-off will be only $3,160.
Example 3: For tax purposes, your business uses the calendar year. You buy a used Dodge Ram heavy long-bed pickup for $35,000 and use it 100 percent for business between now and year end. On your 2013 business tax return or form, you can write off the entire $35,000 thanks to the Section 179 deduction, assuming you have no problem with the business income limitation rule explained later. (The $25,000 Section 179 deduction limit that applies to heavy SUVs doesn’t apply to heavy long-bed pickups.) In contrast, if you spend $35,000 on a used light pickup, your maximum 2013 depreciation write-off will be only $3,360.
2. Take Advantage of $500,000 Section 179 Deduction for New or Used Assets
For tax years beginning in 2013, the maximum Section 179 deduction for eligible new or used assets other than heavy SUVs is a much larger $500,000. For instance, the larger $500,000 limit applies to Section 179 deductions for things like new or used machinery and office furniture, computer equipment, and purchased software. As explained earlier, the up-to-$500,000 Section 179 deduction privilege is also available for new and used heavy long-bed pickups and new or used heavy vans.
Warning: Watch out if your business is expected to have a tax loss for the year (or close) before considering a Section 179 deduction. The reason: You cannot claim a Section 179 write-off that would create or increase an overall business tax loss. Contact your tax adviser if you think this might be an issue for your operation.
3. Benefit from Bonus Depreciation for Other New Assets
Your business can claim 50 percent first-year bonus depreciation for qualifying new equipment and software that is placed in service by December 31, 2013. Used assets do not qualify. For example, this tax break is available for new computer systems, purchased software, machinery and office furniture.
There is no business taxable income limitation on bonus depreciation deductions. That means 50 percent bonus depreciation deductions can be used to create or increase a net operating loss (NOL) for your business’s 2013 tax year. You can then carry back the NOL to 2012 and/or 2011 and collect a refund of some or all taxes paid in one or both those years. Contact your tax adviser for details on the interaction between asset additions and NOLs.
Deadline: The December 31 placed-in-service deadline for assets eligible for 50 percent first-year bonus depreciation applies whether your business tax year is based on the calendar year or not. So time is growing short if you want to take advantage.
4. Take Advantage of $250,000 Section 179 Deduction for Real Estate Improvements
Real property improvements have traditionally been ineligible for the Section 179 deduction. However there’s a big exception for qualified real property improvements that your business places in service in a tax year that begins in 2013 — you can claim a first-year Section 179 deduction of up to $250,000. This temporary break applies to:
- Interiors of leased non-residential buildings.
- Restaurant buildings.
- Interiors of retail buildings.
- The $250,000 Section 179 allowance for real estate is part of the overall $500,000 allowance, and it will not be available for tax years beginning after 2013 unless Congress extends it.
Warning: Once again, watch out if your business is already expected to have a tax loss for the year (or close) before considering any Section 179 deductions. You can’t claim a Section 179 write-off that would create or increase an overall business tax loss. Also, claiming Section 179 deductions for real property can trigger high-taxed ordinary income gains when the property is sold. Contact your tax adviser for details.
Juggle Income and Deductible Expenditures if they Go on Your Personal Return
If you run your operation as a sole proprietorship, S corporation, LLC, or partnership, your share of the net income generated by the business will be reported on your Form 1040 and taxed at your personal rates. The 2014 individual federal income tax rate brackets will be about the same as this year’s (with modest bumps for inflation), so they will remain relatively taxpayer-friendly. Therefore, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. In that case, deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2013 until 2014.
On the other hand, if your business is healthy, and you expect to be in a significantly higher tax bracket in 2014 (say 35 percent versus 28 percent), take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2014. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.
C Corporation: If you run your business as a regular C corporation, the 2014 corporate tax rates are scheduled to be the same as always.
So if you expect your corporation to pay the same or lower rate in 2014, postpone income into next year while accelerating deductible expenditures into this year.
If you expect the opposite, try to accelerate income into this year while postponing deductible expenditures until next year.
How to Do It: Most small businesses use cash-method accounting for tax purposes. If your business is eligible, cash-method accounting gives you flexibility to manage your 2013 and 2014 taxable income to minimize taxes over the two-year period. Here are some specific moves if you expect business income to be taxed at the same or lower rate next year.
- Before year end, charge recurring expenses that you would otherwise pay early next year on credit cards. You can claim 2013 deductions even though the credit card bills won’t be paid until next year. However, this favorable treatment doesn’t apply to store revolving charge accounts. For example, you can’t deduct business expenses charged to your Sears account until you actually pay the bill.
- Pay expenses with checks and mail them a few days before year end. You can deduct the expenses in the year you mail the checks, even if they won’t be cashed or deposited until early next year. For big-ticket expenses, send checks via registered or certified mail. That way, you can prove they were mailed this year.
- Prepay some expenses for next year. This is allowed as long as the economic benefit from prepaying does not extend beyond the earlier of: 12 months after the first date on which your business realizes the benefit, or the end of the tax year following the year in which the payment is made. For example, you could claim 2013 deductions for prepaying the first three months of next year’s office rent or the premium for property insurance for the first half of next year.
- On the income side, put off sending some invoices so you don’t get paid until early next year. The general rule for cash-basis taxpayers is you report income in the year you receive cash or checks in hand or through the mail. Of course, you should never put off sending invoices if it raises the risk of not collecting the money.
When Should You Take the Opposite Approach?
If you expect to pay a significantly higher tax rate on next year’s business income, try to do the opposite of these moves to raise this year’s taxable income and lower next year’s.
Go for a Net Operating Loss
With the exception of the Section 179 depreciation deduction, the business tax breaks and strategies discussed here can be used to create or increase a 2013 net operating loss (NOL) if your business’s expenses exceed its income. You can then choose to carry a 2013 NOL back for up to two years in order to recover taxes paid in those earlier years. Or you can choose to carry the NOL forward for up to 20 years if you think your business tax rates will go up.
Get in Position for 0 Percent Tax on Gains from Selling QSBC Stock
For qualified small business corporation (QSBC) stock that is issued in calendar year 2013, a 100 percent federal gain exclusion break is potentially available. That equates to a 0 percent federal income tax rate on future profits from selling QSBC shares down the road.
However, you must hold the shares for more than five years to be eligible. This break is not available to C corporation shareholders, and many companies don’t meet the definition of a QSBC. (The QSBC must be a C corporation.) Contact your tax adviser if you have a start-up business that you think might be eligible. But hurry — the 100 percent gain exclusion deal won’t be available for shares issued after this year unless Congress extends it.
Take Advantage of S Corp Built-In Gains Tax Exemption
Do you operate a corporation that converted from C to S status a few years ago? You probably know that a corporate-level built-in gains tax (the BIG tax) may apply when certain S corporation assets (including receivables and inventories) are turned into cash or sold within the recognition period. The recognition period is normally the 10-year period that began on the date when the C to S conversion occurred.
However, for gains recognized in tax years beginning in 2013, there’s an exemption from the BIG tax. It applies if the fifth year of your corporation’s recognition period went by before the start of the tax year beginning in 2013. If your S corporation is eligible, consider making some asset sales that trigger built-in gains this year (when the BIG tax exemption is available) instead of selling in future years (when the BIG tax might bite).
Contact your tax adviser if you have questions about any of the tax planning strategies described in this article.