Small Business Strategies Monthly Newsletter - May 2008

Tax Planning Strategies
Tax Deductions: How Much $$$ Are They Saving You?

Business & Management Practices
Big Business Write-Offs Available In 2008
How to Avoid Common Business Mistakes
Is Now The Time To Consider a Real Estate Rental Property?

General Information
The Rebates Are On Their Way - But That’s Not the End Of It!
Plan for Bigger Auto Deductions In 2008

Briefs
Husband and Wife Joint Ventures
Lunch as a Business Expense

Due Date Reminders
May 2008

TAX PLANNING STRATEGIES

Tax Deductions: How Much $$$ Are They Saving You?

Taxpayers frequently ask what benefit is derived from a tax deduction. Unfortunately, there is no straightforward answer. The reason why the benefit cannot be determined simply is because some deductions are above-the-line, others must be itemized, some must exceed a threshold amount before being deductible, and certain ones are not deductible for alternative minimum tax purposes, while business deductions can offset both income and self-employment tax. In other words, there are many factors to consider, and the tax benefits differ for each individual, depending upon his or her situation.

For most non-business deductions, the savings are based upon your tax bracket. For example, if you are in the 25% tax bracket, a $1,000 deduction would save you $250 in taxes. However, if taxable income is close to transitioning into the next-lower tax bracket, the benefit will be less. You also need to consider whether the particular deduction is allowed on your state return and what your state tax bracket is to determine the total tax savings.

Some deductions such as IRA and self-employed retirement plan contributions, alimony, student loan interest, moving expenses, etc., are adjustments to income or what we call “above-the-line” deductions. These deductions provide a dollar-for-dollar benefit. Deductions that fall into the itemized category must exceed the standard deduction for your filing status before any benefit is derived. In addition, the medical deductions are reduced by 7.5% of your AGI (income), and the miscellaneous deductions are reduced by 2% of your AGI. For taxpayers subject to the alternative minimum tax, the medical adjustment raises to 10%, while the deductions for taxes, home equity interest, and the miscellaneous deductions above the 2%-of-AGI floor are not allowed at all.

The most beneficial deductions, business deductions, fall into two categories: employee business expenses, which are treated as miscellaneous itemized deductions subject to the limitations described previously, and self-employed business expenses that offset both income tax and, depending upon the circumstances, self-employment tax. For 2008, the self-employment tax rate is 12.4% of the first $102,000 of income subject to SE tax plus 2.9% for the Medicare tax with no cap. For self-employed businesses with less than $102,000 of net income, the effective SE tax rate is 15.3%. Thus, for small businesses with profits of less than $102,000, the benefit derived from deductions generally will include the taxpayer’s tax bracket plus 15.3%. For example, for a taxpayer in the 25% tax bracket, the benefit could be as much as 38.3% (25% + 15.3%) of the deduction. If the deduction were $2,000, the tax savings could be as much as $766 - and even more when the taxpayer’s state income tax bracket is included.

If you are planning an expenditure and expect the tax deductions to help cover the cost, please give us a call in advance to ensure that the tax benefit is what you anticipate it to be.

back to top

BUSINESS & MANAGEMENT PRACTICES

Big Business Write-Offs Available In 2008

Section 179 of the tax code allows taxpayers to elect to treat any portion of the cost of qualified business property as an expense deduction for the tax year in which the Section 179 property is placed in service - instead of having to capitalize the expense and recover the cost over several years.

Generally, Section 179 property is acquired by purchase for use in the active conduct of a trade or business and is either:

• tangible property such as machinery, equipment, office furnishings, computer systems, certain vehicles (within special limits), or

• off-the-shelf computer software. (Off-the-shelf software qualifies for the Section 179 deduction only through 2011.)

Under the Economic Stimulus legislation passed earlier this year, the Section 179 expensing deduction has been increased to $250,000, almost double the prior $128,000 limit. For property placed in service by an enterprise zone company, the expense deduction limit increased to $35,000.

For 2008, the Section 179 expense deduction limit has been phased out for larger companies by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $800,000 ($510,000 before the new legislation).

Example: A small business acquires and places in service, during the 2008 tax year, $200,000 of machinery. Under the Economic Stimulus legislation, the small business can deduct the entire $200,000 cost of the machinery in 2008.

One potentially negative aspect of taking the Section 179 expense deduction is that recapture is necessary if the property is removed from business service (or not used more than 50% for business) at any time before the end of its recovery life. The recapture is the excess of the Section 179 amount over the normal depreciation deduction that would have been allowed.

If recapture is a potential problem, the Economic Stimulus legislation also reinstated the 50% bonus depreciation (which applies to most tangible property, purchased computer software, and qualified leasehold improvement property) for 2008 only. This provision allows a deduction of up to 50% of the cost of the property within the first year with the balance depreciated in the normal manner. There are no recapture issues associated with the 50% bonus depreciation.

The Section 179 deduction and the 50% bonus depreciation also can be combined to provide your business with virtually any write-off (up to the cost of the property) needed for 2008. Another benefit is that there are no alternative minimum tax (AMT) issues, since both are deductible when computing the regular tax and the alternative minimum tax.

2008 offers some interesting opportunities if you are acquiring certain business property. Please give our office a call if we can assist you in planning your acquisitions to provide the greatest tax benefits.

back to top

How to Avoid Common Business Mistakes

It is not uncommon for business owners to become so involved with their day-to-day operations that they overlook some important issues associated with being in business. Here are some tips to help you avoid making costly mistakes and to ensure that your business runs smoothly.

• Minimize personal liability. Individuals should try to avoid putting their personal assets at risk when they enter into a business venture whether solely or with others. Many overlook or dismiss the fact that personal liability can be minimized with the proper business structure. There are several types of entity forms that afford different degrees of protection, but there is no perfect entity that will provide an all-purpose, one-size-fits-all protection. Included among the various entity options for business owners are sole proprietorships, partnerships, corporations, s-corporations, and limited liability companies. In addition to liability protection, when choosing an entity, take into account the character of the business, the business partners you have, your options for exiting the business, and your estate plan.

• Consider a buy-sell agreement. When partners first go into business together, they do so with high expectations and mutual respect. A joint business venture is like a marriage, and often, it ends in a divorce. A binding buy-sell agreement is probably one of the most important documents that a business with multiple owners can have. Typically, a buy-sell agreement is entered into by the owners of a business, and possibly the business entity itself, to purchase or sell interests of the business at a preset price or formula in the event of a future occurrence that will impact the operation and continuance of the business. Such events are numerous and can include death, disability, divorce, disagreement, or retirement. Imagine your business partner passing away and his or her heirs or surviving spouse stepping in as a partner.

• Hold shareholder and board meetings. “Piercing the corporate veil” is terminology we hear associated with court cases when someone is attempting to go around the liability protection provided through an entity such as a corporation. Courts can “pierce the corporate [or business] veil” and hold the business owner personally liable for failure to conduct the business properly. Failure to hold the required meetings and maintain a minutes book is one indicator that a business is not being run as a corporation but rather by an individual or group of individuals. Bottom line…Hold the required meetings and maintain the minutes book.

• Plan for family business succession. Determine whether there is a desire by a family member or members to participate in the business. If family succession is anticipated, then the business should be organized in a type of entity that lends itself to transfers of entity interests to family members with little or no loss of management or control, such as family-limited partnerships, limited liability companies, and subchapter s-corporations. The main goal is to allow the donor to retain control and derive income from the entity while removing considerable estate value through gifts of interests or making gifts using the applicable exemption amount ($1 million) or the annual gift tax exclusion amount. An understanding of estate and gift tax ramifications of gifts of entity interests, such as valuation issues and available discounts, is also crucial.

• Understand the tax ramifications of your actions. Just about everything that we do that is related to business, investments, and retirement has tax ramifications. Many individuals fail to consider these ramifications, and they find themselves caught in tax traps or miss out on available tax deductions and credits, at significant cost. What we do know is that Congress has not, and probably will not, let a year go by without making changes to the tax code. Before making any major decisions such as purchasing a new business, making substantial purchases for an existing business, buying equipment for an existing one, setting up a retirement plan, selling a business or investment asset, or making investments, investigate the tax ramifications beforehand so that you can structure the course of action in a way that provides the most tax benefits.

If you need assistance with any of the above, please give our office a call so that we might help you directly or refer you to someone who can assist with your particular situation.

back to top

Is Now The Time To Consider a Real Estate Rental Property?

Does the decline in real estate values present a business opportunity? Real estate rentals historically have been a popular long-term investment, and if you believe that this market eventually will rebound from its current slump, this may be the time to consider such an investment. This material will explain some of the tax ramifications of renting both residential and commercial real estate.

One of the biggest benefits of owning rental property is that the tenants, over time, buy the property for you. In addition, if structured properly, the allowable depreciation deduction will shelter the rental income. Another historical benefit of real estate rentals is capital appreciation. Before acquiring a rental property, there are several things to consider, including:
• after-tax cash flow,
• potential for long- or short-term appreciation,
• property condition (with an eye on when you might get stuck with a large repair
bill),
• debt reduction,
• type of tenants,
• potential for rent increases or re-zoning, and
• whether there is community rent control, etc.

Although most of the considerations are subjective, the after-tax cash flow can be estimated fairly easily, as illustrated in the example below.

In this example, there is a column for actual cash flow (after taxes) and another for reportable tax profit or loss. For actual cash flow purposes, we must consider the entire mortgage payment (interest and principal), while for the rental tax P&L, only the interest is deductible, but an allowance for depreciation is included. As a result, in the example, there is a negative cash flow of $1,300. However, for tax purposes, the rental shows a loss of $4,550, primarily because of the depreciation allowance. Assuming that the taxpayer is in the 25% tax bracket, that $4,550 loss yields a $1,138 savings in taxes for the year. Thus, our after-tax cash flow is negative only by $162. You also will need to consider whether your loss deduction is limited by the passive loss rules. Generally, you can deduct virtually all expenses incurred to operate and maintain (not improve) the rental. Improvements must be capitalized and depreciated.

Rental real estate income is business income but is not subject to Social Security taxes. Real estate rentals are also considered passive activities. Generally, passive activity losses are deductible only to the extent of passive activity income. However, where there is active participation by the taxpayer in managing the rental, the taxpayer can deduct up to $25,000 of losses each year as long as his or her Adjusted Gross Income (AGI) for the year is less than $100,000. For higher-income taxpayers, the $25,000 loss exception is ratably phased out between an AGI of $100,000 and $150,000. There is also a special allowance for real estate professionals. Any losses not allowed under these two exceptions are not lost but suspended and carried forward indefinitely to tax years in which your passive activities generate enough income to absorb the losses. To the extent your passive losses from an activity are not used up in this fashion, you will be allowed to use those losses in the tax year in which you dispose of your entire interest in the passive activity in a fully taxable transaction.

When a rental is sold, it is treated as a capital asset, and the gain, except for depreciation recapture, is taxed at capital gains rates. Recaptured depreciation, depending upon your tax bracket, can be taxed up to 25%. Besides outright selling of a rental, there are a number of options such as exchanging the existing rental for another while deferring the gain and avoiding current taxes, selling the property in an installment sale (which spreads the taxable gain over multiple years), or even converting the property to personal use (which forestalls the taxable gain until the property ultimately is sold).

Buying, operating, and selling a rental property can have profound tax ramifications and provide some interesting options not available to other investments. Please contact this office prior to the purchase or disposition of a rental property so that the tax impact can be analyzed prior to making a financial commitment.

back to top

GENERAL INFORMATION

The Rebates Are On Their Way - But That’s Not the End Of It!

By the time you read this article, the IRS has already started sending out the stimulus rebates. A new schedule was released, accelerating the distribution of the payments. Payments were direct deposited into qualifying individuals' bank accounts starting April 28 instead of May 2, and paper checks will be mailed starting May 9 instead of May 16. The schedule that was released in March remains the same, with payments either direct deposited or put in the mail by the dates listed on the schedule.

These rebates are actually advance payments for a new refundable tax credit called the “Recovery Rebate Credit” that is claimed on your 2008 tax return and must be accounted for when you file the 2008 tax return. So the government can get the money into people’s hands quickly and not wait for the 2008 returns to be filed in 2009, the IRS will calculate and mail out advance payments of this 2008 credit based upon the information included on a taxpayer’s 2007 tax return. The IRS will make a direct deposit of the advance payment into a taxpayer’s account if direct deposit was requested for the 2007 return refund. When the taxpayer files his or her 2008 return, the Recovery Rebate Credit will be reduced by the amount of the advance payment. Should the advance payment exceed the amount of the credit, the taxpayer will not be required to make up the difference!

Since these advance payments (cash rebates) are computed based on the data from the 2007 return, a 2007 return must be filed to obtain a cash rebate. Thus, some taxpayers (such as those receiving SS income and who are not otherwise required to file a return and otherwise qualify for the rebate) must file one to qualify for the advance payment. However, if a taxpayer does not file a 2007 return, he or she still would qualify for the Recovery Rebate Credit when a 2008 return is filed. This also applies to taxpayers who file late. They do not lose the Recovery Rebate Credit; they just do not receive it in advance and will have to wait for the benefit when their 2008 return is filed. The IRS is prohibited from issuing advance payments after December 31, 2008.

How much will your rebate be? The rebates are broken into two categories, the basic credit rebate and the qualifying child rebate credit. For the basic credit rebate, a single person with no qualifying children gets a maximum rebate of $600 or a minimum rebate of $300. A married couple filing jointly with no qualifying children gets a maximum rebate of $1,200 or a minimum rebate of $600. To receive the maximum, your 2007 tax (figured in a special way) must be $600 or more for a single person and $1,200 or more for a married couple filing jointly. To get the minimum, you must have at least $3,000 of qualifying income (explained above) or owe tax (figured in a special way) of at least $1. Your rebate amount will fall in between the minimum and maximum if your tax is more than $300 but less than the maximum rebate for your filing status. In that case, your rebate will be equal to your tax. Let’s say that you are single and that your tax is $500. In this scenario, your rebate will be $500.

An eligible individual who is entitled to any amount of the basic credit is also allowed a credit equal to $300 for each qualifying child of the individual in addition to the basic credit. “Qualifying child” has the same meaning for this purpose as it has for purposes of the child tax credit. Thus, for each child who qualifies for the child tax credit, a taxpayer qualifies for an additional $300 rebate.
For example, a married couple filing jointly with one qualifying child could be eligible for a maximum rebate of $1,500 ($1,200 + $300).

Phase-out for higher-income taxpayers: The amount of the rebate (both the basic and the child amount) is reduced by 5% of a taxpayer’s adjusted gross income (AGI) above $75,000 ($150,000 for joint returns). For example, a married couple filing jointly with one child has an AGI of $170,000 and a net tax liability of over $1,200. Their rebate is $500: [$1,200 basic rebate plus $300 qualifying child rebate - $1,000 phase-out (i.e., 5% × ($170,000 - $150,000)].

Do all qualified individuals get rebates? No. Each individual must qualify for the rebates in one of two ways, and the rebates and the credit in 2008 is phased out for higher-income taxpayers. To qualify, a taxpayer must (1) owe tax, as computed in a special way, or (2) have at least $3,000 of qualifying income. Qualifying income generally includes earned income, social security benefits, and veterans’ disability payments (including payments to survivors of disabled veterans).

If you think that you might qualify for the rebate and have not yet filed a return, please call this office for assistance.

back to top

Plan for Bigger Auto Deductions In 2008

When you use a vehicle for business purposes, the business portion of the operating expenses can be deducted on your self-employed business or, if you are an employee, as a miscellaneous itemized deduction. The tax code provides two possible options: using the standard mileage rate or using actual expenses. For vehicles purchased and placed into service during 2008, the recent Economic Stimulus legislation and inflation adjustments substantially increase the first-year write-offs for business use. The following is a summary of these changes for vehicles purchased in 2008.

Standard Mileage Rate Method: The standard mileage rate takes the place of fuel, oil, insurance, repair, maintenance, and depreciation (or lease) expenses. The rate varies from year to year; for 2008, the standard mileage rate is 50.5 cents per mile. In addition, the cost of business-related parking and tolls is deductible. Caution: If the standard mileage rate is not used in the first year in which the vehicle is placed into service, it cannot be used in future years. If, in a subsequent year, there is a switch to the actual method, the straight-line method for depreciation must be used. If the car is leased, the standard mileage rate must be used in future years.

Actual Expenses Method: To use the actual expense method, determine the entire actual cost of operating the car for the year first and then the business portion attributable to the business miles driven. Vehicle depreciation is included as part of the operating costs of a vehicle. Until this year, the depreciation was limited to about $3,000 for the first year. However, for 2008, the 50% bonus depreciation is back, which boosts the first-year allowable depreciation limit by $8,000, increasing the limit for passenger vehicles to $10,960 ($11,160 for small trucks and vans).

SUV Special Limits: Vehicles with a gross unladen weight of more than 6,000 pounds are not subject to the limitations that apply to passenger vehicles, small trucks, and vans. Instead, their business portion can be depreciated like any other type of business property, except that they are limited to $25,000 of the Section 179 expense deduction. However, by combining the Section 179 deduction with the new 50% bonus depreciation that applies to 2008, the purchase of an SUV for business can produce a substantial first-year write-off. The following is a representative example (assuming 100% business use) of the write-off for a newly purchased vehicle placed into service in 2008.

Caution: There has been some discussion in Congress about limiting the write-offs for heavy SUVs. However, Congress is sensitive to the negative effect that such a decision would have on U.S. car makers. So, we must wait and see! For those of you planning to purchase an SUV based upon this big write-off, be sure to call first to see the current status of the deduction and pending legislation.

back to top

BRIEFS

Husband and Wife Joint Ventures

Beginning in 2007, a married couple that owns a joint business venture in which they both participate can elect to file two self-employed business schedules (Schedule C or Schedule F) on their personal income tax return, dividing the income and expenses instead of filing a partnership return. However, the IRS has made it clear that this special provision does not apply to state law entities, such as general or limited partnerships or limited liability companies. If you are interested in pursuing this option for 2008 and currently have employees, are also required to file other types of tax returns, or simply have questions about this option, please give this office a call.

back to top

Lunch as a Business Expense

Many individuals spend time away from their offices while calling on customers and vendors. As a result, they end up having to buy their lunch and want to deduct the cost of that lunch as a business expense. Unfortunately, the cost of meals can only be deducted when you are away from home overnight. However, you may be able to deduct the cost of your lunch as business-related entertainment if you take one of your customers to lunch with you. In any case, even when the meals are allowed, they are only 50% deductible.

back to top

DUE DATE REMINDERS

May 2008

May 12 – Social Security, Medicare and Withheld Income Tax

File Form 941 for the second quarter of 2008. This due date applies only if you deposited the tax for the quarter in full and on time.

May 15 – Employer’s Monthly Deposit Due

If you are an employer and the monthly deposit rules apply, May 15 is the due date for you to make your deposit of Social Security, Medicare and withheld income tax for April 2008. This is also the due date for the non-payroll withholding deposit for April 2008 if the monthly deposit rule applies.

back to top