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Year End Tax Planning: Strategies for Businesses and Individuals
By Jim Bailey
It's just around the corner. The end of the calendar year signals the annual planning
process for tax season, and with a couple fairly new tax laws on the books and another
couple set to expire, right now is the time to make sure you are familiar with and taking
optimal advantage of all benefits coming your way.
Business owners should keep abreast of several tax issues, including the following:
New U.S. Production Activities Deduction: For business owners, tax-year 2005
introduces a new deduction for U.S. production activities, whereby businesses,
incorporated or not, can deduct up to 3% of the net income from certain business
activities. In addition to traditional manufacturing, this deduction is available for income
from selling personal property that the business manufactures, grows, produces or
extracts and can be applied to the construction, software production, film, videotape or
farming industries. This new deduction can be significant, but take notice - the
deduction can't exceed 50% of the wages paid to employees for the year.
S Status Election: Electing S status often saves a fair amount of tax since it avoids the
double taxation experienced by many C corporations, however S status is only available
if the corporation meets several requirements, including a limit on the number of
shareholders. This year, new changes to S status requirements increases the maximum
number of eligible shareholders from 75 to 100, thereby opening up the availability of
this entity to larger corporations. Moreover, family members can elect to be treated as
one shareholder, making the number of shareholders limitation more palatable.
Expiring Tax Breaks: Several credits and deductions are slated for reduction or
expiration following 2005, (although it is certainly possible that Congress will extend
them) so if you are considering either hiring individuals whose wages qualify for "work
opportunity" or "welfare to work" credits or purchasing qualified electric or clean fuel
vehicles it makes sense to do so before year-end.
Maximize Deductions: Deductions are certainly the name of the game during year-end
planning, so be sure to take advantage of all legitimate deductions. For example,
business owners can expense up to $105,000 of the cost of qualifying depreciable
property placed into service in 2005. Eligible property for this immediate tax write-off
includes "off-the-shelf" computer software, office furniture, equipment, vehicles or other
tangible business property.
Work Opportunity Tax Credit: Employers can claim the work opportunity tax credit
(WOTC) if they hire individuals from designated target groups. "Hurricane Katrina
employees" are now included on that target group list. The credit generally equals 40%
of the first $6,000 of wages paid to the employee in the first year.
The Dividend Option: Business owners can get a break by paying dividends in lieu of
owner salaries if their personal tax rate will be in the 28% or higher tax bracket for tax year
2005 and if they own a corporation anticipated to be in the 15% income tax bracket.
By paying themselves some dividends, a business owner could net more cash after taxes
since dividend income is subject to a maximum 15% tax rate, while salaries are taxed at
28% or higher.
The business owner who is considering evaluating his or her corporate status should
check with a CPA and an attorney to be certain to take advantage of maximum legal tax
benefits allowed.
And, for individuals (many of whom are business owners), it makes sense to be aware of
the following conventional and less publicized options:
State and Local Sales Tax Deductions: If you itemize deductions, you can deduct
either state and local sales taxes or state and local income taxes, and if it turns out that the
sales tax deduction is more beneficial, you can choose between claiming the actual sales
taxes you paid during the year or an amount from IRS-published tables. Remember to
always save your receipts to document the tax you actually paid as those year-end totals
may yield a larger deduction than using the IRS tables, which are based on your income
level and the size of your family.
Minimize Tax on Capital Gains: Generally, when you sell stock or mutual fund shares,
the shares you purchased first are considered sold first. That translates into good news
since it can be beneficial to qualify for the long-term capital gain rate by selling shares
that have been held for more than one year. However, if you're selling less than your
entire holding of a specific stock or mutual fund, situations can arise when you're better
off selling shares other than those held the longest as newer shares may have a higher
cost-basis that could result in a smaller taxable gain or even a loss.
Benefit from Your Itemized Deductions: If your itemized deductions end up being
either just under or over the standard deduction, you can double up on itemized
deductions every other year and claim the standard deduction in the intervening years.
Let's take a closer look at this option. For 2005, the standard deduction for joint filers is
$10,000 and $5,000 for single filers. If you file jointly and your property taxes are your
only itemized deduction and run about $9,000 a year, you will wind up claiming the
standard deduction annually. But, if you pay two years worth of property taxes in 2005,
you can get the benefit of an $18,000 itemized deduction in that year. In 2006, you
would have no itemized deductions and would claim the standard deduction. So, by
bunching your itemized deductions into the year 2005, you will get $28,000 of
deductions over a two-year period, instead of the $20,000 you would deduct if just
claiming the standard deduction each year. Keep in mind that deductions eligible for
shifting from year to year include certain property taxes, final estimated state income tax
payments, your January mortgage payment and charitable donations.
Consider a Health Savings Account: Commonly referred to as an HSA, a Health
Savings Account allows you to pay medical expenses on a pretax basis. If you meet
certain requirements, HSA contributions in the year 2005 of up to $5,250 for family
coverage and $2,650 for single coverage (plus an additional $600 for those 50 years or
older) can be made regardless of your income level. Moreover, these contributions are
deductible above-the-line, so you can benefit even if you don't itemize or are subject to
the high-income itemized deduction phase-out. By having an HSA, you can take tax-free
withdrawals to pay uninsured medical expenses. If in good health, you can use an HSA
to build up a substantial medical expense reserve fund for future use. And, if you reach
age 65 and don't need the funds for health care costs, you can withdraw them for nonmedical reasons and pay only the income tax. What a deal! In addition to paying medical expenses with pretax dollars, HSAs allow you to save on a tax-deferred basis, similar to an IRA.
These are just a few ideas and suggestions to get you started as we approach the filing
season. And as always, it's wise to consult with a reputable Certified Public Accounting
firm to be sure you're reaping as many benefits as possible. With a little research and
planning, 2005 could be your least "taxing" year to date.
(Editor's note: Jim Bailey is a principal in the Rockland, MA CPA firm Needel, Welch &
Stone, P.C. 781-982-1001. www.nwscpas.com )
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