Tax Tips For The Small Business Owner

Presented by Thomas J. Murphy


1.     Just write it off – it’s free

Not quite.  The after-tax effect of expensing items reduces the cost by the tax bracket you are in.  For most of us (those with taxable incomes of $58,100 up to $117,250), this effectively reduces the price by 25%.

You can expense (and not depreciate) up to $100,000 of business-related purchases.  Special deal for big SUV’s ends this year – can expense up to $100,000 (rather than normal limit of $10,710) for purchase of auto in excess of 6,000 lbs.

2.  How Long Should I Hold Onto My Records?

Answer: hold onto as many of your records for as long as you can.

First, if you never file, the period for the IRS to contest the return never starts to run.  It also never begins to run if a return is filed that is fraudulent or constitutes willful tax evasion (usually, unreported cash)

If you file a return, the IRS has three years to challenge the return.  The Arizona Dept of Revenue has four years.

If a return has omitted 25% of gross income, the period is 6 yrs.

Once a deficiency has been assessed, the tax can be collected by lien or levy.  The IRS has 10 years to initiate and complete collection activity.

As a result of all of this, an enforceable deficiency due the IRS can linger for 15 years or longer.  You need to keep records for at least that long.

3. Maximize retirement contributions

These numbers increase each year.  For 2004:

  • SEP – 25% up to $41,000
  • SIMPLE — $9,000
  • 401(k) — $13,000 plus $3,000 catch-up if over 50
  • Other qualified plans – 25% up to $41,000
  • IRA’s — $3,000 plus $500 catch-up if over 50

Protected from creditors, plaintiffs lawyers, etc

  • Exceptions – IRS (maybe) & (soon-to-be) ex-spouses

4.  Put your children on your payroll

Can pay children up to $4,850 per child per year TAX-FREE

Can use this to fund a Roth IRA (which requires earned income) – great way to fund a college education

If your child is under 17 and you are a sole proprietor, no withholding for payroll taxes

Make sure you can document hours worked

5.  Put your spouse on your payroll

If spouse is not otherwise employed, spouse can participate in retirement plan.  Attribution rules among spouses no longer apply.

Easier to deduct travel with spouse

6. Repayment of loans by owner

If owner has loaned $ to business, treat $ as return of principal rather than as W-2 (ie, taxable) income

7. Home office deduction

Rules have changed making it much easier to take this deduction.  No longer the audit flag it once was.

Allows you to deduct portion of utilities, insurance & maintenance.  Can depreciate portion of home or deduct portion of rent.  Also eliminates commuting costs.

To qualify, must have office in home that is used exclusively for business.

8. Fringe benefits

Creates, in effect, a tax-free raise

Expense reimbursement – Cellular phones, dues & licenses, professional subscriptions, tools & supplies, seminars, working clothes & uniforms

Child & dependent care – up to $5,000 per employee per year

Tuition reimbursement

  • $5,250 per employee per year
  • Maintains or improves work skills
  • Covers tuition, fees, books, supplies & equipment

Accident and health insurance, including disability and long term care.

Medical costs reimbursement

Group term life insurance – up to $50,000 per year

Meals for employees – for 100% deduction, must be provided on premises and for convenience of employer

9. Gifts

The deduction for gifts to business associates cannot exceed $25 per recipient per year.

10.  Estate planning issues

Very critical area – planning for death or incapacity.  What will happen to your business if you die or can no longer work?

Upon your death, estate taxes can loom very large.  For 2004 and 2005, the estate tax applies to all property (not just income) with a combined FMV at death of $1.5M.  Begins at a 45% rate.  For married couples, this can be doubled to $3M through the use of an “A/B” trust.  Property left to spouse also qualifies for the “marital deduction”, which means that the property is not taxed until the death of the surviving spouse.

Having a trust works two other advantages in addition to the estate tax.  One advantage is that it avoids probate.  A trustee can be put in place the day you die.  With probate, a personal representative or conservator must be appointed which could take weeks or months.  Many important business decisions will require prior court approval. Your business records become a matter of public record.  The second advantage is that it prevents your minor children from receiving their entire inheritance at age 18.  You can create a “Symington” trust that will protect these assets from the children’s future creditors or ex-spouses as well as preventing the children from wasting the funds.

The most difficult estate planning issue for business owners is succession – who will get the business?  Particularly difficult where nearly all of the value of your estate is in the business.  Crucial to address this if you have partners – you must address the 3D’s – death, disability and divorce.  What is the value of the business and how do we value it?  How much will be paid to buy out a partner and where will the money come from?  Life insurance looms large here.