INTRODUCTION
As a small business owner, you must not only cope with daily responsibilities, but
you must take time to plan which direction your business will take in the future. One
vital component of your planning should be your yearly tax bill. With some preparation and
knowledge, you can steer clear of some common mistakes and take advantage of tax laws
meant to help small businesses.
2003
TAX CHANGES FOR SMALL BUSINESS
The following are some of the tax changes for small business that take
effect in 2003 and could affect your estimated tax payments for 2003.
Health
insurance deduction
for the self-employed.
For 2003, this deduction is 100 percent of the amount you
paid for medical insurance for yourself and your family.
Self-employment
tax. The maximum net self-employment earnings subject to the
Social Security part of the self-employment tax increases to $87,000 for
2003.
Section
179 deduction.
For 2003, the total cost you can elect to deduct under section
179 of the Code is increased to $25,000.
Standard
mileage rate. The standard mileage rate for the cost of operating your
car, van, pickup or panel truck in 2003 is 36 cents a mile for all
business miles.
Reportable
transactions.
New disclosure rules require you to file Form 8886, Reportable
Transaction Disclosure Statement, to report certain transactions entered
into after 2002. Reportable transactions include (1) transactions the same
as or substantially similar to tax avoidance transactions identified by
the IRS, (2) transactions offered to you under conditions of
confidentiality, (3) transactions for which you have contractual
protection against disallowance of the tax benefits, (4) transactions that
result in losses of at least $2 million in any single year or $4 million
in any combination of years, (5) transactions resulting in book-tax
differences of more than $10 million and (6) transactions with asset
holding periods of less than 45 days and that result in tax credits
exceeding $250,000. For more information, see the Instructions for Form
8886.
Fewer
tax forms for small businesses to file Starting
with the 2002 tax year, companies with less than $250,000 of total
receipts and less than $250,000 in assets no longer have to complete
Schedules L, M-1 and M-2 of Form 1120; Parts III and IV of Form 1120-A;
and Schedules L and M-1 of Form 1120S. Small businesses will be able to
use recordkeeping based on their checkbook or cash receipts and
disbursements journal instead of creating additional records just for tax
purposes. The companies must still maintain records detailing assets,
liabilities, equity accounts and adjustments used to arrive at taxable
income.
Five-year
carry back of net operating losses
Taxpayers with net operating losses (NOLs) for tax years ending
in 2001 or 2002 will generally carry them back five years rather than two
(three, for certain casualty, theft and disaster-related losses). How-
ever, they may choose to use the two- or three-year period instead or to
carry the entire NOL forward for up to 20 years. Taxpayers waiving the
five-year rule must do so by their filing deadline (including extensions).
Electric
and clean- fuel vehicles
The maximum amounts for the clean-fuel vehicle deduction and
the electric vehicle credit, which were scheduled to begin dropping by 25
percent per year in 2002, will remain unchanged until 2004, when the
three-year phase-out will begin.
Welfare-to-Work
and Work Opportunity Credits
These credits, which were scheduled to end in 2001, have been
extended to cover qualified wages paid to individuals who begin work
before 2004.
TAX BASICS
Your business' tax bill varies depending on whether its income is taxed at the
individual or corporate rate. Individual rates begin at 10%, but may reach 39.6%.
Corporate rates are as follows:
| Taxable Income Over |
But Not Over |
The Tax Rate Is: |
Of The Amount Over |
| |
|
|
|
|
$0 |
$50,000 |
15% |
$0 |
|
50,000 |
75,000 |
$ 7,500 + 25% |
50,000 |
|
75,000 |
100,000 |
13,750 + 34% |
75,000 |
|
100,000 |
335,000 |
22,250 + 39% |
100,000 |
|
335,000 |
10,000,000 |
113,900 + 34% |
335,000 |
|
10,000,000 |
15,000,000 |
3,400,000 + 35% |
10,000,000 |
|
15,000,000 |
18,333,333 |
5,150,000 + 38% |
15,000,000 |
|
18,333,333 |
- - - - - |
35% |
0 |
YOUR TAX IDENTITY
Given the wide range of individual and corporate tax rates, CPAs recommend that you
carefully consider how your business is organized. The type of business organization you
choose will determine your legal and tax treatment. The basic categories, available in
most states, are sole proprietorship, partnership, corporation, and limited liability
company (LLC).
Sole Proprietorships and Partnerships.
In a sole proprietorship or partnership,
business income and losses are "passed through" to the individual owners and are
taxed at their individual rates.
C Corporations. A "C Corporation" is the most standard form of
corporation, with business income taxed at corporate rates. Under federal and state tax
laws, regular C Corporations and their owners are treated as separate taxable entities.
When earnings are distributed as dividends, they are taxable to the shareholders at
individual rates. For this reason, income from a C Corporation is said to be subject to
"double" taxation--once at the corporate rate and once at the individual rate.
S Corporations. An "S Corporation" is a special type of elected tax
status in which your business' income and expenses are passed through to shareholders and
taxed at their individual rates, whether or not the income is actually distributed. S
Corporations are generally not subject to corporate income tax, and distributions usually
are not taxable to shareholders. So, income is taxed only once. Keep in mind, though, that
S Corporation status carries special eligibility requirements.
Personal Service Corporations (PSCs). PSCs are corporations that provide
services in such areas as health, law, engineering, architecture, accounting, and
consulting. PSCs operating as C Corporations pay a flat tax rate of 35%, regardless of the
level of income. You can also elect to have the PSC taxed as an S Corporation, or convert
it to an LLC to change its tax treatment, but check first with your CPA.
Limited Liability Companies (LLCs). Generally, LLCs combine the "limited
liability" feature of a corporation with the tax treatment of a partnership. This
means that the LLC's income is taxable to the LLC members at their individual rates, and a
separate corporate tax is not assessed on the LLC. In most cases, members are not liable
for debts and obligations of the business.
TAX-TRIMMING TIPS FOR THE SMALL BUSINESS
Tax Deductions for Compensation for Services. If your business takes a corporate
form and your corporate tax rates exceed the individual tax rates, you can reduce overall
taxes by compensating yourself and family members for services provided to the
corporation. However, the amount of the compensation must be reasonable in relation to the
services provided. If the IRS determines that the compensation is excessive, it may
disallow the compensation deduction and treat unreasonable payments as nondeductible
dividends to the owner. In addition, you should also consider the effect of employment
taxes assessed on such wages.
Employment Tax Reductions. Since income distributions to an S Corporation
shareholder are not subject to employment taxes, you can pay yourself a reasonable salary
and withdraw the excess from the company free of such taxes.
Employee vs. Independent Contractor Status. You may be able to save on
employment taxes (as well as fringe benefits) by classifying certain workers as
independent contractors, rather than as employees. However, you must know the special
rules for qualifying as an independent contractor, as opposed to an employee. You will
face stiff penalties and back taxes for misclassifying an employee as an independent
contractor.
Retirement Plan Contributions. CPAs recommend that you take advantage of tax
benefits associated with qualified retirement plans for your employees. As the employer,
you can take current tax deductions for contributions to qualified retirement plans for
your employees, and your employees will not recognize taxable income until they withdraw
the funds from the plans. Savings Incentive Match Plans for Employees (SIMPLE) is a type
of plan with eased reporting and testing rules so small businesses can offer tax-favored
retirement programs to their employees.
Deferred Compensation Plans. The use of qualified and non-qualified deferred
compensation plans also can provide valuable tax benefits both to you and your employees.
Deferred compensation plans allow employees to postpone receipt of part of their current
salary to later years. Therefore, if you or your key employees currently are in a high tax
bracket, you may want to consider establishing a deferred compensation plan to defer
income from high-income years to low-income (such as retirement) years.
Flexible Spending Accounts. Flexible spending accounts provide you and your
employees tax savings because the contributions are not subject to federal income or
employment taxes. Contributions also may be free from state and local income tax, but
generally have to be used by the end of the year or are forfeited by the employee.
Medical Savings Accounts. MSAs are available to small businesses and
self-employed individuals who have insurance plans with high deductibles. Both employers
and employees can contribute to the accounts, and employee contributions and withdrawals
are generally tax-free. Unlike flexible spending accounts, if the money is not spent
during the year, you don't lose it at year-end.
Business Property Depreciation. Generally, businesses can elect to deduct
immediately up to $25,000 in 2003 of the cost of qualifying property in the year it is
placed into service. However, keep in mind that this "immediate expensing"
deduction is limited to certain depreciable property used in the business (such as office
equipment or machinery) and begins to be reduced dollar-for-dollar once the cost of
business property exceeds $200,000.
Travel, Meal, and Entertainment Expenses. If your business routinely reimburses
employees for travel, meal, and entertainment costs, make sure you meet the accountable
reimbursement plan rules to ensure that such reimbursements will be deductible by your
business and that they will not be treated as taxable income to the employee. Business
travel expenses are fully deductible, and business-related meals and entertainment are 50%
deductible. The rules mandate that the employee submit adequate supporting documentation.
In addition, you may elect to pay your employees a "per diem" allowance, in lieu
of reimbursing actual travel and meal expenses, as long as the amount does not exceed the
applicable federal rate, which varies depending on geographic location.
Donating Overstocks to Charity. Excess overstock, if donated to a qualified
charity, can earn your company a federal tax deduction.
Bad Debt Write-Offs. If your business uses the accrual method of accounting,
review all outstanding business debts to determine which are uncollectible. If you have
outstanding receivables with no chance of collection, write them off in the year they
become partially or totally worthless.
The Most Advantageous Accounting Method.
One aspect of tax planning you should
not overlook is choosing the right accounting method. Generally, taxpayers may choose
between the cash and accrual methods of accounting for reporting income and deductions.
All taxpayers generally are required to use the accrual method if inventory is a material
income-producing factor. Therefore, you should seek the advice of your CPA to determine
which method is best (or required) for your business, and, if you currently are using an
impermissible one, how to minimize the tax cost of changing methods.
Acceleration of Deductions and Deferral of Income.
If you use the cash method of
accounting, you may be able to defer recognizing income and prepay some expenses to reduce
your current year's tax bill. If you are an accrual-basis taxpayer, however, you generally
must report income in the year when the right to the income is secured, whether or not it
has actually been received. Likewise, as an accrual-basis taxpayer, you generally will not
be able to prepay your expenses. Regardless of what method you use, your CPA can help you
make the most of the opportunities that are available.
Estimated Tax Payments.
Corporate taxpayers with annual taxable income of $1
million or less may avoid stiff underpayment penalties by making quarterly estimated tax
payments of at least 100% of the prior year's tax (provided there was tax owed, and it was
a full tax year). However, if your company's taxable income was at least $1 million in any
of the last three years and you made estimated tax payments that totaled less than your
actual current year's taxes, you cannot avoid the underpayment penalty.
Home Office Deduction.
The definition of "principal place of business"
has been changed to include a home office that is used by a taxpayer to conduct
administrative or management activities of a business, as long as there is no other fixed
location where the taxpayer conducts substantial administrative or management activities
for that business. This new definition helps those self-employed persons who manage a
business from their homes, but also provide a service or meet clients at another location.
Remember, however, that the office is deductible only if it is used exclusively,
on a regular basis, as a place of business. Taxpayers won't benefit from this new
definition until 1999, since it is effective for tax years beginning after December 31,
1998.
Health Deduction for Self-Employed. For those who are self-employed and must pay
their own health insurance, 100% of the cost is deductible in 2003.
Estate Tax Exemption for Family Businesses. Previously, there was no exemption
for family-run businesses; only the individual unified credit exemption was available.
Effective in 1998, when more than 50% of the estate consists of a family-owned business
and/or farm, the amount exempt from estate taxes will be $1.3 million (inclusive of the
unified credit exemption).
Penalty Avoidance.
Making a mistake in calculating your taxes can be quite
costly. The IRS may assess a 20% penalty on negligent underpayment, in addition to any
taxes that are owed, if you fail to follow the tax rules.
Financial Advice. Even for the smallest of businesses, tax rules can be complex
and compliance difficult. CPAs--as highly qualified business and financial advisers--can
provide the expertise you need to minimize your taxes and maximize your profits.
