People who have their own businesses are in an enviable position this time of year. They tend to have far more flexibility than other individuals to take advantage of year-end tax-saving opportunities.
Self-employed workers, including free-lancers and employees with sideline businesses, have considerable control over when deductible expenses are paid and when taxable income is received.
For example, business owners can defer tax on some of their year-end income for an extra year just by delaying billing long enough to ensure that customer payments won’t arrive until after Dec. 31. And thousands of dollars in extra deductions can be picked up between now and the end of the year simply by paying some outstanding bills and stocking up on office supplies and equipment you’ll be needing in the new year.
Small-business owners who use the “cash method” of accounting have the most flexibility to maneuver at year’s end to trim their tax bills. Under the cash method, which is used by most smaller businesses, income is reported in the year it’s received and expenses are deductible in the year they are paid. If you use the “accrual method” of accounting, you don’t have as much room to maneuver because you must report income in the year it’s earned and deduct expenses in the year they are incurred.
This is also an opportune time for businesses to evaluate their office equipment needs. Smaller businesses get a special break. They are eligible to immediately write off up to $17,500 a year in equipment purchases without having to depreciate their cost over a period of years. The availability of this first-year “expensing” method provides a big incentive for small businesses to consider accelerating equipment purchases.
“What I say to clients is: If you think you’re going to buy a piece of equipment in the next six months that qualifies for expensing, buy it now and get the deduction,” said Albert Ellentuck, a tax attorney at the Washington, D.C., law firm of King & Nordlinger.
Your equipment purchases are eligible for a full write-off under the expensing method no matter how late in the year the purchases are made. (By contrast, making a lot of year-end equipment purchases can sometimes prove counterproductive if you’re claiming regular depreciation deductions. Under conventional depreciation rules, if more than 40 percent of the year’s equipment purchases are made in the final three months of the year, you could wind up with fewer depreciation deductions for 1996.)
But before you head to the office supply store, figure out how much of a tax benefit you’ll actually get. The expensing method is subject to a number of restrictions. First of all, the amount you can immediately write off is limited to the amount of taxable income you have from your business. So if your business income is meager, your write-offs will be meager. One exception: Employees with sideline businesses are allowed to count salary they earn from their regular job as business income when figuring their limit on expensing deductions.
Special restrictions also apply to personal computers, cellular phones and certain other equipment that is used partly for personal purposes. These items must be used more than 50 percent of the time for business in order to qualify for expensing.
Write-offs for cars are also limited. No more than $3,060 of the car’s cost can be deducted on 1996 returns.
If you’re ordering equipment, be sure it can be delivered before year’s end. That’s because ordering and paying for the equipment by Dec. 31 isn’t enough to make the purchase deductible this year. The tax law requires the equipment to also be “placed in service” by year’s end.
“That means it’s got to be in your office and ready for use before the end of the year,” said Thomas Beneventi, a tax partner in the Schaumburg office of the national accounting firm of McGladrey & Pullen.
Before the year ends, consider paying all your outstanding bills for deductible business expenses, including utilities, insurance, telephone and subscription renewals to trade publications.
In most cases, you’ll be paying up only a few days or few weeks before the bills are due. But you’ll be getting the tax deductions a year early.
Membership dues in country clubs, luncheon clubs and other social clubs are no longer deductible as a business expense. But keep in mind that business-related meal and entertainment charges at a club are still 50 percent deductible. So if you receive a monthly statement from your club for such charges, paying the bill by Dec. 31 will make the business-related expenses deductible on your 1996 return.
Paying outstanding bills for health insurance premiums by year’s end may also bring hundreds of dollars in extra deductions for your 1996 return. Many self-employed individuals are eligible to write off 30 percent of their family’s health coverage costs without having to itemize or qualify for the itemized medical deduction.
But if you have a health insurance payment due in January, you’ll have to decide whether it’s worth paying the bill by Dec. 31 in order to reap the tax savings a year early or wait until next year to pay the bill and qualify for a bigger deduction. The deductible portion rises to 40 percent next year under the new health insurance reform law enacted by Congress last summer.
“I would recommend they make the insurance payment this year so they can get the deduction now,” said Beneventi. He figures next year’s increase in the deduction isn’t large enough to offset the advantage of getting the tax savings a year early for business owners who can make profitable use of the extra cash flow.
