Business owners often ask me how aggressive (or conservative) I am regarding taxes. In proper CPA form, I tell them “it depends.” Most tax questions are black and white, no shade of gray needed. While those areas that are open to interpretation are many and varied, most of the time business owners can manage their tax liabilities through some relatively simple planning to take advantage of the “low hanging fruit.” In my experience, below are the five most often overlooked areas that create additional tax burden for businesses and their owners:
1. Is there such a thing as too many tax deductions? Many times through the ability to take bonus depreciation and make the IRC section 179 expense election, business owners are able to reduce their business income to zero (or less). Unfortunately, that often leaves personal exemptions and itemized deductions on the table, and they normally don’t fold into a net operating loss carry forward. Did you know that the average business owner has over $40,000 of itemized deductions? Since many of these expenses are merely timing, while you get the benefit of the depreciation deduction this year, you would’ve received the benefit of the itemized deductions and personal exemptions anyway. Business owners should consider foregoing certain bonus or section 179 expense elections in order to leave enough adjusted gross income to take advantage of itemized deductions and personal exemptions and still not pay tax.
2. Poorly timed capital gains. Many business owners overlook the fact that the capital gains rates for married filing joint is zero percent up to $74,900 in taxable income. Business owners should consider selling capital assets if their income is going to be below this threshold and enjoy 0 percent income tax bracket!
Conversely, that tax could be as much as 23.8 percent that if gain is recognized in a high income year.
3. Overlooking minor credits and deductions. Consider such credits such as:
a. Differential Wage Payments
b Disabled Access Credit
c. Employer Paid FICA on Tips
d. Employer-provided Healthcare
e. Pension start-up costs
f. Small employer health insurance premiums
g. Work opportunity credit
These credits allow businesses to get dollar for dollar relief for expenses paid rather than getting to simply deduct the item. For example, if you incurred an expense to make your business usable by the disabled you’re entitled to 50 percent credit of the amount of the expenditure up to $5,000. Often times, without knowing it, businesses erroneously capitalize the costs into the building and recapture the deduction over 39 years. Indeed, a tax credit is a terrible thing to waste.
4. Poorly planned self-employment tax. Many businesses operate at a loss when their business is in start-up. Many of the same businesses are taxed either as a sole proprietorship, S corporation or partnership, where the income or loss flow through to the owner. While the loss that flows-through to an individual business owner’s tax return does reduce other active income, a loss in the business does not create a self-employment tax loss carryover.
For example, assume a business has an operating loss of $25,000 in year one. Also assume the same business makes $25,000 in year two. Between the two years the business was at break even. Unfortunately, the loss in year one for self-employment tax does not carry over to year two. Therefore, the business owner will pay self-employment tax on the entire $25,000 of year two profits. Over $3,000 will be paid in self-employment tax, and not be able to be reinvested into the business. The business owner should’ve considered capitalizing certain eligible expenses, or use available accounting methods to accelerate revenue.
5. Lastly, perhaps the most often overlooked expense opportunity for most business owners has to do with optimizing auto expenses. Many business owners don’t recognize that the actual cost of operating a vehicle is significantly less than the 57.5 cents per mile reimbursement rate approved by the Internal Revenue Service.
For example, assume you operate a Prius in your business, and your net cost of operations for $.15 per mile. If you drove 10,000 miles for the business in the current year, your reimbursement would be $5,650. Your actual cost to operate the vehicle on the other hand was only $1,500. Electing to take the mileage rate versus actual expenses would significantly increase tax deductions over the life of the car. In this case, the business owner would have been able to extract $4,150 tax free from the business! Many times business owners get overzealous on taking actual expenses in the first year of a vehicle, and lose the ability to take the mileage rate for the entire life of the car.
Another consideration should be whether to lease or buy the car. Generally, trucks and SUVs are better purchases. High value luxury cars are often better leased, yielding a higher ratio of payment to deduction, even after the lease inclusion amount is factored in.
In conclusion, a thorough review of your tax accounting periods and methods often create opportunities to increase cash flow. Perhaps your strategy would be to follow the guidance offered by the Honorable Judge, Learned Hand, who said, “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes”
Michael D. Bosma, CPA is the founder of Bosma Group, CPAs, and Bosma Business Center, LLC.
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