Tax Tips for Business Owners: Year-End Planning Starts Now

By Rich Gunn, BPM Shareholder
September 5, 2012

You have heard many times that personal income tax rates are scheduled to go up as of January 1, 2013. However, if your business is conducted through an S corporation, limited liability company ("LLC"), partnership, or sole proprietorship, you will actually pay higher taxes on your business income in 2013. That's because for these forms of doing business, all the profits are reported on your personal income tax return, and taxed at the personal income tax rates, which are scheduled to increase in 2013.

Even owners of regular corporations ("C-Corps") will be affected by the increase in personal income tax rates in 2013: if you take wages or dividends from your corporation in 2013, these are reported as income on your personal tax return, and you will pay higher taxes on wages and dividends in 2013 than in 2012.

What Actions Should Business Owners Take Before the Year Ends?

This is a rare year in which you should consider reversing common year-end tax strategies. For example, if you have some control over when your business revenue is subject to tax (based on your method of accounting), as the year-end draws near you may have previously considered deferring income into the subsequent year, so as to defer paying tax until the subsequent year. However, as you see tax rates rising in 2013, you may actually want to accelerate income from 2013 into 2012 so that it is taxed at the lower, current tax rates.

For example, a consulting company – doing business as an S corporation and using the cash basis method of accounting for income tax reporting – has an opportunity to review year-end billing and collection procedures. The purpose is to identify opportunities where the cash collection for client receivables can be accelerated into 2012. Identify the specific clients and their billing and collection cycles, then make the necessary arrangements to the timing of the process, so that you receive income in November or December of 2012 instead of January or February of 2013. Review your income recognition procedures with your tax advisor to identify other opportunities to accelerate income into 2012 if appropriate.

On the expense side of the business, when is the best time to generate tax deductible expenditures? A business owner would typically review 2013 expenses, and determine if it is feasible to accelerate such expenditures into 2012 to get the tax deduction a year earlier. This year you may want to do the reverse of that plan: if tax rates rise in 2013, as currently scheduled, tax deductions are more valuable in 2013 than 2012. Which deductible expenses can you control in terms of the timing? One example would be employer contributions to pension and profit sharing plans: if you normally fund less than the maximum allowable amount each year, you could consider funding less for 2012 and more for 2013. Your pension advisor would help you determine how much you can fund for either year. Discretionary spending items are the best place to find expenses where you have some control over which year they are incurred and deductible for tax purposes.

While deferring deductions to 2013 may seem like a good strategy with tax rates scheduled to rise next year, one noteworthy exception is if your business will be spending a significant amount on equipment, computers, commercial vehicles, furniture, and other personal property used in the business in 2013. This is because there are two generous provisions for expensing equipment purchases that are currently set to expire or be significantly reduced in at the end of this year.

One of those provisions is bonus depreciation, which allows you to deduct 50% of the cost of new business property acquired in 2012. If the same asset was acquired in 2013, bonus depreciation is no longer available: the entire cost would be deducted over the "useful life" of the asset, which could be between 5 and 20 years, depending on the type of asset.

Alternatively, another provision of the tax code that allows for 100% deduction for the purchase of new or used property and equipment is Code Section 179. A business can deduct up to $139,000 of equipment, computers, commercial vehicles, furniture and other personal property acquired in 2012. However, the $139,000 maximum deduction is scheduled to be reduced to $25,000 in 2013. A business that will acquire more than $25,000 of such equipment in 2013 may want to accelerate some of those purchases into 2012. You can do this even if you acquire the property on credit or with third party financing: you don't have to pay for it in 2012; you only have to own it, and have it readily available for use before the year's end. Example: if you have 10 new employees starting in January, you can purchase their desks and computers in 2012, and have them delivered, assembled, installed and owned by the business in 2012; no one has to actually use the equipment in 2012, and you don't need to have paid for it by year-end. As long as your business owns it and it is ready for use in 2012, it can be deducted in 2012, while the depreciable deductions remain more generous than in 2013.

Planning Opportunities for C-Corporations

C-Corporation owners should review their accumulated retained earnings and dividend history. If dividends are advisable, the owners will pay lower taxes on dividends received in 2012 than dividends received in 2013. Not only does this reduce the tax that the owner pays on dividends, but it may also reduce the risk of the IRS asserting a tax on unreasonable accumulation of earnings in a C-Corporation. C-Corp owners may want to review bonus and compensation policies to determine if it is appropriate for the owner to receive bonuses in 2012, instead of 2013. Not only will income taxes on wages be higher in 2013, but there could be social security tax savings as well: for business owners whose 2012 salary is already over the maximum taxable amount of $110,100, you will not pay social security tax on additional wages and bonuses your receive this year.

These strategies should be reviewed carefully to determine if they are appropriate for your situation, and should only be implemented after consulting your tax advisor. Also keep in mind that Congress could act before the end of this year to make changes to the tax law as in effect for 2013, as well as at any time next year.

This publication contains information in summary form and is intended for general guidance only. It is not intended to be a substitute for detailed research nor the exercise of professional judgment. Neither BPM nor any member of the BPM firm can accept any responsibility for loss brought to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.