Jan. 1 marked the end of a popular tax reduction tool, the Section 179 deduction, which expired under the American Tax Relief Act of 2012 (ATRA).
The Section 179 deduction allowed small businesses to expense some assets in the year of purchase, rather than having to depreciate the purchase over its useful life. Those assets included equipment, vehicles, software, furniture and fixtures, provided the deduction was taken the year the purchase was made.
The asset could be paid in cash or financed. If financed, the entire deduction was available even if no cash was expended, which enabled business owners to reduce taxable income significantly without laying out cash. It also gave them much-needed working capital and lowered taxes.
A limitation of the Section 179 deduction is it can’t cause a taxable loss. It may be taken in full or partially to bring taxable income to zero and/or the unused portion can be carried to future years.
The Section 179 deduction allowed up to $500,000 of purchases to be expensed as long as purchases didn’t exceed $2 million for the tax years 2010 to 2013. Prior to 2010, the deduction was less but still significant.
As the extended provision of ATRA 2012 expired at the end of 2013, it reduced the total amount of purchases that qualify for expensing in the year of purchase to $25,000—as long as purchases don’t exceed $200,000. The 2014 maximum is one-twentieth of the deduction available for 2013.
The Section 179 deduction expiration will cause many businesses to scramble to reduce taxes for 2014. What are profitable business owners to do now?
Here are 10 ideas to explore:
- Have your tax adviser do a 2014 tax projection to determine what your tax situation may look like by year’s end. Most small businesses are pass-through entities, meaning income or losses from business flows to your personal tax return. Remember, income will be taxed if distributed or left in the business. Many times this complicates your tax projection and is best left to be done by your CPA, who will consider your business and personal taxes.
- A retirement plan may help reduce taxes. Many contributions to most retirement plans are deductible.
- Giving bonuses will serve two purposes: Reward valued employees, and save taxes. If you’re in the highest marginal tax bracket and you operate in a state with a higher state income tax, every dollar you expense will save you nearly 50 cents in taxes. Stated another way, since salaries are deductible, a bonus to employees will cost you about 50 cents for every dollar you pay.
- Remember the reduced Section 179 deductions. While I painted a grim picture about the amount of equipment that can be expensed in the year of purchase, you still should take advantage of the $25,000 deduction allowable in 2014.
- Pay your state taxes in the current year. Since most of us are cash-basis taxpayers, meaning we report income or deductions in the year they were paid or received, any deductible expense we pay in the current year is deductible. Since payment of state taxes is deductible in calculating federal taxable income, all state taxes should be estimated and paid before the end of 2014 to be deductible in the current year.
- Defer income if possible. Again, if you’re a cash-basis taxpayer, it may make sense to collect on any big jobs pending in 2015.
- Prepay expenses if you’re a cash-basis taxpayer. If you can prepay expenses in 2014 rather than pay in 2015, you’ll reduce your 2014 tax bill.
- Make sure you’ve paid estimated taxes or your withholding is adequate to avoid penalties. Many people believe waiting until April 15 to pay taxes is the best strategy to conserve cash. It may conserve cash, but it also may subject you to under-payment penalties. Special rules apply. Generally, you must have paid at least 90 percent of your current year liability by tax day or be subject to penalties.
- Think about a health savings account (HSA). An HSA combines high-deductible health insurance with a tax-favored savings account. Money in the savings account can help pay the plan deductible and other expenses. A family generally can reduce taxable income by up to $6,550.
- Own stocks? Consider selling those with unrealized losses or gains that you think may be at the end of their run. Winners will be netted against losers, and you can deduct up to $3,000 of net loss annually. If your net loss exceeds that limit, the excess can be carried to future years.
Tax planning will be more difficult for the profitable business owner in 2014 than in other recent years. So it’s paramount you speak to your adviser and take action now.
