business owner issues and depreciation deductions

Transcription

1 business owner issues and depreciation deductions Individuals who are owners of a business, whether as sole proprietors or through a partnership, limited liability company or S corporation, have specific tax planning opportunities available to them.

2 tax advantages for business owners If you are a self-employed individual, or own an interest in an operating business through a partnership, limited liability company ( LLC ), or S corporation, there may be additional tax planning opportunities available to you. Unlike a salaried employee, your business deductions can offset your adjusted gross income rather than be treated as itemized deductions subject to various limitations and disallowances. This chapter deals with some of the tax planning ideas that you should consider. timing of income and deductions If you are a cash-basis business, you can delay billing until January 2012 for services already performed, thereby deferring your tax until next year. Alternatively, if you expect to be in a higher tax bracket next year, or the AMT applies this year, you can accelerate billing and collections into the current year to take advantage of the lower AMT tax rate. Similarly, you can either prepay or defer paying business expenses so that the deduction comes in the year that you expect to be subject to the higher tax rate. This can be particularly significant if you are considering purchasing (and placing in service) business equipment, as the next section discusses. If you are concerned about your cash flow and want to accelerate your deductions, you can charge them on your credit card. This will allow you to take the deduction in the current year, when the charge is made, even though you may actually pay the outstanding credit card bill after December 31, Another advantage of deferring income or prepaying expenses is that you can defer the 2.9% Medicare component of your self-employment taxes. If your self-employment income plus wages are below $106,800 (in 2011), you can also reduce the Social Security tax. taxable years beginning in However, this rule only applies if the total amount of qualifying property placed in service in 2011 does not exceed $2,000,000. There is a partial deduction between $2,000,000 and $2,500,000. For tax years beginning in 2012, a $139,000 deduction limit and a $560,000 investment limit apply. Section 179 expensing is also available for qualified real property placed in service during tax years beginning in Qualified real property is defined as qualified leasehold improvements, qualified restaurant property and qualified retail improvement property. The maximum amount allowed as Section 179 expense under these rules is $250,000. The $250,000 amount will reduce the gross Section 179 amounts allowed during the year. Example: The Section 179 expense limitation amount for 2011 is $500,000. Assuming all of the requirements are met to expense the full $250,000 of qualified real property, the balance, or $250,000, will be available to be taken on tangible personal property placed in service that year. Computer software continues to be eligible for Section 179 expensing as long as it is placed in service prior to increase of first-year depreciation on qualified autos Depreciation deductions can be claimed on passenger autos used in business subject to certain limitations. The maximum amount of first-year depreciation allowed for passenger automobiles placed in service in 2011 and used 100% in business has increased to $11,060 (as indexed for inflation). The maximum amount is reduced based upon the percentage of business use. Example: T uses a vehicle 80% for business and 20% for personal activities. T is allowed a maximum first-year depreciation in 2011 of $ 8,848. To qualify, autos must be new and placed in service during business interest business owner issues and depreciation deductions 25 business equipment Significant tax benefits are available for immediate expensing of business equipment purchases. 100% bonus depreciation applies for qualified property placed in service on or after September 9, 2010 and on or before December 31, The 50% bonus depreciation is effective for qualified property placed in service in Section 179 expensing rules allow you to fully deduct up to $500,000 of qualifying property placed in service during If you have debt traced to your business expenditures including debt used to finance the capital requirements of a partnership, S corporation or LLC involved in a trade or business in which you materially participate you can deduct the interest as business interest rather than as an itemized deduction. The interest is a direct reduction of the income from the business. This lets you deduct all of your business interest, even if you are a resident of a state that limits or disallows all of your itemized deductions. Business interest also includes finance charges on items that you purchase for your business (as an owner) using your credit card. These purchases are treated as additional loans to the business,

3 EisnerAmper 2012 personal tax guide 26 subject to tracing rules that allow you to deduct the portion of the finance charges that relate to the business items purchased. home office deductions When you use part of your home for business, you may be able to deduct the business portion of the costs of running your home, such as real estate taxes, mortgage interest, rent, utilities, insurance, painting, repairs and depreciation. The home office deduction is available to both renters and homeowners, but is subject to an overall limitation that will prevent you from deducting a net loss from your home office. Generally, you must meet the following two requirements to qualify for the home office deduction: You must regularly use part of your home exclusively for a trade or business. Incidental or occasional business use is not regular use. Exclusive use means a specific area of your home is used only for trade or business activities. The home office must be your principal place of business. This requirement can be satisfied if the home office is used for the administrative or management activities of your business if there is no other fixed location where you can conduct these activities. If you deduct depreciation for a home office in your principal residence, your ability to fully use the taxable gain exclusion on the sale of a principal residence will be limited. This is because the portion of the gain attributable to your home office is not eligible for this exclusion. Expenses that are deductible only because the home is used for business (such as the business portion of home insurance and utilities) are limited to the gross income derived from the use of the home. Unused deductions are carried over to the subsequent year but are subject to the limitations calculated in that year. Expenses that would have been deducted anyway, such as real estate taxes and qualified home mortgage interest, are not subject to these rules. capitalize the costs on a timely filed federal income tax return (including extensions). If electing to capitalize, the start up costs are amortized over 180 months. The election to either deduct or capitalize start-up costs is irrevocable and applies to all start-up costs of the taxpayer. The regulations became effective on August 17, 2011 and apply to expenses paid or incurred on or after August 16, Start-up costs in excess of the amount allowed as a current deduction must be amortized over 180 months. ORGANIZATION COSTS The amount allowed as a current expense for organization costs is $5,000. The excess amount must be amortized over 180 months. Similar to the changes noted above, recently issued IRS regulations provide that the election is automatic. Affirmatively electing to amortize the organization costs on a timely filed return (including extensions) will be considered as opting out of the expense election. self-employed health insurance deduction As a self-employed individual, you can deduct 100% of the health insurance premiums you pay for yourself, your spouse, and your dependents. This applies if you are a general partner in a partnership, a limited partner receiving guaranteed payments, or a more than 5% shareholder who receives wages from an S corporation. You can also include the premiums paid for longterm care insurance policies as deductible self-employed health insurance (subject to certain age limitations). To take the deduction, your self-employed earnings, net of the 50% deduction for self-employment tax and any SEP or qualified retirement plan contributions, has to be equal to or greater than the health insurance deduction. Note: If you were eligible to participate in any subsidized health plan maintained by your employer or your spouse s employer for any part of the year, you can not deduct any self-employed health insurance premiums for that portion of the year. start-up expenses The amount of capitalized business start-up expenses eligible for deduction in the year the active business commences (instead of amortization over 180 months) is $10,000, with a phaseout beginning at $50,000. The IRS recently issued final regulations that provide for the time and manner of making the election to amortize capitalized start-up expenses. The election to expense is automatic, and does not have to be formally made. However, taxpayers wishing to elect out, must affirmatively elect to utilize business losses or take tax-free distributions If you have an interest in a partnership, LLC or S corporation, you can deduct losses from the entity only to the extent you have tax basis and are at risk for the losses. If you have a loss from any of these entities that will be limited, you may want to make a capital contribution (or a loan) before year-end to allow you to deduct the loss. However, losses may still be limited by the passive activity loss rules.

4 You can take tax-free distributions from a partnership, LLC or an S corporation if you have tax basis in the entity and have already been taxed on the income. Since you are taxed on your share of the income of these entities, regardless of whether or not distributions were made, you may have paid tax in a prior year, or will pay tax in the current year, on income that you have not received. Therefore, you can now take a distribution without paying additional tax, if funds are available and the entity permits such distributions, to the extent of your tax basis and at-risk amount in the entity. However, there are special considerations for distributions from S corporations. self-employment tax cell phone, the employee receives a taxable fringe benefit to the extent of the employee s personal use. This rule, as well as the related onerous depreciation and substantiation rules, has been repealed for tax years beginning in net operating loss carrybacks Under the Worker, Homeownership, and Business Assistance Act of 2009, net operating losses generated in a taxable year ending after December 31, 2007 and beginning before January 1, 2010 were subject to an election to carryback such losses for up to five years. Net operating losses generated after January 1, 2010 are only allowed the normal two-year carryback period. business owner issues and depreciation deductions 27 Your net earnings from self-employment are subject to Social Security and Medicare taxes. As a self-employed individual, your share of these taxes almost doubles since you pay both the employer s and employee s portions of these taxes. However, if you are also a salaried employee, your wages will offset the portion of your self-employed earnings subject to the Social Security tax. The self-employment tax rate is 13.3% in 2011, which consists of 10.4% Social Security tax and 2.9% Medicare tax. The maximum amount of combined wages and self-employment earnings subject to 10.4% Social Security tax is $106,800 in 2011 and $110,100 in There is no limitation on self-employment income subject to the Medicare tax. See the chapter on tax rate overview. Because of these taxes, your federal effective tax rate on selfemployment income can be as high as 48%, compared to about 42% for income from wages (after including your employee share of Social Security and Medicare taxes). The reason it s not a greater spread is primarily because you receive a deduction against adjusted gross income for 50% of the self-employment tax you pay. pension and profits sharing plans Rules governing contributions to, and distributions from, retirement plans are very complex, so an entire chapter is dedicated to this discussion. You should refer to that chapter for more specific information and various plan restrictions. employer-provided cell phones rules changed Under prior law, if an employer provides a cell phone to an employee for business use, and pays the costs of using the deferral of cancellation of indebtedness income under the american recovery and Reinvestment act of 2009 Under the general rules for cancellation of indebtedness income ( COD ), if a loan is settled for less than the original amount owed, such as where a debt is forgiven, significantly modified, exchanged for new debt or repurchased by the debtor, taxable income is generated to the extent of the debt reduction. The debtor can exclude this income in certain situations, including to the extent of insolvency or to the extent of debt discharged under Title 11 (Bankruptcy). The debtor is required to reduce certain tax attributes to the extent of the debt excluded from income. The tax attributes reduced include net operating losses, general business credits, basis for depreciable and non-depreciable assets, and unused foreign tax credits. A provision was added in the American Recovery and Reinvestment Act of 2009 that provides a debtor the ability to elect to recognize COD income ratably over a five-year period. Under the new rules, a debtor can elect to recognize and report COD income from a reacquisition of an applicable debt instrument that occurs after December 31, 2008 and before January 1, For reacquisitions occurring in 2010, the COD income is reported ratably over five-tax years starting in A reacquisition is defined as an acquisition of the debt instrument by the debtor (or related party) that issued the debt. An acquisition includes a cash purchase of the debt, exchange of new debt for old debt, an exchange of debt for corporate stock or a partnership interest, contribution of the debt to capital or forgiveness of the total debt. An applicable debt instrument is defined as a debt instrument issued by a C corporation or any other person in connection with

5 EisnerAmper 2012 personal tax guide 28 a trade or business. Note that personal debt or debt incurred to acquire personal investments do not qualify. The election is made on a debt-by-debt basis and is irrevocable once made. This election should be considered where the debtor does not qualify for the COD income exclusions. Keep in mind that if the election is made to recognize the COD income over the five-year period, the normal COD income exclusions for insolvency or bankruptcy will not apply, nor will the tax attribute reduction rules. Partnerships or S corporations are required to make this election where the debt is at the pass-through entity level.