Business Tax Planning

We are beginning a periodic series on business tax planning so all readers will have a better roadmap for their own personal successes. We will attempt to cover several topics in the coming few months, beginning with this month’s feature on basic tax planning tactics. While every taxpayer is unique, there are a few rules that apply to most business owners and individuals. Here they are:

Legally avoid the recognition of income (such as not paying taxes on municipal bond income in many instances, being able to rent a property for a few days every year with no income tax consequences, etc.).

Deferring tax by deferring income (such as waiting to bill clients for December’s work until January to defer the taxes on this income until the following tax year).

Deferring taxes by accelerating deductions (such as prepaying mortgage expenses in December to get the deduction in the current year).

Use of the proper business entity (such as the choice between a C and S corporation).

Use of the proper tax year (such as selecting the year end for a C corporation of June 30 to provide planning opportunities).

Spreading income to utilize different tax rates (such as gifting certain dividend paying stocks to a child to gain the benefit of a lower tax rate for the child).

Converting ordinary income to capital gains (especially if the holding period is more than one year- the difference can be as much as 20% plus state tax rates).

Selecting a proper accounting method for your business (cash vs. accrual vs. hybrid).

Medical Expenses and Tax Deductions

We often get questions as to the deductibility of medical expenses by non-business taxpayers (business taxpayers have more opportunities to claim tax deductions because they can utilize a medical reimbursement plan or other tax savings methods for their employees). In order to claim a deduction on your personal tax return (Schedule A- Itemized Deductions), you must make sure that the expense relates to the cost of diagnosis, cure, treatment, mitigation or prevention of any specific disease. You are not permitted a deduction for general health benefits (even if prescribed by your physician) and expenses done solely for cosmetic reasons.

Here are some medical expenses you should consider:

(1) doctor bills (such as for a physician, chiropractor, dentist, Christian Science practitioner, and psychiatric service fees)

(2) any medical equipment/supplies (wheelchair, braces, crutches, ambulances, eyeglasses, splints, oxygen equipment, etc.)

(3) medical treatments (childbirth, injections, vasectomy, insulin, abortion, acupuncture, etc.)

(4) premiums (health insurance, blue cross, etc.)

(5) Hospital Services (room and board, emergency and operating room fees, etc.)

(6) Medicine and Drugs (prescriptions only)

(7) laboratory tests (blood, urine, X-Rays, etc.)

(8) miscellaneous (alcohol/drug treatment, birth control, travel to medical facility (your mileage is tax deductible here), organ donor costs and expenses, lifetime care payments for retirement home, dog/Braille for blind individuals, special telephones for deaf individuals, stop-smoking programs, special schools for handicapped individuals, childbirth classes, education costs for handicapped children, etc.). As long as the expense is for a legal medical procedure (do not try to deduct illegal drugs!), you should be safe in claiming it.

Please also recall that the recent Health Care bill made some changes to what can be claimed as tax deductions in future years. We will report on these changes and how to plan for them as we get closer to the implementation date for this new law.

June Tax Tip

A recent Tax Court case, McNair Eye Center v. Commissioner, T.C. Memo 2010-81, has held that reliance on a CPA is NOT a valid defense to the failure to file employment taxes. In this case, Dr. McNair hired a CPA in 2004 to tax care of all tax filing matters, including payroll taxes. The CPA failed to prepare or file the tax returns, and also failed to make tax deposits of the amounts withheld from the employees’ wages. Unfortunately, Dr. McNair did not realize these failures until the CPA left his employment in 2006.

The IRS assessed penalties for the failure to deposit the withheld taxes, the failure to file the tax returns timely and the failure to pay the amounts due on the tax returns. The Tax Court upheld all three penalties, noting that the duty to file a tax return rests with the taxpayer and cannot be delegated to a third party for purposes of the late-filing penalty. The Court also noted that it was Dr. McNair’s responsibility to check on the CPA and make sure that all work was being done properly, especially given that the CPA was hired after Dr. McNair had already had problems with the filing and paying of these tax returns. The Court held that the failure to monitor the tax filings and the progress of paying was an indication of the lack of “ordinary business care and prudence” such that all of the penalties were appropriate.

This case should make it very clear to all taxpayers that the duty to file is theirs alone and cannot be delegated. Thus, it is important to keep tabs on any tax professional that you hire, either for you personally or your business.

Q&A: IRA Distributions

Question: I am 74 years old and I did not take any distributions from my IRA in 2009. Do I need to take any in 2010?

Steven, Anaheim, CA

Answer: Yes. Congress waived any Required Minimum Distributions (RMD) for 2009 due to the economy but this rule was NOT extended to 2010.

Thus, for 2010, all taxpayers who are over Age 70 1/2 must take out the RMD. Hopefully, your IRA trustee or custodian has provided these calculations to you so you know what your RMD actually is for 2010. If you have not yet received this information, please contact your custodian so that any RMD can be taken by the end of 2010 as the law requires.

Q&A: Youth and IRA Contributions

Question: My 16 year old son is working this summer and I wondered if he can contribute to an IRA?

Steve H., Denver, CO.

Answer: Steve, your son is in luck, as he can contribute up to $5,000, or the amount of his earnings, whichever is less. You can even gift this amount to him, although this will count against the $13,000 annual gift amounts.

If a 16 year old contributes $5,000 to his Roth IRA (the most attractive IRA for younger workers) this year, it would be worth $137,650 when he turns 65 and $193,061 at age 70, assuming an annual rate of return of 7% per year and no future contributions (i.e. only the initial $5,000 contribution). A Roth IRA is tax free when withdrawn and the funds can also be used for other purchases, such as a first home.

Q&A: Buying Assets

Question: I own a small business outside of Chicago and I was wondering if leasing or buying assets for my business is better from a tax perspective.

Lou, Palatine, IL

Answer: Lou, there are certain situations in which leasing makes sense over buying and here are some general rules and guidelines for you:

With a short-term lease (often three years or less for most business property), you get a faster write off using a lease than depreciating property over the 5 or 7 year useful life cycles.

With a lease you do not need to worry about resale value (especially if equipment is becoming obsolete, such as the computer industry and the rapid changes with technology).

If your company only needs the equipment for a short period of time, leasing makes sense, as you would not need to worry about reselling the equipment if you bought it.

It is more cost effective to lease in that you can typically put down a small % of the asset’s value rather than having to use up valuable capital to make an asset purchase.

The lease transaction may not need to appear on your balance sheet such that your financial ratios will appear better if your business is in the market for financing.

There are, of course, some advantages to buying and actually owning an asset. For instance:

You can elect to expense, under Section 179, up to $250,000 of equipment purchases in 2010. This applies when the equipment is placed into service and not when it is actually paid for.

The low current interest rates (relative to recent history) makes buying very favorable right now.

You can take advantage of any appreciation in an asset with a purchase that is not available for a lease.

The decision whether to lease or own can be quite complicated and hopefully these general guidelines will assist in the decision-making process.