Tax planning for year-end 2007 presents new opportunities and
challenges for small business taxpayers to reduce or defer federal
income tax liability. While traditional planning techniques remain
fundamentally important this year, new opportunities born from recent
legislation and changes in the tax laws provide significant prospects
for saving or deferring taxes in 2007 and the expiration of many
popular tax incentives may complicate planning for your business. This
letter discusses important year end tax planning strategies -- from the
tried and true techniques to new opportunities -- that can operate to
reduce the tax burden for your small business.
BUSINESS PLANNING BASICS
Tax planning strategies do not come in a one-business-fits-all package.
Tax planning is as unique and varied as today's businesses and, while
certain traditional planning opportunities can help businesses across
the board minimize or defer taxes, every plan must account for the
particular needs and circumstances of the business. Three factors that
will affect year-end planning for every business, including yours, are
the company's: business structure, accounting method, and anticipated
profits and losses for 2007 and 2008.
The structure of your business determines how business income will be
taxed. While C corporations are subject to two levels of tax, income,
losses, deductions, and credits of S- corporations, partnerships, and
limited liability companies (LLCs) are passed through to the owners and
reported on their individual income tax returns. Therefore, not only is
the structure of the business important, but with pass-through
entities, their owners' individual tax situation is particularly
significant in year-end tax planning.
The accounting method used by your business is a factor that impacts
year-end tax planning strategies. Your accounting method is important
to tax planning because it affects your ability to time and shift
income between 2007 and 2008. Whether your business operates on a cash
or accrual basis will determine when income must be recognized for tax
purposes and when expenses are deductible.
Comment. Many small businesses and sole proprietors operate on a cash
basis. Cash-basis taxpayers recognize and report income when they
actually or constructively receive cash or its equivalent (i.e.,
checks, notes, letters of credit, forgiveness of debt), and take
deductions when expenses are actually paid or transferred, regardless
of when the cost was incurred. For accrual-basis taxpayers, the right
to receive income, rather than actual receipt, determines the year of
inclusion in income. Expenses are deductible in the year in which all
events have occurred to establish the liability and the amount of the
item can be ascertained with reasonable certainty.
Cash-basis businesses that anticipate being in the same or higher tax
bracket in 2007 than 2008 can smooth out their taxable income by
deferring income to 2008 and accelerating deductions this year. To push
income into 2008, cash-basis businesses can delay billing clients or
customers (for example, wait until mid-January) for services and
products so that payment is not received until 2008. Alternatively, if
you anticipate your business's taxable income to be higher in 2008, you
may want to accelerate income in 2007 and defer deductions until next
Accrual-method businesses can defer income by delaying the shipment of
products or provision of services until the beginning of the 2008 tax
Deduction planning is an integral aspect of year-end business tax
planning. There are many important deductions beyond the Code Section
162 deduction for ordinary and necessary business expenses that may
lower a small business's tax liability.
Most small businesses are eligible for the Code Section 179 deduction,
a generous and lucrative tax break that enables businesses (especially
capital intensive businesses) to immediately deduct up to $125,000 in
2007 for equipment purchases that otherwise would have to be
depreciated over a number of years. (The 2007 Small Business Tax Act
increased the base limit from $112,000 to $125,000 for 2007.)
To qualify for the deduction, equipment must be used more than 50
percent for business purposes and must be in use by December 31, 2007.
The deduction applies to new and used equipment, as well as computer
and software purchases. Property also eligible for Code Section 179
expensing includes tangible recovery property that is Code Section 1245
property (i.e., most depreciable property other than buildings and land
improvements). If feasible, consider maximizing the deduction by using
the expensing deduction for property with the longest recovery period.
However, the Code Section 179 deduction is essentially a "use it or
lose" tax break: any unused Code Section 179 allowance can not be
rolled over into the next year.
Comment. A business cannot expense under Code Section 179 more than the
amount of taxable income and the amount of available expensing from all
its active trade and businesses. Thus, the Code Section 179 deduction
is not allowed for small business taxpayers that do not have taxable
income from any trade or business in the year in which the property is
placed in service. (But the amount of the deduction disallowed for this
reason can be carried forward to a non-loss year.) However, the expense
deduction is not barred simply because the specific business in which
the equipment is used does not produce any net income in that
particular year; the taxpayer's aggregate net income from all trades
and businesses is considered. Wages, salaries, tips, and other types of
compensation received by employees are taken into consideration for
purposes of the taxable income limit.
If your business is considering additional equipment purchases but is
close to reaching the $125,000 expensing limit this year, consider
postponing additional purchases until 2008, if possible. In 2008, you
can expense $128,000 for equipment purchases.
The Code Section 179 deduction is subject to an investment limitation.
It begins to phase-out by the amount by which qualifying property
placed in service during the tax year exceeds $500,000. (This amount
had been $450,000, but the 2007 Small Business Tax Act retroactively
raised the investment limitation for tax years beginning in 2007.) This
means that, for 2007, the maximum amount that you can expense under
Code Section 179 is reduced dollar-for-dollar for eligible property
placed in service during the tax year in excess of $500,000. For tax
years beginning in 2008, the investment limitation increases to
The Code Section 199 deduction for qualifying domestic production
activities benefits a broad array of businesses, including
construction, engineering, architecture, and farming. For 2007, the
deduction generally equals six percent of the lesser of (1) qualified
production activities income for the tax year, or (2) taxable income
that does not take the deduction into account for the tax year.
However, the deduction cannot exceed 50 percent of W-2 wages allocable
to domestic gross receipts. The deduction applies for both regular and
alternative minimum tax (AMT) liability. Code Section 199 rules are
extremely complex and calculating the deduction is complicated as
taxpayers must make numerous allocations. Our office can help you
determine the deduction you may be entitled to under Code Section 199.
Compensation and bonuses
If your company operates a qualified retirement plan, consider
maximizing 2007 contributions to the plan since the contributions are
tax deductible in the year that they are made to the plan.
Moreover, paying year-end bonuses in January or February can create a
significant compensation-based business deduction for a calendar-year,
accrual-basis corporation. For example, such businesses can deduct in
2007 a bonus paid in 2008, as long as the obligation is paid within two
and one-half months of the close of 2007. Calendar-year, accrual-basis
businesses can take a deduction in 2007 for bonuses not actually paid
to employees until 2008 as long as (1) the employee does not own more
than 50 percent in value of the business's stock, (2) the bonus is
properly accrued on the company's books before the end of 2007, and (3)
the bonus is paid within the first two and one-half months of 2008.
To further complicate planning for this year end, new nonqualified
deferred compensation rules under new Code Section 409A kick in on
January 1, 2008. These rules take in a broad array of compensation
packages and have been a surprise to many businesses. Although the IRS
has listened to the outcry of complaints and will allow retroactive
compliance with the written-compensation-plan requirements throughout
2008, it is insisting that operational compliance start as originally
planned on January 1, 2008. Penalties for noncompliance are
substantial, including the immediate acceleration of deferred
compensation into the current year for tax purposes, whether or not the
compensation is actually paid out early.
Business losses sustained during the tax year can be deducted if your
business has not been compensated by insurance or otherwise. For pass-
through entities such as S corporations, LLCs, and partnerships, losses
will be passed through and deducted on the owners' personal income tax
returns. Loss deductions can be taken for:
Casualty and theft losses;
Losses on the sale of business assets; and
Net operating losses.
If you just launched your business in 2007 and you incurred expenses
before the business actually began operating (start-up costs), you may
be able to deduct these expenses. As long as the business is up and
running by the end of 2007, you can elect to currently deduct up to
$5,000 of start-up expenses. Once start-up costs exceed $50,000, the
$5,000 limit is reduced dollar for dollar. The remainder of the costs
must be deducted ratably over a 180-month period.
Businesses should examine whether they can benefit from certain popular
tax incentives that were set to expire in 2007, but have been extended
and enhanced under the 2007 Small Business Tax Act, including the:
Work Opportunity Tax Credit;
FICA Tip Credit;
Qualified Zone Academy Bond Credit; and
Certain energy credits and deductions.
EXPIRING TAX BREAKS
Unless Congress extends them, this year will be the last chance for
businesses to take advantage of certain tax breaks set to expire in
Qualified leasehold and restaurant improvements. For property
placed in service before 2008, qualified leasehold improvements
and qualified restaurant property can be deducted over a 15-year
period (in lieu of 39 years) using the straight-line depreciation
Qualified environmental remediation costs. Taxpayers can elect to
treat qualified environmental remediation expenses paid or
incurred before 2008, that would otherwise be chargeable to a
capital account, as deductible in the year paid or incurred.
Contributions of food, books, or computer technology. Businesses
may take an enhanced deduction for contributions of food and
books through 2007. C corporations may also take an enhanced
deduction for contributions of computer technology or equipment
donated to schools or libraries before 2008.
Research credit. The incremental research credit may be claimed
for increases in business-related, qualified research
expenditures and for increases in payments to universities and
other qualified organizations for basic research. Research funded
by a person other than the taxpayer is not eligible for the
credit. The credit may not be claimed for expenses paid or
incurred after December 31, 2007, but credits from previous years
may be carried forward.
The alternative minimum tax (AMT) is not a challenge reserved solely
for individual taxpayers; it may affect your small business as well.
While it is anticipated that Congress will enact another round of
temporary AMT relief before year's end, whether such relief will come
in the form of another "patch" or more comprehensive reform is
The 2007 AMT exemption amount for corporations is $40,000, subject to
an income-based phase-out. The AMT income tax rate for businesses is a
flat 20 percent rate. The AMT method requires calculation of
alternative minimum taxable income (AMTI), which is determined by
adjusting the corporation's regular taxable income by certain
adjustments, preference items, and an exemption amount. The AMTI is
multiplied by 20 percent to determine the tentative minimum tax. The
AMT equals the excess, if any, of the tentative minimum tax over the
regular tax for the tax year. The AMT is reduced by AMT foreign tax
Small corporations that meet an annual average gross receipts test
(GRT) under Code Sec. 55(e) are exempt from the AMT. To qualify under
the GRT, a corporation's average annual gross receipts for all three-
tax-year periods beginning after 1993 and ending before the current
year can not exceed $7.5 million. Computing the AMT is complicated and
time-consuming. For help determining your business's potential AMT
liability, please call our office today.
Most tax laws are based on the calendar year. Once December 31 passes,
the opportunities to reduce your business's income taxes for the year
significantly diminish. Virtually every business can benefit from a
year-end tax plan. Please call our offices early enough to receive
assistance in customizing a plan for your business.