As 2011 draws to a close, there is still time to reduce your 2011 tax bill and plan ahead for 2012. This post highlights several potential tax-saving opportunities for you to consider. I would be happy to meet with you to discuss specific strategies and issues.
Deferring Income to 2012
Deferring income to the next taxable year is a time-honored year-end plan. If you expect your AGI to be higher in 2011 than in 2012, or if you anticipate being in the same or a higher tax bracket in 2011 than in 2012, you may benefit by deferring income into 2012. Some ways to defer income include:
- Use of Cash Method of Accounting: By using the cash method of accounting instead of the accrual method of accounting, you can generally put yourself in the best position for accelerating deductions and deferring income. There is still time to accomplish this strategy, because an automatic change to the cash method can be made by the due date of the return including extensions. The following three types of businesses can make an automatic change to the cash method: (1) small businesses with average annual gross receipts of $1 million or less (even those with inventories that are a material income producing factor); (2) certain C corporations with average annual gross receipts of $5 million or less in which inventories are not a material income producing factor; and (3) certain taxpayers with average annual gross receipts of $10 million or less. Provided inventories are not a material income producing factor, sole proprietors, limited liability companies (LLCs), partnerships, and S corporations can change to the cash method of accounting without regard to their average annual gross receipts.
- Delay Billing: Delay year-end billing to clients so that payments are not received until 2012.
- Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.
Accelerating Income into 2011
You may benefit from accelerating income into 2011. For example, you may anticipate being in a higher tax bracket in 2012, or perhaps you need additional income in 2011 to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2011 will be disadvantageous if you expect to be in the same or lower tax bracket for 2012.
If you report income and expenses on a cash basis, issue bills and attempt collection before the end of 2011. Also see if some of your clients or customers are willing to pay for January 2012 goods or services in advance. Any income received using these steps will shift income from 2012 to 2011.
- Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses, and their dependents as an above-the-line deduction, without regard to the 7.5%-of-AGI floor.
- Equipment Purchases: If you purchase equipment, you may make a “Section 179 election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property. For 2011, you may elect to expense up to $500,000 of equipment costs (with a phase-out for purchases in excess of $2,000,000) if the asset was placed in service during 2011. Also, certain real property can qualify for the expense deduction, but—of the $500,000 limitation—only $250,000 can be attributed to qualified real property. Note that for assets placed in service in 2011, taxpayers can expense all of their business equipment purchases under a provision giving taxpayers 100% bonus depreciation. In 2012, the dollar amounts for §179 expensing are scheduled to be $139,000, with a phase-out amount of $560,000. Also, the allowance for real property does not apply for 2012. In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2011. In general, under the “half-year convention,” you may deduct six months’ worth of depreciation for equipment that is placed in service on or before the last day of the tax year. (If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.) A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the statutory dollar limit, $11,060 for 2011 (due to bonus depreciation rules), $11,260 in the case of vans and trucks (due to bonus depreciation rules). Therefore, the vehicle would qualify for the full equipment expensing dollar amount. However, for SUVs (rated between 6,000 and 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000.
- NOL Carryback Period: If your business suffers net operating losses for 2011, you generally apply those losses against taxable income going back two tax years. Thus, for example, the loss could be used to reduce taxable income—and thus generate tax refunds—for tax years as far back as 2009. Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.
- Bonus Depreciation: Taxpayers can claim 100% bonus depreciation for assets placed in service in 2011. Bonus depreciation is also allowed for machinery and equipment used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials and qualified disaster assistance property. In 2012, the bonus depreciation amount is scheduled to be reduced to 50%. A contractor using the percentage-of-completion method of determining taxable income from a long-term contract does not need to take bonus depreciation into account in determining the cost of property otherwise eligible for bonus depreciation that has a MACRS recovery period of seven years or less and is placed in service during 2010 for most property, but placed in service in 2011 for long-production-period property.
- Bad Debts: You can accelerate deductions to 2011 by analyzing your business accounts receivable and writing off those receivables that are totally or partially worthless. By identifying specific bad debts, you should be entitled to a deduction. You may be able to complete this process after year-end if the write-off is reflected in the 2011 year-end financial statements.
- Home Office Deduction: Expenses attributable to using the home office as a business office are deductible under §280A if the home office is used regularly and exclusively: (1) as a taxpayer’s principal place of business for any trade or business; (2) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (3) in the case of a separate structure not attached to the residence, in connection with a trade or business.
- Basis Adjustment to Stock of S Corporations Making Charitable Contributions of Property: Section 1367(a)(2) provides that an S corporation shareholder’s §1367(a)(2)(B) basis reduction resulting from the corporation’s charitable contribution of property equals the shareholder’s pro rata share of the adjusted basis of the contributed property. This special rule expired at the end of 2009, but the 2010 Tax Relief Act revived it and extended its availability to contributions made on or before December 31, 2011.
- Small Employer Pension Plan Startup Cost Credit: For 2011, certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new retirement plan for employees. The credit applies to 50% of qualified administrative and retirement-education expenses for each of the first three plan years. However, the maximum credit is $500 per year.
- Employer-Provided Child Care Credit: For 2011, employers may claim a credit of up to $150,000 for supporting employee child care or child care resource and referral services. The credit is allowed for a percentage of “qualified child care expenditures,” including for property to be used as part of a qualified child care facility, for operating costs of a qualified child care facility, and for resource and referral expenditures.
- Work Opportunity Credit: The work opportunity credit is an incentive provided to employers who hire individuals in groups whose members historically have had difficulty obtaining employment. The credit gives a business an expanded opportunity to employ new workers and to be eligible for a tax credit against the wages paid. Wages paid after 2011 are not eligible for the credit.
- Credit for Employee Health Insurance Expenses of Small Employers: Eligible small employers are allowed a credit for certain expenditures to provide health insurance coverage for their employees. Generally, employers with 10 or fewer full-time equivalent employees (FTEs) and an average annual per-employee wage of $25,000 or less are eligible for the full credit. The credit amount begins to phase out for employers with either 11 FTEs or an average annual per-employee wage of more than $25,000. The credit is phased out completely for employers with 25 or more FTEs or an average annual per-employee wage of $50,000 or more. The credit amount is 35% of certain contributions made to purchase health insurance.
- Differential Wage Pay Credit: The 2010 Tax Relief Act revived the differential pay credit (which had expired at the end of 2009) and extended the availability of the credit to amounts paid on or before December 31, 2011. Therefore, if an employer meets certain qualification requirements, it can take a credit against its 2011 income tax liability in an amount equal to 20% of the sum of the “differential wage payments,” up to $20,000, that the employer makes to an employee in active duty in the military.
- Subnormal Goods: You should check for subnormal goods in your inventory. Subnormal goods are goods that are unsalable at normal prices or unusable in the normal way due to damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including second-hand goods taken in exchange. If your business has subnormal inventory as of the end of 2011, you can take a deduction for any write-downs associated with that inventory provided you offer it for sale within 30 days of your inventory date. The inventory does not have to be sold within the 30-day timeframe.
Other 2011 Opportunities
- S Corporation Built-In Gains Tax: An S corporation generally is not subject to tax; instead, it passes through its income or loss items to its shareholders, who are taxed on their pro-rata shares of the S corporation’s income. However, if a business that was formed as a C corporation elects to become an S corporation, the S corporation is taxed at the highest corporate rate on all gains that were built in at the time of the election if the gains are recognized during a special holding period. While for tax years beginning in 2009 and 2010, the special holding period was shortened from 10 years to seven years, it is shortened even more for tax years beginning in 2011, to five years.
- 100% Exclusion of Gain Attributable to Certain Small Business Stock: The incentive for individuals to acquire qualified small business stock is higher before the end of 2011. An individual ordinarily may exclude 50% of the gain from qualified small business stock that is held for at least five years (subject to a cap). “Qualified small business stock” is stock of a corporation the assets of which do not exceed $50 million when the stock is issued. The 50% exclusion of gain was increased to 75% for qualified small business stock acquired after February 17, 2009, and before September 28, 2010. The 2010 Small Business Jobs Act excluded 100% of the gain for qualified small business stock acquired or issued after September 27, 2010, and before January 1, 2011, and the 2010 Tax Relief Act extended the 100% exclusion to qualified small business stock acquired before January 1, 2012. In addition, the alternative minimum tax preference item attributable to the sale is eliminated.
- Qualified Dividends: Qualified dividends received in 2011 are subject to rates similar to the capital gains rates. Therefore, qualified dividends are taxed at a maximum rate of 15%. Qualified dividends are typically dividends from domestic and certain foreign corporations. Note that the reduced dividend rates apply through 2012.
- Uncertain Tax Positions: A corporation needs to file new Schedule UTP, Uncertain Tax Position Statement, with its 2011 income tax return if it: (1) files Form 1120, Form 1120-F, Form 1120-L, or Form 1120-PC; (2) has assets of at least $100 million (a threshold amount that will drop starting with 2012 tax years); (3) issued (or a related party issued) audited financial statements reporting all or a portion of the corporation’s operations for all or a portion of the corporation’s tax year; and (4) has one or more “uncertain tax positions” (UTPs). A UTP is a tax position that will result in an adjustment to a line item on a return if the position is not sustained, provided the corporation has taken the position for the current or a prior tax year and the corporation (or a related party) either recorded a reserve for the position or did not record a reserve because it expects to litigate the position.
- Electronic Funds Transfer: As of January 1, 2011, a corporation must make its deposits of income tax withholding, FICA, FUTA, and corporate income tax by electronic funds transfer (EFT), including through the IRS’s Electronic Federal Tax Deposit System (EFTPS).
If you would like to meet to discuss specific strategies and issues regarding tax planning for 2011 as the year draws to a close click here to contact Paul.