News & Tech Tips

Projecting Income Can Allow Businesses to Use Timing to Their Tax Advantage

mnarog on November 14, 2012

By projecting your business’s income for this year and next you can determine how to time income and deductions to your advantage.

Typically, it’s better to defer tax. You can do so by:

  • Deferring income to next year. If your business uses the cash method of accounting, you can defer billing for your products or services. Or, if you use the accrual method, you can delay shipping products or delivering services. But don’t let tax considerations get in the way of making sound business decisions.
  • Accelerating deductible expenses into the current year. If you’re a cash-basis taxpayer, you may make a state estimated tax payment before Dec. 31, so you can deduct it this year rather than next. But consider the alternative minimum tax (AMT) consequences first. Both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid.

In 2012, taking the opposite approach might be better. If it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax. And, because individual income tax rates are scheduled to go up in 2013, if your business structure is a flow-through entity, you may face higher rates even if your tax bracket remains the same.

Congress may, however, extend current tax rates for some or all taxpayers. Keep a close eye on Washington as year end approaches so you can adjust your timing strategy as needed if tax law changes do occur.

Image courtesy of www.freedigitalphotos.net.

With Election Results In, What's Next for Tax Law Changes?

mnarog on November 8, 2012

President Obama has been reelected, the Senate will remain in the hands of the Democrats (but without a filibuster-proof supermajority) and the House will continue to be controlled by the Republicans. In other words, the political makeup of Washington will be about the same in 2013 as it is now. As a result, it’s still very uncertain what will happen with tax law changes.

When it comes to tax law, Congress and the president have much to address, including tax breaks that expired at the end of 2011 as well as the rates and breaks that are scheduled to expire at the end of this year.

The “lame duck” session is scheduled to begin next week, but Congress will soon break again for Thanksgiving. How long it will be in session from after Thanksgiving through the end of the year is up in the air.

It’s still unclear what Congress will try to accomplish in the lame duck session — and what they’ll punt to next year. (In terms of the latter, tax law changes could be made retroactive.)

The lack of change in the political makeup of Washington could make it very difficult to pass tax legislation, considering how far apart the parties are on what should be done. Yet now that both parties know the outcome of the Nov. 6 elections, they may be more willing to compromise.

Whatever happens, it could have an impact on your year end tax planning. So keep an eye on Congress before implementing year end strategies.

Image courtesy of www.freedigitalphotos.net.

Consider Tax Implications if You're Awarded Restricted Stock

mnarog on November 2, 2012

In recent years, restricted stock has become a popular form of incentive compensation for executives and other key employees. If you’re awarded restricted stock — stock that’s granted subject to a substantial risk of forfeiture — it’s important to understand the tax implications.

Income recognition is normally deferred until the stock is no longer subject to that risk or you sell it. You then pay taxes based on the stock’s fair market value (FMV) when the restriction lapses and at your ordinary-income rate.

But you can instead make a Section 83(b) election to recognize ordinary income when you receive the stock. This election, which you must make within 30 days after receiving the stock, can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly before income would otherwise be recognized. Why? Because the election allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.

There are some disadvantages of a Sec. 83(b) election:

1. You must prepay tax in the current year. But if a company is in the earlier stages of development, this may be a small liability.

2. Any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or its value decreases. But you’d have a capital loss when you forfeited or sold the stock.

If you’re awarded restricted stock before the end of 2012 and it’s looking like your tax rate will go up in the future, the benefits of a Sec. 83(b) election may be more likely to outweigh the potential disadvantages.

Image courtesy of www.freedigitalphotos.net.

Why 2012 May Be the Right Year for a Roth IRA Conversion

mnarog on October 18, 2012

If you have a traditional IRA, you might benefit from converting all or a portion of it to a Roth IRA. A conversion can allow you to turn tax-deferred future growth into tax-free growth. It also can provide estate planning advantages: Roth IRAs don’t require you to take distributions during your life, so you can let the entire balance grow tax-free over your lifetime for the benefit of your heirs.

The downside of a conversion is that the converted amount is taxable in the year of the conversion. But there are a couple of reasons why 2012 may be the right year to make the conversion and take the tax hit:

1. Saving income taxes. Federal income tax rates are scheduled to increase for 2013 and beyond unless Congress extends current rates or passes other rate changes. So if you convert before year end, you’re assured of paying today’s relatively low rates on the conversion. In addition, you’ll avoid the risk of higher future tax rates on all postconversion growth in your new Roth account, because qualified Roth IRA withdrawals are income-tax-free.

2. Saving Medicare taxes. If you convert in 2012, you don’t have to worry about the extra income from a future conversion causing you to be hit with the new 3.8% Medicare tax on investment income, which is scheduled to take effect in 2013 under the health care act. While the income from a 2013 (or later) conversion wouldn’t be subject to the tax, it would raise your modified adjusted gross income (MAGI), which could cause some or all of your investment income in the year of conversion to be hit with the Medicare tax.

Likewise, you won’t have to worry about future qualified Roth IRA distributions increasing your MAGI to the extent that it would trigger or increase Medicare tax on your investment income, because such distributions aren’t included in MAGI. While traditional IRA distributions won’t be subject to the Medicare tax, they will be included in MAGI and thus could trigger or increase the Medicare tax on investment income.

Make the Most of Depreciation-Related Breaks While You Can

mnarog on October 10, 2012

Many businesses may benefit from purchasing assets by Dec. 31 to take advantage of depreciation-related deductions that are scheduled to either disappear or become less favorable in 2013:

Bonus depreciation. For qualified assets acquired and placed in service through Dec. 31, 2012, this additional first-year depreciation allowance is, generally, 50%. Among the assets that qualify are new tangible property with a recovery period of 20 years or less and off-the-shelf computer software. With a few exceptions, bonus depreciation is scheduled to disappear in 2013.

Section 179 expensing. This election allows a 100% deduction for the cost of acquiring qualified assets, and it’s subject to different rules than bonus depreciation. On the plus side, used assets can qualify for Sec. 179 expensing. On the minus side, a couple of rules may make Sec. 179 expensing less beneficial to certain businesses:

  • For 2012, expensing is subject to an annual limit of $139,000, and this limit is phased out dollar for dollar if purchases exceed $560,000 for the year. So larger businesses may not benefit.
  • The election can’t reduce net income below zero. So for businesses that are having a bad year, it can’t be used to create or increase a net operating loss for tax purposes.

The expensing and asset purchase limits are scheduled to drop to $25,000 and $200,000, respectively, in 2013.

These depreciation opportunities, however, bring with them a challenge: Determining whether the larger 2012 deductions will prove beneficial over the long term. Taking these deductions now means forgoing deductions that could otherwise be taken later, over a period of years under normal depreciation schedules.

In some situations, future deductions could be more valuable. For example, tax rates for individuals are scheduled to go up in 2013, which means flow-through entities, such as partnerships, limited liability companies and S corporations, might save more by deferring the deductions.

Finally, keep an eye on Congress: It’s possible the current versions of these breaks could be extended or even enhanced.

Image courtesy of freedigitalphotos.net

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