Tax savings for small businesses
This tax season, small businesses could really use a break.
But in the mad dash to file their returns, many will probably overlook some valuable tax breaks — a yearly blunder akin to passing up free money from Uncle Sam, said Dan Gibson, a certified public accountant with accounting firm EisnerAmper.
"These aren’t nickel-and-dime types of things. People could potentially save thousands of dollars," said Gibson, who advises small businesses at the firm’s Bridgewater office.
Your Business spoke with Gibson about some of the most overlooked tax breaks.
- The manufacturer's deduction: Don’t be deceived by the name. Created in 2004 to spur domestic production, this incentive applies not only to manufacturing but also construction, engineering, architecture, software development and even film production. Almost any company that plays a role in creating a U.S.-manufactured product — like an architecture firm that draws up plans for a building, for instance — can get an uncapped 6 percent tax deduction on qualifying income. That is slated to increase to 9 percent for 2010.
- Research & development credits: This isn’t just for scientists in white lab coats anymore. In recent years, the scope of R&D credits has expanded to include almost any business that can prove it is trying to create a product or improve an existing process. Business expenditures like salaries and supplies can be transformed into tax credits, which are better than deductions because they provide dollar-for-dollar reductions on taxes.
- Cost-segregation studies: Any company that constructs a new building usually deducts the cost of the structure over a set 39-year depreciation life. A cost segregation study helps concentrate more deductions in the first few years by singling out parts of the building for 5-, 7- and 15-year depreciation lives. A major downside is that the studies can cost from $8,000 to $12,000, but businesses ultimately save by recovering costs more quickly.
- IC DISCs (interest-charge domestic international sales corporations): Forming a paper company might sound a bit dubious, but it’s actually a perfectly legal way for export businesses to score a 20 percent tax rate savings. The IRS allows exporters to form an IC DISC — a separate, nontaxable corporation — to act as middleman between the company and overseas buyers. The IC DISC charges the mother company a tax-deductible sales commission, then returns that money to shareholders in the form of dividends, which are taxed at 15 percent instead of the usual 35 percent for income. Because it can be expensive to form an IC DISC, this strategy only makes sense for companies with more than $2 million in annual foreign sales.
- Cash basis of accounting: Service-based businesses that still use the accrual basis of accounting — the standard method — may be asking for trouble when it comes to tax time. Under this system, a company registers income when a sale occurs, not when the actual payment is received. Thus many businesses that operate on invoices are paying tax on income they haven’t actually received yet. Switching over to a cash basis of accounting ensures a business always has enough cash to pay its taxes. Because accounting methods are usually set in the first year of business, many companies are unaware they can switch.
- Retirement plans: Many family-owned businesses don’t realize that hiring relatives without giving them retirement plans is like taking money out of one pocket and putting it in the other. Creating 401(k) or profit-sharing plans — which combined grant up to $49,000 in deductions — ensures at least some of the money you dole out to them is nontaxable. In addition, defined benefit plans, while more complex and costly to create, can grant up to $400,000 in deductions. The drawback: If your company grows, you must offer the benefit to other employees, too.
- Incorporate as an S corporation: This is another easy trick that seems almost too good to be legal. Business owners can incorporate as an S corporation, which allows them to draw some of their pay as distributions instead of salary, avoiding the 7.65 percent in FICA and Medicaire payroll taxes. But be careful not to abuse this strategy. Owners still need to pay themselves a "reasonable" base salary, complete with payroll taxes — or risk giving the IRS a reason to interfere and pitch a higher number.
- Form an LLC (limited-liability company): Startups funded by a third party should consider forming an LLC. Unlike S Corporations, LLCs allow business owners to take losses, and therefore earn tax deductions on those losses, as long as the loan is guaranteed by the owner.
- Depreciation for equipment: Incentives for buying new equipment have gone up and down in recent years. Under the current version of the Section 179 deduction, businesses can deduct up to $250,000 for equipment in the first year of purchase, as long as the total cost does not exceed $800,000.
This allows companies to accelerate the cost recovery of equipment, which normally depreciates over five to seven years. For 2010, that deduction goes down to $134,000 for up to $530,000 worth of equipment.