2010 year-end tax planning challenges and opportunities for businesses

2010 year-end tax planning involves consideration of tax laws going into effect in 2011 as much as it involves tax provisions effective this year. Some tax incentives that expired for businesses at the end of 2009 have been resurrected for 2010 (and 2011 in some cases), including bonus depreciation and small business expensing. However, with higher tax rates set for 2011, traditional planning techniques, such as acceleration and deferral, may require more thought this year especially. This article explores some planning opportunities, challenges, and issues presented by year-end tax planning for 2010.

Accelerating income/deferring deductions

Every year, businesses can take advantage of a traditional planning technique that involves alternatively deferring income and accelerating deductions. However, business taxpayers such as passthrough entities (limited liability companies, partnerships, S corporations, sole proprietorships) should consider accelerating business income into the current year and deferring deductions until 2011 (and perhaps beyond) in light of the scheduled 2011 tax rate increases (the top two income tax brackets are set to rise from 33 and 35 percent to 36 and 39.6 percent respectively). Since pass-through entities generally pay tax at the individual income tax rate level, and those levels are expected to rise, this may be a significant factor affecting this year’s planning.

For example, limited liability companies, partnerships, and S corporations can avoid or minimize the impact of the scheduled 2011 rate increases by accelerating certain business transactions and thus income into 2010 (and deferring deductions until next year). For instance, if your business is planning to sell certain property, you may want to close the sale in 2010 to avoid the higher 2011 rates. Not only are the ordinary income tax rates scheduled to rise, but too are the capital gains rates. Thus, this strategy can generally help regardless of the type of income generated since rates in both categories are going to rise next year.

The strategy of accelerating income and deferring deductions may apply to a number of transactions affecting your business, including leasing, inventory, compensation and bonus practices, depreciation and expensing. Pass-through entities need to be particularly sensitive to the scheduled 2011 income tax rate increases and therefore plan accordingly.

Cash basis businesses that expect to be in the same or a higher tax bracket in 2011 should consider moves to shift income into 2010 by accelerating cash collections this year, and deferring deductions until next year. Thus, delay payment of certain expenses until next year, where possible, since deductions are allowed when the expenses are actually paid. If you have outstanding accounts receivable, collect on those payments due to your business in 2010.

Accrual method businesses that anticipate being in higher rate brackets next year may want to accelerate the shipment of products or provision of services into 2010 so that your business’s right to the income arises this year.

Take advantage of increased small business expensing

For 2010 and 2011, businesses can benefit from enhanced Code Sec. 179 small business expensing. Congress increased the amount of qualifying property that business that immediately expense to $500,000 (up from $250,000) for tax years beginning in 2010 and 2011. This amount is reduced dollar for dollar to the extent the cost of the qualifying property placed in service during the year exceeds $2 million (increased from $800,000). The increase in the expensing cap from $800,000 to $2 million for 2010 (and 2011) effectively opens up the availability of Code Sec. 179 expensing to many more businesses. If you have bought qualifying property – even computer software qualifies – or plan to buy property, consider doing so now to take advantage of the immediate tax benefit. You can also do so again in 2011, when tax rates are expected to be higher.

Also included in the definition of qualified Code Sec. 179 property (only temporarily though) is qualified real property, which is defined as qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. However, businesses are limited to expensing of up to $250,000 of the total cost of these properties. The dollar cap applies to the aggregate cost of qualified real property.

Bonus deprecation

Bonus depreciation is not limited by the size of the business, unlike practical access to Code Sec. 179 “small business” expensing.  It is valuable because there is no limit on the total amount of bonus depreciation that may be claimed in any given tax year. Bonus depreciation allows taxpayers to immediately deduct 50-percent of the cost of qualifying property purchased and placed in service in 2010. Unlike Sec. 179 expensing, bonus depreciation is only available for 2010. Qualifying property must be purchased and placed into service on or before December 31, 2010.

Before Congress passed the 2010 Small Business Act, 50 percent bonus depreciation applied to property acquired after December 31, 2007, and placed in service before January 1, 2010. Certain property with a longer production period was eligible for an extended placed-in-service deadline before January 1, 2011.

The 2010 Small Business Act extends 50 percent bonus depreciation for qualified property placed in service before January 1, 2011. Bonus depreciation applies to new property (property whose original use begins with the taxpayer) that is depreciable under MACRS and has a recovery period of 20 years or less, is MACRS water utility property, is off-the shelf computer software depreciable over three years under Code Sec. 167(f), or is qualified leasehold improvement property. There is also an extended place-in-service date through December 31, 2011 for property with a longer production period.

Increased start-up expense deduction

New businesses can take advantage of the increased deduction for start-up expenditures. For 2010, the start-up expense deduction limit has been raised from $5,000 to $10,000. The phaseout threshold is also increased to $60,000 (up from $50,000). Thus, if you have incurred during 2010 costs relating to the creation of an active trade or business, or the investigation of the creation or acquisition of an active trade or business, you may be able to benefit from this increased deduction. Entrepreneurs can recover more small business tart-up expenses up-front, thereby increasing cash flow and providing other benefits.

Payroll tax exemption

Employers that hire certain unemployed individuals after February 3, 2010, and before January 1, 2011 may qualify for a 6.2-percent payroll tax incentive. The incentive exempts businesses from paying the employer’s share of Social Security taxes on wages paid to qualified new hires after March 18, 2010 and before January 1, 2011. Some employers mistakenly believe that they cannot claim the incentive unless they had previously laid off employees. This is incorrect. The payroll tax exemption can apply to wages paid to any qualified employee.

Not every new hire may qualify for the incentive. Generally, a qualified employee is an individual who was unemployed or who was employed but worked 40 hours or less during the 60-day period ending on the date of new employment. The individual also must not have been hired to replace another employee of that employer, unless the other employee separated from employment voluntarily or was terminated for cause. Certain family members of the employer or employees who are related in other ways to the employer are not qualified employees for purposes of the payroll tax exemption.

Worker retention credit

Related to the payroll tax exemption is a new but temporary worker retention credit. An eligible employer may claim the credit for each new hire who meets certain retention requirements. A retained worker is a qualified employee (as defined for purposes of the payroll tax exemption) who remains an employee for at least 52 consecutive weeks, and whose wages (as defined for income tax withholding purposes) for the last 26 weeks equal at least 80 percent of the wages for the first 26 weeks. The amount of the credit is the lesser of $1,000 or 6.2 percent of wages (as defined for income tax withholding purposes) paid by the employer to the retained worker during the 52 consecutive week period. The credit may be claimed for a retained worker for the first taxable year ending after March 18, 2010 for which the retained worker satisfies the 52 consecutive week requirement.

Code Sec. 199 deduction

Often overlooked is the Code Sec. 199 domestic production activities deduction. The deduction is targeted to U.S. taxpayers engaged in manufacturing activities. The definition of manufacturing is broad for purposes of the deduction but its under-utilization may be due to the complexity surrounding the deduction. Generally, the maximum Code Sec. 199 deduction is equal to a percentage of the lesser of either the taxpayer’s qualified production activities income (QPAI) or taxable income. The maximum deduction for 2010 is, for most taxpayers, nine percent. The deduction is, however, limited to 50 percent of the W-2 wages actually paid to employees and reported by the employer. Additionally, certain businesses, such as oil producers, must reduce their Code Sec. 199 deduction.

Code Sec. 45R credit

Small employers offering qualified health insurance coverage to their employees may be eligible for a new tax credit. The Code Sec. 45R credit is generally available to small employers that pay at least half the cost of qualified coverage. For the 2010 tax year, the maximum credit is 35 percent of premiums paid by eligible employers (nonprofit employers may be eligible for a reduced credit of 25 percent). The maximum credit goes to employers with 10 or fewer full-time equivalent (FTE) employees paying average annual wages of $25,000 or less. The credit is completely phased out for employers with more than 25 FTEs or with average annual wages of more than $50,000.

The Code Sec. 45R credit has many restrictions. For example, many small businesses may employ family members of the owner(s). Certain family members are excluded from the definition of employee for purposes of the Code Sec. 45R credit. A sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses also are not considered employees for purposes of the credit.

General business credit

The 2010 Small Business Act made some taxpayer-friendly changes to the Code Sec. 38 general business credit. The eligible small business credits of an eligible small business (ESB) determined in the first tax year of the business that begins in 2010 may be carried back five years and forward for 20 years. An ESB is a corporation the stock of which is not publicly traded; a partnership; or a sole proprietorship (Code Sec. 38(c)(5)(C), as added by the 2010 Jobs Act). Additionally, the ESB must have average annual gross receipts for the three-tax-year period before the tax year of $50 million or less. The provision is intended to encourage ESBs to accelerate their business expenditures to 2010.

Energy tax incentives

A variety of tax incentives are available to encourage businesses to invest in energy conservation, energy efficiency and the production of alternative energy. Taxpayers generally have through December 31, 2013 to place in service biomass, marine and other types of renewable energy property to claim the renewable energy production tax credit (although the placed in service date for wind facilities is through December 31, 2012). Additionally, taxpayers that place in service qualified renewable energy property may elect to claim the investment tax credit in lieu of the production tax credit. Taxpayers may also be eligible to apply for a grant instead of claiming the investment tax credit or the renewable energy production tax credit for property placed in service in 2010.

Additional planning techniques

There are a number of other year-end tax planning strategies you may want to consider utilizing for 2010. These include potentially changing your accounting method to advance income or defer expenses (however, accounting method changes can have a binding elect on taxpayers for future years); accelerating installment sale proceeds or electing out of the installment method; electing slower depreciation methods, deferring payments of accrued bonuses; and determine if you can write-off any bad debts.


About Don James, CPA/PFS, CFP
Don is the Tax & Financial Planning partner with Kiplinger & Co., CPAs headquartered in sunny Cleveland, Ohio since 1982. He partners with business owners and families and specializes in goal achievement solutions, tax minimization strategies and serves in the role of gatekeeper of sound financial advice.

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