Issue 16 - December 2004

A year-end finale to 2004 tax savings
By Mark E. Battersby

Death and taxes are two certainties in life. Another is that to reduce this year’s tax bill, you have to act before December 31.

Fortunately, year-end tax planning can have a significant impact on that April 15 tax bill — and many tax bills down the road.

The goal of year-end tax planning is to time income to fall in years when it will be subject to the lowest tax bite and to time deductible expenses to fall in years when they will offset income subject to a higher tax rate.

Six steps are involved in tax planning:

1. Record essentials. Maintain accurate and up-to-date business records. The type of income revealed by these records is vitally important in the planning process.

By separating different types of income (e.g., general receipts from gains resulting from the sale of assets) either you or the practice will pay a lower rate of tax on capital gain and, perhaps, sidestep Social Security (self-employment) tax payments on certain income items.

Break down the practice’s expenses as well. This may involve breaking out deductible business expenses, capital purchases and personal expenses.

2. Prepay and defer. Deferring income into next year may provide tax benefits. But, deferrals must be legitimate.

If you use the cash method of accounting, you may be able to legitimately prepay some business expenses. With the cash method of accounting, most expenses are deductible in the year they are paid. All that is required may be a business purpose for the prepayment (e.g., locking in a price, anticipating a scarcity, etc.).

You might also benefit from delaying income until next year. Deferring income does not mean leaving checks uncashed or receipts in a drawer until January. All income actually received during the tax year is taxable under the constructive receipts rule.

The way to defer income is to delay billing, forego advance payments or make a sluggish collection effort.

3. Benefit from hard-hitting events. Year-end planning can help you benefit from hard-hitting events, such as acts of nature, theft or other casualties.

Keep in mind that a loss from theft or embezzlement is generally deductible for the tax year in which the loss is discovered.

If you were hit by the hurricanes or other natural disasters determined by the President of the United States to warrant federal assistance, a special timing rule exists to help cushion the loss. You can elect to deduct a 2004 disaster loss in 2003 but the decision must be made before the due date of the 2004 tax return. The loss is claimed by filing an amended 2003 return.

4. Take advantage of lingering tax write-offs. You may be able to continue to benefit from a significant, but temporary, increase in the amount that you can write off as a Section 179 expensing election. Also include in your planning a similar doubling of the ceiling for eligible equipment purchases before a phase-out occurs.

Take advantage of another temporary increase in the first-year “bonus” depreciation allowance, from 30 percent to 50 percent of the cost of qualifying business property. Planning may enable you to achieve even greater benefits, if you exceed the Section 179 limits. Increase the maximum first-year write-off by expensing purchases of used assets and assets with lengthier depreciable lives and saving the bonus depreciation for any qualifying purchases not picked up by Section 179 to increase the maximum first-year write-off.

In another area, if you have a closely held incorporated practice, you now have an option when taking profits from your practice. Compen-sation will still be deductible at the corporate-level, but dividends will not.

One planning strategy might involve finding a method other than compensation to reduce the incorporated chiropractic practice’s tax bill — such as retirement plan contributions and interest deductions.

5. Use tax credits. A tax credit is defined as a dollar-for-dollar reduction in the amount of tax owed.

What qualifies as a general business tax credit?

• Disabled access credit. Any eligible small business is entitled to a nonrefundable, disabled access income tax credit for expenditures incurred in making the business accessible to disabled individuals.

• Pension start-up credit. For tax years after 2001, if a business begins a new qualified defined benefit or defined contribution plan — including a 401(k) plan or SIMPLE plan (simplified employee pension plan) — it can receive a tax credit equal to 50 percent of the first $1,000 in startup costs.

6. Consider restructuring. Year-end tax planning should include a review of your practice’s current way of doing business. Many chiropractors have discovered that another practice entity would be more beneficial. Remember, however, taxes are only one consideration when it comes to a business entity.

With certain exceptions, an incorporated practice operating as an S-corporation, does not pay federal corporate income taxes. Instead, S-corporate income, losses, deductions and credits “pass through” to the principals to be reported on their tax returns. Thus, S-corporation income generally is taxed only once — to the shareholders — unlike regular C-corporation income, which is taxed twice — once to the corporation and again to the shareholder as dividend income. Dividends paid from an incorporated chiropractic practice are temporarily taxed at a rate of only 15 percent.

Like a corporation, a limited liability company (LLC) provides its owners with protection from personal liability for business debts and obligations. But most LLC owners can choose to have their practices treated as partnerships for income-tax purposes. Partnership treatment means:

• Income, losses, deductions and credits pass through to the individual owners to be reported on their individual income tax returns.
• LLC income is not subject to double taxation.
• An LLC can specially allocate income and expenses among its principals to the same extent that a partnership can.

Although the Internal Revenue Service may occasionally disagree, you should keep in mind that the courts strongly back every taxpayer's right to choose the course of action that will result in the lowest legal tax liability.

Tax planning is a process of looking at various tax options to determine when, whether and how the chiropractic practice should handle transactions so that taxes are reduced or even eliminated.

Remember, however, the tax law requires that a transaction be “closed” or completed before the end of the tax year. With many of the recently enacted tax cuts scheduled to expire after this year or after the 2005 tax year, now is the time to plan those moves that will reduce your practice’s annual tax bill.