Practical planning strategies for electrical contractors who want to keep their tax bill at its legal minimum this year and every year
Even though the weak economy may have already driven it down, there's no time like the present to think about reducing your electrical contracting business' tax bill even further. While many of us rely on advice provided by tax professionals or use software programs to ensure a lower tax bill, the real goal should be achieving savings not only this year, but also for many years to come (see Consistency Pays Off on page C30). The best way to do this is by implementing simple tax planning strategies.
Tax planning is easy. The more deductions you take, the lower your business' taxable income will be. Of course, ignoring potential tax deductions this year might mean significant savings later on when profits — and tax bills — are higher. Either way, the time to take the necessary steps to lower your tax bill is now — before the end of the 2009 tax year. It's not too late.
What every electrical contractor should know is that although the IRS may occasionally disagree, the courts strongly back every taxpayer's right to choose the course of action that will result in the lowest legal tax liability. Thus, with the end of the tax year fast approaching, every business owner faces several options as to how to complete certain taxable transactions.
Considering that the nation's tax system has graduated rates that increase along with your business' income, one strategy for saving taxes means reducing your operation's tax bracket. Getting the most from the temporary 15% tax rate for dividends means finding another way to reduce corporate level income and taxes. Obviously, neither electrical contractors nor any other business owners can literally reduce their federal income tax rate. However, they can take certain actions, some of which are highlighted below, to achieve a similar effect.
- Choosing the optimal form of organization for the business (such as sole proprietorship, partnership, corporation, or S corporation)
Although this is not a year-end tax planning strategy, this option deserves attention in the overall tax planning process, especially in light of the current temporary 15% tax rate on dividends paid by incorporated electrical design, construction, or maintenance businesses.
- Structuring transactions so payments received are capital gains
Long-term capital gains earned by non-corporate taxpayers are subject to lower tax rates than other income.
- Shifting income from a high-tax bracket individual (such as yourself, the business owner) to a lower-bracket individual (such as your child)
One fairly simple way to accomplish this is by hiring your children. Another possibility is to make one or more children partners in the business so that net profits are shared among a larger group.
While the tax laws limit the usefulness of this strategy for shifting “unearned” income to children under the age of 14, some opportunities to lower tax rates still exist. Remember, however, the time to think about those strategies is during the course of the tax year.
Look to the law for answers
Earlier this year, the American Recovery and Reinvestment Act (ARRA) extended a number of expiring provisions and created a few more that may affect your year-end planning process. For example:
ARRA extended the 50% bonus first-year depreciation allowance available for 2008 to 2009.
During 2009, electrical contracting businesses can choose to expense and immediately deduct up to $250,000 of the cost of qualifying property and equipment. The $250,000 maximum expensing amount is reduced if the cost of all Sec. 179 property placed in service in 2009 exceeds $800,000.
For tax years beginning in either 2009 or 2010, ARRA eliminates the corporate level tax on the built-in gains of an S corporation that converted from regular “C” corporation status at least seven tax years before the current tax year.
Making year-end planning more urgent than usual, a number of tax provisions will also expire in 2009, including:
The tax credit for research and experimentation expenses.
Increased alternative minimum tax (AMT) exemption amounts.
15-year straight-line cost recovery for qualified improvements to leased business property.
Additional first-year depreciation for 50% of basis of qualified property.
Increase in expensing to $250,000/$800,000.
Empowerment zone tax incentives.
Tax incentives for investment in the District of Columbia.
Renewal community tax incentives.
The FUTA surtax of 0.2%.
Reduced estimated tax payments for small businesses.
Tax tail should not wag the dog
Given the current economic climate, there's a great deal of pressure in many electrical contracting businesses to continue cutting costs, including taxes. Unfortunately, this coincides with an increased scrutiny of tax returns on many levels. Identifying opportunities for tax deductions without running afoul of cash-strapped state and local tax authorities should play a role in the planning process.
On a similar note, the financial or operational strengths of a business transaction should always stand on their own, aside from any tax benefits derived from them. There is also the question of whether a tax deduction should be taken or — if legally feasible — ignored.
An excellent illustration of the flexibility of tax rules involves governing bonuses. Let's say an electrical contracting business operating on an accrual basis has the opportunity to fix the amount of employees' bonus payments before January 1 but plans to pay them early next year. Generally, bonuses are not taxable to employees until 2010, but are deductible on the electrical contracting operation's 2009 tax return — so long as announced before the end of 2009 and paid before March 16, 2010.
On the other hand, while few businesses are in a position to pay employee bonuses, any electrical contractor may benefit by delaying income until next year. Remember, however, the “constructive receipt” rules dictate that income is “income” when it is made available, not necessarily when it is physically received.
Planning makes perfect
Although tax planning should be a year-round effort, a number of year-end strategies can reduce not only this year's tax bill, but also future tax bills. That means the owners and managers of every electrical contracting business should immediately begin taking additional steps now to ensure the success of their operations in 2010.
Whether or not the electrical contracting firm is facing a large tax bill or severely lower taxable income, professional advice is almost always a necessity. However, as outlined above, implementing continuous tax planning strategies will go a long way toward taking the bite out of your tax bill this year and every year.
Battersby is a freelance writer in the suburban Philadelphia community of Ardmore, Pa. He can be reached at MEBatt12@earthlink.net.
Sidebar: Consistency Pays Off
Although most people's goal is usually to reduce taxes this year, to be really effective, your tax bracket should remain consistent year after year. If income is up this year but expected to be down the next, for instance, you might want to postpone asset sales or other unusual transactions until next year — when the additional profits may not be as likely to put the operation into a higher tax bracket. Conversely, if income and profits are down this year, disposing of unneeded equipment or business assets via a profitable sale just might generate extra income — income taxed at a lower tax rate.
Depending on the circumstances, employing a number of legitimate strategies before year's end, as outlined below, can help you remain in the same bracket this year, next year, and for many years to come. Those basic year-end savings strategies include:
Delaying collections — A cash-basis electrical contracting firm can delay year-end billings or processing of credit card receipts until late enough in the year so that payments will not come in until the following year.
Accelerate payments — Wherever possible, prepay deductible business expenses, including rent, interest, taxes, insurance, etc. Also, keep in mind that the tax rules limit tax deductions for some prepaid expenses.
Accelerate large purchases — Close the purchase of depreciable personal property or real estate within the current year.
Accelerate operating expenses — If possible, accelerate the purchase of supplies/ services or the making of repairs.
Accelerate depreciation — Elect to expense or immediately write off the cost of new equipment instead of depreciating it. Remember, the new Sec. 179 tax rules now permit every electrical contractor and electrical contracting business to deduct (as an expense) up to $250,000 in expenditures for new equipment.
Naturally, what an electrical contractor can do depends a great deal on the accounting method used by the operation. A cash basis contractor, for example, deducts expenses as paid and receipts become income when received — or made available. An accrual-basis electrical contracting business realizes income when billed and expenses when incurred — regardless of when income is actually received or when payment is made.