Year-End Tax Advice for Small Businesses

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Are you missing out on any money-saving tax deductions? What should you do if you can’t pay your taxes this year? Get the answers to these and other questions affecting your business from Craig Malmgren, a director and CPA with Lautze and Lautze, and former tax auditor.

Chris Bjorklund: You’re listening to the Allbusiness podcast. I’m Chris Bjorklund. If you’re getting this through iTunes, an RSS feed or an online streaming-media player, you can hear interviews with other experts at Allbusiness.com.

Bjorklund: Just about any time is a good time to get useful tax advice from the experts. Experts like Craig Malmgren, a CPA and director at the firm Lautze and Lautze in San Jose, California. Craig is a former tax auditor who has nearly 30 years of experience in the field of tax planning and business consulting. Craig, if you were asked by a business owner, what is your most invaluable tax advice? What would you say?

Craig Malmgren: Well my advice would be, it’s not what I’d call earth shattering, it’s just good record keeping. Too many times, clients come in and they haven’t been maintaining good records on what they’ve spent, especially if they’ve paid for a business expense out of their personal account and not the business and they’ve lost track of that and those are deductions that are lost when it comes down to filing their tax return. So, good record keeping contemporaneously recording those items and this is probably the best advice for the small business person.

Bjorklund: How do I know if my CPA is really doing everything possible to save me money on my taxes?

Malmgren: Well, your CPA should be asking you questions, either over the phone when you call in during the year on some transactions or when they prepare their tax returns. Our clients receive a questionnaire for their taxes that has four pages of questions on items that may be relevant to them or may not but if they answer yes, then we have to, it may result in a credit or deduction or additional tax filing that they have a requirement for. So it’s asking questions from the client and not just relying on what they give you as a complete package.

Bjorklund: I think some people, they just think it’s a once-a-year kind of relationship. Is that your experience?

Malmgren: Many times it is and we try to encourage our clients before they get into a transaction during the year to contact us to see if there is any alternative ways to structure it to try to minimize the taxes because many times they’ve come in, they’ve already completed the deal or sell a property and there’s not much you can do after the end of the year.

Bjorklund: Yeah, too late.

Malmgren: That’s right.

Bjorklund: What about tax planning then? Should I expect my CPA to help me with tax planning or should I be talking to a financial adviser about that so they’re not, they’re sort of you get separate independent opinions?

Malmgren: Well, second opinions are good but I just specifically deal with the tax planning and not the investment planning. You have to separate the two. Sure, the CPA is the best one who knows your situation, your past history in your business to make tax decisions and discuss them with you while the investment adviser is trying to make investments. He may be on a commission basis, so tax planning should be with your preparer or your CPA who deals with you year in and year out.

Bjorklund: What time of year is the best time to do that?

Malmgren: Before you’ve done something.

Bjorklund: Back to your original point.

Malmgren: The tax laws now have made it very difficult to do a lot of planning at the end of the year, like in 20 years ago. They have a lot of restrictions of what you can prepay and do in December to save taxes primarily because of this new alternative minimum tax that is catching more and more clients where what we used to have in planning and doing it in December doesn’t help you anymore.

Bjorklund: For example, paying my property tax?

Malmgren: Property taxes, paying the second installment for December, prepaying your California tax before the end of the year if you’re going to owe it rather than next year in April because you’ve got a deduction on your federal. But if you knew the alternative minimum tax, there’s no benefit to prepaying in California so it’s best to talk to your CPA before you sell property or sell a massive amount of stocks especially this year and what the ramifications are.

Bjorklund: What about for businesses, let’s say, they’re about to get a down payment on a big job or something like that but they know maybe next year won’t be as good as this year. Is there some, for instance, advantage to asking the client to pay in January versus the end of the year?

Malmgren: Yeah, if you have a good year now and you’re in a higher tax bracket than you expect to be next year, the thing you want to do is defer your billings so that you aren’t paid until after the first of the year, to put that income into the following year. The same thing if you have any expenses. You want those all paid off if you’re on a cash basis before the end of the year. In that way, you could accelerate the deductions that consist income where it’s more beneficial than next year because small business, there’s a double benefit in lowering your income. Not only do you save income tax but you’re really going to save a lot of the self-employment social security tax as well by increasing your deductions into this earlier year.

Bjorklund: And what are some examples of things that I might go out and buy in December for my business or for my office, equipment for instance?

Malmgren: With equipment, exactly because under the law now for federal, small business can expense up to $250,000 purchases of equipment, furniture in the year that they normally would not have been able to expense and they would have to depreciate. And they continue to do that as long as it’s placed in the service, in the business before the end of December, you can expense that in its entirety in this year. So that’s what it comes under, if you have plans to buy equipment at the beginning of the next year, accelerate that into December.

Bjorklund: So I should make a run to Office Depot now and get those new monitors…

Malmgren: Yeah, whether it’s a computer, yeah exactly.

Bjorklund: Get the paper that I need, other supplies. What about, one of the questions that came up for me this year was whether I should lease a car for my business or buy a car. Is that something I can get advice on it from my CPA on?

Malmgren: Sure. I mean, most CPA firms have software that can do an analysis of the cost of leasing and the tax benefits versus the tax benefits of buying a car and depreciating because depreciation is limited on vehicles especially if they’re under 6000 pounds and so you really have to look at the cost of that and then also the economics of leasing and what happens at the end of the lease on the buyout versus selling the car once it’s left the showroom.

Bjorklund: Under 6000 pounds, that’s an interesting number.

Malmgren: What’s interesting, last week at the seminar, they were talking about the new Hummer 3 that came out, the gross vehicle weight which is what the test the IRS uses came out at 6001 pounds. So it was built exactly to meet the IRS ruling, the law that it has to be over 6000 pounds so those big SUVs like the Hummer can qualify for larger tax deductions than the smaller sedan or sports car.

Bjorklund: Interesting. So can the hybrid? Hybrids, are they fitting in that category now of getting some tax credit for that?

Malmgren: Yeah, hybrids qualify for credit but it depends on the model because it phases out once a model went over 60,000 units sold so the Prius which is the top selling hybrid, no longer qualifies for a credit. The Honda Civic credit is totally phased out in 2009, that’s gone. But if you have like a Ford SUV hybrid that just came out, it qualifies for a $2000 credit even though it gets half the mileage rating than the Prius. So it’s not totally fair but you have to make sure you qualify, that the car has not been oversold plus if you’re going to be on alternative minimum tax, people are being surprised to find out, they don’t get the credit because the credit cannot be used against your AMT and also we’re the bad guy telling you when we do their tax return that they’ve lost the credit for the hybrid.

Bjorklund: Oh my word! I really had never thought before about calling my CPA before buying a car but you have opened my eyes on that one. Another big area probably for many small business owners, should they have a home office? Should they be taking deduction for that?

Malmgren: There are rules to qualify but it’s definitely more beneficial now than it used to be in the past, having a home office to reduce your net income in your business. Primarily because in the old law, if you had a home office that occupied say 20% of the home, when you sold it, 20% of the gain did not qualify for the exemption that you get on the sale of a personal residence. Well the law has been changed and now, if you do sell your home and you have a home office, all you have to do is repay the depreciation that you’ve claimed in the past and you still get to exclude 100% of the gain up to the limitations on the house. You don’t have to segregate the business portion from the personal portion so you basically get the deduction upfront, you prepay that later. I mean, you pay it back when you sell the house but you’ve had the use of that money saving your taxes. So definitely, if you are using your home office as the exclusive location of your business, that’s something you look at because not just depreciation but it’s the percentage of the mortgage, property taxes, the insurance, maintenance on the home that would count as a deduction.

Bjorklund: It isn’t a red flag for the IRS, I mean, I’ve heard that.

Malmgren: For certain businesses, if they work for a company that provides them another office somewhere else then it’s a lot more difficult to qualify but if you’re an outside sales rep and you don’t have an office, you can as long as you keep track of what’s in the office. It’s not working on your dining table. It’s something like you have an office with a desk and files and computer for that. As long as it’s reasonable, the square footage, I don’t think it’s that much of a red flag as long as you’re showing income.

Bjorklund: Boy, it’s certainly going to become more common, I would think as more and more companies use people as outside sales reps and don’t want the bricks and mortar. It’s huge.

Malmgren: Yeah, with telecommuting, yeah, if they’re not provided an office anymore, that’s a good point that maybe that’s something that the IRS may allow in the future.

Bjorklund: Now tell me, you talked about, you handled both business taxes as well as represent individuals, you must see a lot of overlooked tax-saving strategies. What about those for people who own their businesses? What are some of the most commonly overlooked? Maybe we’ve touched on a few of them.

Malmgren: Well, the home office is one; I think that could be overlooked. Auto use for business because clients may not be keeping a good log of the actual business use of the vehicle. Not only does it support a larger deduction but also in case you get audited, you’d be able to support that tax deduction to the IRS.

Bjorklund: And literally a log in the car?

Malmgren: Well, that’s what the rules say. In practice, a lot of people don’t. I mean, some people have calendars and they have the locations where they visited but they don’t have the mileage. But I think if you get audited, that’s what it comes down to; the IRS doesn’t like reconstructed records of the auto mileage. So that’s one if you’re keeping track of it, then you have a better idea that your percentage the business use is higher than what you expected by just estimating. So that’s one, I think is left out. If you’re under a high-deductible medical plan, if there’s a deductible contribution to a health savings account, now it’s too late this year to do anything with the health savings account but for 2009, if you qualify and you have a high-deductible medical plan, an individual who’s single can put a $3000 deductible contribution in and a joint return, $6000 that’s deductible; and if you don’t use it for medical, it can carry over for the future. You don’t lose it like a flexible spending account and eventually take it out to pay tax on it in the future if you want to use it for retirement. So it’s a tax deduction now over and above like the IRA rules and so on. So as long as your employers aren’t providing a normal medical insurance but a high-deductible, you’ll want to look at that. One thing, if the CPA does your business and also your personal return, you want to make sure he is not over deducting items. For example, I have a client who has an X corporation and that’s her primary source of income but she also has high mortgage interest and other expenses so I want to make sure we don’t overdo the deductions on the business that passes out to her and then waste her other deductions so you kind of work backwards. You know what kind of income she can support with her deductions and then structure the business account by how much you expense under this election to expense assets rather than just all maximize everything, reduce the income as low as you can and then when you flow it through the personal return, it goes to waste because your personal deductions don’t qualify for a loss carry back or a loss carry over. So you would be lost. So that’s a strategy, if the CPA is doing both, you want to make sure he’s looking at both parts of it.

Bjorklund: It’s easy for people to miss that if their CPA isn’t, I mean, they should ask about that.

Malmgren: Right, right. Sometimes they work for a company, they’re a small shareholder and someone in the house does the books for the corporation or the business and they have their own practitioner who does their return. But if that somebody is solely controlling that business, you want to make sure you look at both sides and not wasting deductions. As I said, we talked about not billing in December. You want to try to hold back collections, if you want or sometimes, if someone’s going to be in an alternative minimum tax, the tax rate is lower than the regular tax. So then you want to reverse the strategy and you want to accelerate. You want to get your clients to pay you in advance because you could pay a lower tax now than next year. No one knows what’s going to be the taxes of next year whether how it’s going to change or the rates are going to change, the capital gains are going to change, so that’s an unusual one that people would accelerate income especially in this economy.

Bjorklund: It sounds like your job is more creative than most people realize, seriously.

Malmgren: That’s right. I mean, the tax law is complicated. There’s a lot of gray areas and so people can go with the flow and try to not bend the rules but just try to see an opening that the IRS may not have considered or Congress. If you get audited, then you have deal with it at that time but many times if you have a good argument, you win.

Bjorklund: Any other ways to increase your deductions? I know we’ve touched on a few, maybe we’ve tapped out on your expertise there. Any others?

Malmgren: Well, the biggest one that you can do after the end of the year if you’re self-employed is you can set up a simplified employee pension plan which can be done up until the due date of their tax return and you can put up to 25% of your income up to $42,000 as a deductible contribution against your income. Now if you have employees who’ve been there for a year, you have to cover them as well where if you’ve set up a normal retirement plan with a 401K option for the employees, you had to set that up before the end of December and then fund it later. But this one, it’s a type of plan that you can put in 15% one year and zero the next. It’s flexible, you’re not obligated like some retirement plans to put in a percentage whether or not you’re profitable and as I said, that can be done after the end of the year, once you see what your net income is because many clients don’t know how profitable they were until they come in and get their taxes done. And the tax return may be a different method of accounting than what your books have been during the year so they don’t have the same bottom line. That’s one thing they can do especially when they have a retirement account.

Bjorklund: Yeah, let’s talk about this.

Malmgren: Well, now it’s a good time because with the mutual funds being done, you can probably buy more shares of the fund than you could a year ago. And along the same lines, if someone has an IRA account, there’s also the Roth IRA which if you leave the money in, it could be taken out tax free when you retire and you can roll over an IRA account into a Roth IRA and you pay tax on the amount in your IRA now and then that carries over and accumulates tax free in the future. As long as your other income is under $100,000 you can do that and this is a good time to do it because of the depressed value in the IRA, you’d be paying a lot less income tax on that amount now than you would, say a year ago if you had done that. So that’s one way if you want to get into some tax-free income and you qualify is to think about rolling your IRA over but again time is running short.

Bjorklund: What about contribution limits? Will they be changing? You know, we’re going to talk about ’09 towards the end of the program but the contribution limits, will they be changing for 401Ks, IRAs, and so on?

Malmgren: Yeah, it may go up. I think right now that this year, they’re $5000 for an IRA and if someone is 50 or over, you could put another $1000 in it, up to $6000. A 401K is $15,500 and then another $5000 if you’re 50 or over that you can put up to $20,000 away up to 100% of your salary. It’s adjusted for inflation so I don’t have the exact number. It may go up to $500 or something but it’s definitely better. The idea is when you retire you’re going to be in a lower tax bracket. Now, I don’t have a crystal ball and who knows what the rates are going to be then but at least if you get the deduction now, just the value of money between now and 20 years from now is a lot less so it’s a good idea to put away the maximum if you can afford it in these tough economic times.

Bjorklund: What about new tax credits? We talked a little bit about hybrid cars already and some of the pitfalls around that. What about solar tax credits? Are we still getting those, federal and state?

Malmgren: Yes, solar credit for federal was extended for two years and it’s at 30% just like on a home, you can put a solar system. It doesn’t qualify for the solar part that’s heating your pool but the house, it does qualify and there’s a slew of tax credits for alternative energy that are coming in now and also coming in at 2009 depending on as Congress is trying to encourage more alternative energy sources so there’s a lot of credits.

Bjorklund: Commercial too?

Malmgren: Yeah, business as well. If you do stuff to a business building, some you could use against the alternative minimum tax, some of them you can’t. So you really have to talk with your preparer before you embark on this and see what the rule is.

Bjorklund: Not just the solar salesperson.

Malmgren: Right, right, exactly. It sounds good and then there may not be a credit for the state.

Bjorklund: The people selling the equipment, they may not have…

Malmgren: Another new credit that was passed this year is if you have an employee who gets called in the military service, and you decide to make up his differential in pay between what he was receiving under you and what he’s getting under the military, there’s a 20% tax credit to the employer for making up that differential because it’s a big drop in pay when he goes into the military. So that’s a new credit and as I said, we talked about the hybrid credits but there’s a first-time home buyer credit for this year and it’s kind of a misnomer in that first-time home buyer can be anybody who hasn’t owned a house for the last three years. So you could own five houses prior to that and still qualify for the first home time buyer. Secondly, it’s not really a credit. I’ve been in this business for 30 years and this is the most unique credit in that it’s really an interest-free loan in that it has to be repaid. The credit is, I believe, it’s 10% up to $7500 on the cost of a house so anything over $75,000 which is almost everything in California, even in this market will qualify for the maximum credit of $7500 but you have to repay $500 a year starting in two years for 15 years until it’s paid off or if you sell the house, then you have to pay the balance of it off. So it’s just an interest-free loan from the government. It’s not really a credit and it’s not really only for first-time home buyers.

Bjorklund: But it’s worth mentioning. There are some interesting twists to it. What should I do now if I don’t know if I’m going to be able to afford my taxes for this year due to the bad economy?

Malmgren: Well, the most important thing you do is that you make sure you file on time even if you can’t pay the taxes. That’s one mistake I see some taxpayers make is that if they can’t pay, I don’t want to file because they’re going to come after me. Because if you don’t file, the penalty is 5% a month up to a maximum of 5 months so it’s 25%. If you file and don’t pay your taxes, the penalty is 0.5% a month so the penalty is a lot less to file and not pay and you can work out arrangements with the IRS to pay in installments. There’s an installment agreement form 9465 and if you do it online and you owe less than $25,000 it’s basically almost automatically agreed to on how much you can pay each month. The one kicker is, though, is that you have to give them bank information because it would be an automatic withdrawal out of your account for them to approve it but you don’t have to show your financial statement to show that you can’t pay it and you can work it up over time, how long it takes to pay it and there’s offers and compromise and when it gets to worse situations down the road, if someone goes into foreclosure and then it’s how much you can afford to pay when you see ads for paying pennies on the dollar and that’s limited situations that that would work. But that’s an option too. So it’s best to pay and then contact the IRS about working out a payment structure but don’t not file because there’s so much information they have on you now, they can reconstruct the tax return and assess you and assess to 25% penalty.

Bjorklund: It’ll be so much worse if you just panic and just crawl in a hole.

Malmgren: Right. Yeah, the IRS doesn’t have enough personnel to come knocking on your door within a month if you don’t file.

Bjorklund: So Craig, in closing, I’d love to hear from you what we should be looking for in ’09?

Malmgren: Well just a couple of new things for business to look at for at ’09 which is unique that I can count. Especially in California, employers starting in 2009 can pay a $20 per month bicycle fringe benefit to employees to keep you on bicycles. That’s always been something that was never allowed before as far as a tax-free benefit but that’s new for 2009. Also, if you are a single-member LLC which is a structure in California where you have limited liability, a single-member LLC is usually disregarded. You just file as a sole proprietor like you’ve done in the past. Well starting first of January now, the LLC will be the employer. If you have employees not your sole proprietor, so you have to get a new ID number from the IRS and start differently if you have that single-member LLC so that’s going to fix people. Estate tax is the big change starting first of the year. The exemption that a person gets on their assets at death goes from $2 million to $3.5 million so a lot less people would be subject to an estate tax who passed away in 2009. The big thing that this year, we talked about the increased deduction for equipment up to 179 is also a 50% bonus depreciation in the first year over and above that. For other assets, if you qualify you get a 50% bonus depreciation of the cost in the first year rather than over a period of time. That expires at the end of ’08 unless it gets extended next year on another stimulus package. So again, that’s something you would want to try to get into this year rather than in 2009. A couple of things to look out for in California is that starting for 2009, your estimated tax payments now are going to be accelerated where before it was paying 25% each quarter, now it’s part of the budget reconciliation that they did back in September, the first two quarters you pay 30% and in the last two you pay 20%. They just accelerated some of the income into the first two quarters. Secondly, if you have a tax liability of $80,000 or a payment due of $20,000 from now on, you have to pay it electronically either online or through the phone or through a credit card. We have elderly clients who don’t even have a computer and there are going to be a lot of flak when they start having to transmit these tax payments electronically because we have clients that don’t even want to e-file because they’re afraid of giving information out there in cyberspace so this is something. It’s not a federal requirement, it’s just California. They want this money two days earlier so they’re going to require and there’s a 1% penalty if you don’t it and you’re required to. So that’s something you have to look forward to when your practitioner CPA will be telling you about come April, you’ll be having to pay these electronically online or in June the state is supposed to come out with a phone system on how you could do it by phone. But again, you’re giving bank information to someone over the phone and that’s going to make clients nervous.

Bjorklund: And of course, all of these could change next year where it could be more changes.

Malmgren: Well yeah, well the California budget, they haven’t resolved this, it was worse than it was when they did this so who knows what they’re going to do with it yet?

Bjorklund: And the same with federal. Same with federal, who knows?

Malmgren: Yeah, federal, who knows, yeah. There’s a whole new administration coming in, the idea of what the tax rates are going to be and so on.

Bjorklund: So stay in touch with your CPA.

Malmgren: Exactly.

Bjorklund: Craig, thanks for coming down to the studio today.

Malmgren: My pleasure, Chris.

Bjorklund: Craig Malmgren is a CPA with a master’s degree in taxation and a director in the firm Lautze and Lautze in San Jose, California. You can hear interviews with other experts by going to the podcast library at Allbusiness.com. I’m Chris Bjorklund, thanks for listening.