By Mike Mares
With the election over, it’s appropriate to turn our attention to reducing taxes for 2008. Without question, it’s been a turbulent year. The market drop, coupled with the housing crisis has many, if not most Americans, uneasy. With unease, though, comes opportunity, and we’d like to outline some planning opportunities that could reduce your tax liability.
There can be little doubt that 2008 was a chaotic year for the tax law. The good news is that those changes provide a number of ways to reduce your federal and state income taxes.
Business tax considerations
Let’s start with business planning ideas. In order to stimulate the business economy, Congress adopted two significant tax breaks for 2008. First, Congress expanded small businesses’ ability to deduct the purchase of equipment, computers and other tangible business property. Called the Section 179 deduction, this has been a popular tax break for small businesses. In 2008, up to $250,000 of such property can be expensed. Additionally, this deduction also reduces the self-employment tax liability for sole proprietors, partners and LLC members. There is also a special $8,000 increase in depreciation for business autos purchased in 2008. Unfortunately, the Section 179 deduction is subject to phase out when total purchases exceed $800,000.
Congress also provided a 50 percent bonus depreciation deduction in 2008. Thus, if you purchased any qualified business property in 2008 that isn’t expensed using the Section 179 deduction, you can expense 50 percent of the cost of the property. Additionally, the deduction also applies to certain land improvements and other property not included in the Section 179 deduction.
Funding a retirement plan is another outstanding way to cut your taxes. For 2008, you can contribute and deduct up to $46,000 to a retirement plan. Not only do you get a deduction for the contribution, but all earnings remain tax free until they are withdrawn after you retire. Generally, your business must adopt the retirement plan before year end, although there are some plans that can be set up as late as April 15, 2009. As with any tax provision, the rules are complicated and contributions must generally be made for most, if not all, employees.
Now is also an excellent time to take a look at 2009. It’s always a good idea to consider what the income and expenses will likely be next year. If you expect your income to drop in 2009, you might want to consider deferring income from 2008 into 2009. In the past, this may not have made sense, since incomes traditionally rose in subsequent years. Given the state of the economy, though, that doesn’t appear to be the case this year, and deferral of income could substantially reduce your 2008 tax without causing an undue burden in 2009.
Of course, there’s the issue of whether tax rates may rise in 2009. At this time, it’s too early to accurately predict whether the promised increases will occur in 2009 or at the end of 2010, when the existing rates are automatically scheduled to increase. It’s also interesting to note that the Democratic leadership has previously promised not to raise individual tax rates before 2011. So it seems that it makes sense to defer income to 2009 and to accelerate deductions into 2008.
Individual tax considerations
There are also individual tax savings that can be taken in 2008. For those who don’t itemize, Congress now provides that up to $500 ($1,000 for couples filing a joint return) of real estate taxes can be deducted in addition to the standard deduction. Congress also reduced the likelihood that the Alternative Minimum Tax (AMT) would affect middle-class taxpayers by increasing the 2008 AMT exemption and permitting most of the personal credits to reduce both the regular income tax as well as the AMT. In another very important AMT change, Congress substantially expanded the ability of individuals hurt by the AMT consequences of exercising stock options to recoup the AMT paid (plus interest and penalties) in 2008.
Several popular tax breaks were also extended through 2008, including the tuition deduction and the $250 unreimbursed teacher expense deduction. Charitable contributions are still a great way to reduce taxable income, but stiff record keeping rules dictate that you must obtain a written receipt if your contribution is $250 or more. There are also a variety of energy credits for alternative fuel vehicles and home heating and cooling systems available but, as one should expect, the requirements are complicated and require an analysis of the net tax benefit to you.
There are a number of other ways to reduce other federal, state and local taxes. For example, the current real estate market is depressed. This means the value of your home (and other real estate) may have dropped significantly. The reduced value may mean that your real estate is over assessed. By requesting a reassessment, you might reduce your assessment value, and in turn, your real estate taxes. Likewise, getting rid of old equipment or other business assets can reduce the personal property taxes you will owe.
One issue that may dominate tax policy during 2009 and 2010 is how to fund Social Security and Medicare. President Barack Obama’s platform called for the imposition of a 2 percent to 4 percent additional Social Security tax on those earning more than $250,000. This proposal has led many to conclude that LLCs, which usually subject the members to the self-employment tax on earnings, are now less attractive as business entities than S corporations, where all earnings in excess of reasonable compensation are exempt from the self-employment tax or other payroll taxes.
While certainly a valid concern, remember that the SE tax issue is but one of many considerations in deciding what business entity to use. Further, Congress is eyeing the inconsistencies in the application of payroll taxes among sole proprietorships, partnerships, LLCs and S corporations. Recent efforts to “fix” Social Security have involved the application of consistent rules on all small business entities, thus eliminating, or at least substantially reducing, the benefits of S corporations in this area.
As always, good year-end planning is worth its weight in gold. Reviewing your tax situation for 2008 as well as 2009 can provide significant tax savings, often with only minimum changes in your plans.
Mike Mares is co-founder of accounting firm Witt Mares. He can be reached at .