2011 Year-End Tax Planning for Businesses

While some businesses may still be sorting through all the legislative changes from 2010, it is getting to that time of year again when we need to complete our year-end planning for 2011. It’s uncertain if any major acts will be passed before year-end, but in the meantime, there are still plenty of opportunities that your business can benefit from–or at least plan for–such as bonus depreciation and routine year-end planning, such as writing off bad debts.

Depreciation and Expensing of Capital Purchases
During previous economic slowdowns, Congress has incorporated bonus depreciation and enhanced Code Sec. 179 small business expensing to help jumpstart business spending. As part of the 2010 Tax Relief Act, the new law provides for 100% bonus depreciation for acquired qualified property if placed into service after September 8, 2010 and before January 1, 2012. Qualified property generally includes new property, which has a recovery period of 20 years or less (including computer software) or qualified leasehold improvement property. Businesses planning to purchase new depreciable property this year or next year should try to accelerate their buying plans (if doing so makes sound business sense) in order to take advantage of the far more generous expensing deductions allowed in this year compared to next year.

In addition, the election to take 50% bonus depreciation instead of 100% has been extended to 2012. This could be a better choice under certain circumstances.

The bonus depreciation deduction is allowed without any proration based on the length of time an asset is in service during the tax year. In other words, an asset placed into service in the fourth quarter of the year will be afforded the same percentage as an asset placed at the beginning of the year. Additionally, certain corporations may be able to elect to accelerate any alternative minimum tax (AMT) credit in lieu of bonus depreciation.

Code Sec. 179 provides extraordinarily high expensing limits for small business in 2011. For tax years beginning in 2011, the dollar limitation on the expense deduction is $500,000 and the investment-based phase-out begins after $2,000,000. For tax years beginning in 2012, the dollar limitation is reduced to $125,000 and the phase-out drops to $500,000. Compared to bonus depreciation, additional property that qualifies under the Code Sec. 179 includes used property and qualified real property (qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property).

The 2010 changes did renew the 15-year recovery period for qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property for 2010 and 2011, but note that property placed into service after December 31, 2011 will no longer be eligible and instead will be depreciated over 39 years.

Tax Credits Expiring After 2011
Some business credits are scheduled to sunset on December 31, 2011, including the research credit and work opportunity tax credit. This makes 2011 a time where businesses should evaluate current expenditures and policies in order to determine if it makes sense to accelerate expenses during 2011, as well as scale them down beginning January 1, 2012.

The research credit can be complicated to calculate, but the savings to certain taxpayers can be substantial. The credit applies to amounts paid or accrued before January 1, 2012 and equals the sum of: (1) 20% of the excess (if any) of the qualified research expenses for the tax year over a base amount; (2) 20% of research payments to certain outside organizations and (3) 20% of the taxpayer expenditures on qualified energy research undertaken by an energy research consortium.

The work opportunity tax credit provides employers who hire members of certain targeted groups with an income tax credit of a percentage of first-year wages up to $6,000 per employee (or $12,000 for qualified veterans and $3,000 for qualified summer youth employees). Generally, the percentage of qualifying wages is 40% of first-year wages for employees who have completed 400 hours of service for the employer. No wages paid or incurred after December 31, 2011 qualify for the credit.

For 2011, certain small business employers who did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administrating a new retirement plan for employees. The credit applies to 50% of the first $1,000 in qualified administrative and retirement-education expenses for each of the first three plan years.

Additional credits scheduled to sunset after December 31, 2011 include the new markets credit, differential wage payment credit for employers and new energy efficient home credit.

The new markets tax credit is 39% of qualified equity investment during a seven-year credit period for taxpayers who hold qualified equity investments in a qualified community development entity.

Eligible small business employers can claim a credit equal to 20% (up to $20,000) of differential wages, which are payments to employees for periods that they are called to active duty with the U.S. uniformed services (for more than 30 days) that represent all or part of the wages that they would have otherwise received from the employer.

The new energy efficient home credit of $2,000 or $1,000 for each qualified new energy efficient residence will also expire after 2011.

Other Specific Items for 2011
Along with the list of credits and deductions no longer available beginning in 2012, some of the enhanced charitable contributions deductions for taxpayers will also be limited.

Specifically for S corporations, 2011 provides a temporary tax incentive where shareholders of S corporations would receive lower adjustments to their stock basis for donations of appreciated assets. Under the temporary rules, shareholders reduce their basis in their S corporation stock by their pro rata share of the adjusted basis of the contributed property. After 2011, the adjustment reverts back to the fair market value of the charitable contribution. Therefore, during 2011, the shareholder would get the fair market value deduction of the charitable contribution as a flow through item, but only reduce their basis by the likely smaller adjusted basis of the property.

Taxpayers may elect to treat qualified environmental remediation costs that are typically chargeable to a capital account as a deduction in the year paid or incurred before January 1, 2012. To be deductible currently, pre-2012 expenses must be paid or incurred in connection with the abatement or control of hazardous substances (including petroleum products) at a qualified contaminated site.

General Year-End Planning
Deferring income and accelerating deductions should be part of most businesses’ strategic year-end tax planning.

The deferral of income is most effective for cash basis taxpayers, as they will generally recognize income when received and deductions when paid. Remember that certain business entities are required to use the accrual method, while others are permitted to use the cash method. One method for deferring income to 2012 is to delay billing so that payments are not received until 2012.

Accelerating deductions would include prepaying for certain expenses or making capital purchases near year-end that qualify for bonus depreciation. If you anticipate being in a higher income tax bracket in 2012 or you need additional income to take advantage of certain deductions in 2011, your business may see an overall reduction in taxes by accelerating income and deferring deductions at year-end.

The end of the year is a great time to evaluate inventories and business accounts receivable. You should also check for subnormal (damaged, unsalable, etc.) goods in your inventory because your business may take a deduction for any write-downs associated with that inventory provided you offer it for sale within 30 days of your inventory date. For accrual taxpayers with receivables, evaluating these accounts to determine which are totally or partially worthless could lead to deductions that should be taken before year-end.

If you’re self-employed, you can deduct health insurance premiums for yourself, your spouse and your dependents as an above-the-line deduction. This deduction is limited to your income from a trade or business.

Conclusion and Looking Forward
As mentioned earlier, there is currently action in the White House and Congress to pass a new Jobs Act by the end of 2011 that may impact you and your business. The current proposals include extending the bonus depreciation, reductions in payroll taxes for 2012 and other hiring incentives.

Please contact your BPW advisor at (805) 963-7811 if you would like to start your year-end planning. We’re ready when you are!