As the year 2005 comes to a close, there is no better time than the present to begin to evaluate your tax situation. The fall is the best time of the year to assess your tax liability and make the necessary transactions to maximize your tax savings for the year. For a typical small business owner, your personal tax situation and company’s tax situation may overlap. In the coming days we will take a look at various year end tax saving ideas for yourself and your business. The first post will deal with individual tax saving strategies and the next with tax savings for your business.
Individual Tax Saving Strategies
Let’s first deal with retirement plan contributions and health saving accounts. This is a great time to maximize your retirement plan contributions to lower your taxable income and invest more for retirement. If you are a business owner it is also a good time to setup a retirement plan if you don’t already have one set up. If your business is a sole proprietor, consider setting up an IRA to lower your taxable income. Health savings accounts (HSA) are another way to lower your tax bill for 2005. Consider setting up a HSA because you can deduct contributions to the account and the account earns interest. These earnings are tax –deferred until withdrawn and any amounts used to pay medical expenses are withdrawn tax free. If amounts are withdrawn after the age of 64 and not used for medical bills, these will be treated like an IRA.
If you invest in mutual funds, it is a good idea to determine whether the mutual fund will pay a dividend that will occur early in the next year but considered paid in the year 2005. The year end dividend can make a difference in the amount of tax you pay for the year 2005. If the mutual fund has an automatic reinvestment of dividends option, those dividends reinvested will be taxable as a long term capital gain. These gains will qualify for tax relief as long as they are considered long term. Short term capital gains will not qualify as tax relief and will be considered as “ordinary dividends.” To get the best tax advantage, it will be good to wait till after the dividend to buy additional shares and to buy those shares in 2005. Also it is important to opt to take the dividend in cash instead of reinvesting it.
Speaking more on gains and losses, a great way to minimize your tax liability is to match your gains with your losses for the year. Try to avoid short-term gains which are usually taxed at up to 35% as opposed to long-term gains of 15%. If possible try to reduce short-term gains with short-term losses (up to $3000). Some ways to accomplish this are to sell an investment that you have accumulated a loss on in the year that you have a large capital gain, selling an investment that has generated a loss and repurchasing the same security or a similar security within 30 days, and if you have losses selling another investment as a gain and immediately repurchasing it.
Another way to minimize your tax bill is to either accelerate deductions and/or defer income. Great ways to accelerate deductions are the following:
· pay state estimated taxes in December as opposed to the January due date. The payment must be reasonable estimate of your tax liability.
· Paying your property taxes in 2005 instead of in installments due in 2006
· Bunching “threshold expenses” into one year. These expenses include itemized deductions, medical expenses and dues.
· Purchasing large items subject to state sales taxes that may give you a larger deduction that your state income tax deduction
Ways to defer income for 2005 are:
Selling investments that will produce a gain at the end of the year to defer payment of taxes to another year
Deferring receipt of a year-end bonus till next year to defer payment of taxes (other that the withheld portion). Only works for bonuses that are not contractually due in 2005
Waiting till next year to exercise stock option sells
If self employed, delay cash inflows until the end of December. Consider billing customers until the end of December.
These are just a few personal tax moves for you to make in 2005. In the next post we will uncover additional tax saving for small business owners and how those strategies may affect their personal tax situation. As with any suggestions on tax planning, check with your tax advisor for more specific suggestions and strategies for your own tax situation. Until next time, happy tax planning.
Brian N. Stovall
Consultant – Accounting and Business Advisory
The Brico Group, Inc.
Small Business Consulting and Outsourcing