Earlier this year, Congress passed — and President George W. Bush quickly signed into law — a $330-billion, 10-year tax-cut plan. The Jobs and Growth Tax Relief Reconciliation Act of 2003 is already having a significant impact on many distributors’ yearly taxes. Under these new but temporary rules (some provisions expire after a year or two), every sanitary maintenance supply distributor will benefit, regardless of status as an incorporated businesses, or one that operates as a pass-through business entity such as a partnership or a sole proprietorship. However, distributors must plan now to take advantage of the new rules.

Many distributors, for instance, will benefit from a significant increase in the amount that can be expensed or immediately written off under the Section 179 expensing election, which raises the limit from $25,000 to $100,000. The temporary (applies to purchases made in 2003, 2004 and 2005), but sizeable, doubling of the amount of equipment purchases that can be expensed — $200,000 to $400,000 — under Section 179 will also help, although few sanitary supply distributors routinely acquire that amount of equipment in one tax year.

An increase in the first-year “bonus” depreciation allowance, from 30 percent to 50 percent of the cost of qualifying business property, will also benefit distributors. A few will achieve the maximum benefit by using Section 179 expensing first on purchases of used assets and assets with lengthier depreciable lives. They can then save the bonus depreciation for any qualifying purchases not picked up by Section 179.

Do Dividends
In another area, many closely held sanitary supply businesses have traditionally tried to extract funds in the form of compensation, rather than as dividends. Now there is a new change to consider: compensation will still receive a corporate-level tax deduction while dividends will not. Compensation, however, will continue to be taxed at rates as high as 35 percent at the individual level while dividends will now be taxed at only 15 percent.

One planning strategy worth exploring: distributors should look at other methods besides compensation to reduce the incorporated sanitary supply operation’s tax bill — retirement plan contributions and interest deductions are two options. This simple strategy, combined with going back to paying dividends to shareholders, might offer the best of both worlds. And yes, such strategies are legal.

Tax-Planning Basics
With any type of tax planning, distributors should keep in mind 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, as the end of the tax year fast approaches, every distributor will be faced with several different options as to how to complete certain taxable transactions.

Since the tax law requires that a transaction be “closed” or completed before the end of a distributor’s tax year, now is the time to think about those moves that will reduce the annual tax bill not only this year, but in future years. That process is called “tax planning.”

At its most basic level, tax planning is a process of looking at various tax options in order to determine when, whether and how to conduct business and personal transactions so that taxes are reduced or even eliminated.

Year-End Strategies
Our tax system has graduated rates that increase with the income of the business at various tax rates. Thus, one strategy for saving tax money is to change the tax bracket of the distribution operation. This ties into that strategy for getting the most from the new 15-percent tax rate for dividends, and finding another way to reduce corporate-level income and, more importantly, taxes.

Obviously, no business can reduce its federal income tax rate in the literal sense. It can, however, take actions that will produce a similar effect. For example:

  • Choosing the optimal form of organization for the business (such as sole proprietorship, partnership, corporation or S corporation). Although not a year-end tax planning strategy, this decision deserves attention in the overall tax planning process, especially in light of the new 15 percent tax rate on dividends paid by incorporated businesses.

  • Structuring a transaction so that payments received are classified as 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 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 in shifting “unearned” income to children under age 14, some opportunities to lower tax rates do still exist. Remember, however, the time to think about those strategies is during the course of the tax year.

The goal is usually to reduce taxes this year. To be really effective, however, the tax bracket should be consistent year-after-year. If income is up this year, many distributors might want to postpone assets sales or other unusual transactions that might generate additional profit until next year when the additional profits won’t be quite as likely to put the operation into a higher tax bracket.

Depending on individual circumstances, there are a number of legitimate strategies that a distributor can employ before year’s end to balance the company and remain in the same bracket year after year. Those basic year-end savings strategies include:

    Delaying Collections: Delay year-end billings or processing of credit card receipts until late enough in the year that payments won’t come in until the following year.

    Delaying Capital Gains: If the distributor is planning to sell assets that have appreciated in value, delay the sale until next year if this can be accomplished without significantly reducing the price.

    Accelerate Payments: Wherever possible, prepay deductible business expenses, including rent, interest, taxes, insurance, etc. But 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 or 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 Section 179 tax rules permit every distributor to immediately deduct as an expense up to $100,000 in expenditures for new equipment.

Naturally, what a distributor can do depends a great deal on the accounting method used by the operation. A cash-basis business, for example, deducts expenses as paid and receipts become income when received, or made available. An accrual-basis business realizes income when billed and expenses when incurred, regardless of when items are paid for.

To Your Credit
A tax credit is defined as a dollar-for-dollar reduction in the amount of tax that a distributor owes. Unlike deductions that reduce the amount of income that is subject to taxes, a credit reduces the actual amount of tax owed.

What qualifies as a general business tax credit?

  • Disabled Access Credit: years after the passage of the Americans With Disabilities Act, any eligible small business is entitled to a non-refundable, disabled access income tax credit for expenditures incurred in making a business accessible to disabled individuals.

    The amount of this credit is 50 percent of the amount of eligible access expenditures for any year that exceed $250, but that don’t exceed $10,250. And, an eligible small business is defined as any distributor that either 1.) had gross receipts for the preceding tax year that did not exceed $1 million or 2.) had no more than 30 employees.

  • A Pension Start-Up Credit: for tax years after 2001, if a distributor begins a new qualified defined benefit or defined contribution plan, including a 401(k) plan, SIMPLE plan or simplified employee pension plan, it can receive a tax credit equal to 50 percent of the first $1,000 in startup costs.

Early-Bird Specials
By beginning that tax-planning process now, many sanitary supply distributors can legitimately deduct benefits that would otherwise be classified as nondeductible personal expenses. No business owner should, for instance, overlook the possibility of purchasing health insurance, investing for retirement or providing perks such as a company car through the business. But perks, particularly those that benefit the owner of a closely-held business or operation, require advance planning.

A Helping Hand
Despite any rumored changes to these tax rules, every distributor should immediately begin thinking how to reduce their 2003 income tax bills using the rules now in effect. Tax planning should be undertaken immediately, perhaps with professional assistance from your accountant or tax adviser.

Mark Battersby is a freelance writer based in the suburban Philadelphia community of Ardmore, Pa.




POSTED ON: 9/1/2003