Put Tax Savings in Your Pocket in 2005

March 3, 2005

The tax laws are always changing and this year is no different. New tax rules and cost-of-living adjustments create great tax breaks that you can take advantage of now. By learning what breaks are available, you can plan your activities for the remainder of the year.

Be profitable and save taxes
There is a new tax break – the manufacturer’s deduction – that effectively cuts the tax rate you’ll pay on profits this year. The deduction is designed to encourage domestic production of all kinds, from building factories to mining for ore.

The deduction in 2005 and 2006 is 3% of the lesser of taxable income or qualified production activities income (domestic production grow receipts reduced by related expenses). The deduction will increase to 9% by 2010. For individuals, the deduction is based on adjusted gross income rather than taxable income.

Who’s a manufacturer?The definition isn’t limited to traditional manufacturers. Congress envisioned a liberal interpretation of the term to include:

Construction firms

Engineering and architectural firms

Film and video production companies

Computer software makers

Agricultural processors

Some service providers

To date, there has been no IRS guidance on who is or is not a manufacturer. But some things are clear: food processing can be a qualified production activity (e.g., a meat packing plant), while the sale of food prepared by the taxpayer at a retail establishment (e.g., sausage prepared by a restaurant’s chef) is not. Minor repair work, such as paint jobs, probably won’t qualify as well.

Important: The deduction is allowed for alternative minimum tax (AMT) purposes, so claiming it will not trigger or increase AMT liability.

If you are thinking about taking your production offshore, think again. The deduction only applies to domestic production gross receipts, which are receipts derived in whole or significant part by manufacture, production, growing or extraction within the U.S. Work with a tax professional to weigh the projected savings from going offshore against the loss of this tax deduction.

Buy capital equipment
If you’ve been waiting to upgrade your computers and other equipment, now may be a great time to take action. In 2005, you can opt to expense the cost of equipment up to $105,000, rather than depreciating it over several years. (Bonus depreciation, an additional first-year deduction, no longer applies.)

While you have until the last day of the year to buy and place the equipment in service in order to elect expensing, the earlier you act, the sooner you can enjoy the use of the new equipment.

Build our staff
Your business is growing and you need more help. Should you hire an employee or take on an independent contractor (IC)? Obviously, you avoid the employment tax cost with an IC. But there are now several breaks to encourage staff expansion. These include:

Employment tax credits. The work opportunity credit, welfare-to-work credit, Indian employment credit and empowerment zone employment credit give you a dollar-for-dollar reduction on your tax bill when you hire certain employees. Caution: Many employment tax credits are set to expire at the end of 2005 unless Congress extends them.

Manufacturer’s deduction.This is not a direct write-off for hiring employees. However, the manufacturer’s deduction is limited to 50% of a company’s W-2 wages for the calendar year. Thus, a highly profitable company with a small staff can increase its manufacturer’s deduction by hiring employees.

Provide new employee benefits
Employee benefits can be used to attract and retain qualified workers. Large corporations usually offer a wide range of benefits; small businesses can compete effectively when it comes to retirement plans and medical coverage.

Retirement plans.You can save more for your own retirement because deduction limits for qualified retirement plans have increased in 2005, as follows:

401(k) plans – the elective deferral limit on employee contributions is $14,000 ($18,000 for those age 50 or older by the end of 2005).

SIMPLE plans – the elective deferral limit on employee contributions is $10,000 ($12,000 for those aged 50 or older by the end of 2005).

Profit-sharing and SEP plans – the deduction limit is the lesser of 25% of compensation or $42,000.

Defined benefit (pension) plans – the benefit limit is $170,000.

Note: In figuring contributions to retirement plans, only compensation up to $210,000 can be taken into account in most cases.

Medical coverage. If you now have an expensive plan or do not yet provide any medical coverage, consider using a high-deductible health plan and supplementing it with contributions to health savings accounts (HSAs) for employees. The cost of both the insurance and the HAS contributions can be substantially less than paying for a more comprehensive health plan. For 2005.

A high-deductible plan is one with an annual deductible of not less than $1,000 for self-only coverage or $2,000 for family coverage and an annual out-of-pocket limit on expenses of $5,100 for self-only coverage or $10,200 for family coverage.

The annual contribution cannot exceed the lesser of the deductible or $2,650 for self-only coverage or $5,250 for family coverage.

Neither employer contributions to retirement plans nor employer-paid medical coverage (including HSA contributions) are subject to employment taxes, so consider offering these benefits in lieu of more substantial wage increases. The employees can enjoy added benefits and the company can wind up saving money.

For more details on HSAs and a listing of insurers and trustees offering coverage and accounts, go to www.hsainsider.com.

Category: Finance, Accounting, and Taxes