Tax Discretion: 5 Elections You Can Make to Save Money

Barbara Weltman

You don't have a choice about paying your taxes, but you do have some control over how much they will be. Here are five tax rules that give you wiggle room for decision making.

Equipment purchases
Business needs and budgets dictate when you buy a new copier or office furniture. Tax rules govern when you can write off the costs you incur.

Election: Instead of depreciating the cost of equipment purchases over a number of years (fixed by the tax law), you can opt to deduct the purchase price in full in the first year. This is called the Sec. 179 deduction or first-year expensing.

When to make the election: The election makes sense if you are profitable in the year of the purchase. If you're not, you get no tax benefit from the election (it cannot be used to increase a net operating loss, discussed later). Instead, you'll claim depreciation -- some in the year of purchase and the balance of the remaining recovery period for the property set by law (usually five or seven years for most items).

Start-up costs
Before a new business opens its doors it may incur various expenses to get the business started. These could include legal and accounting fees, travel expenses, and other costs.

Election: Normally, these costs are "capitalized," which means you carry them on the books of the company. You can opt to deduct up to $5,000 of these costs in the first year of business (Congress is considering an increase of the dollar limit to $20,000). If you have more than this amount in start-up costs, you can deduct the excess ratably over 180 months (special rules apply for start-up costs over $50,000). Similar rules apply to organizational expenses of partnerships and incorporation costs for corporations.

When to make the election: The election is usually advisable for most businesses. It creates an immediate deduction that can be claimed in the first year of the business.

Installment sales
Installment sales in the tax law mean that a capital asset, such as a building or stock in a corporation, is sold and at least one payment is received in a year following the year of the sale.

Election: Usually, gain from an installment sale is reported when installments are received, effectively spreading the gain over the period of the installments. However, you can elect to report all of the gain in the year of the sale, even though you have not yet received all, or any, of the proceeds.

When to make the election: Tax deferral usually is advisable. However, with the prospect of higher capital gains rates becoming effective after 2010, it may make sense to report all of the gain from 2010 sales this year to take advantage of the 15% maximum capital gains rate.

It also makes sense to report all of the gain in a single year when you have a sizable capital loss that can offset the sale's gain.

If you have a corporation and take bonuses, you can arrange to defer this compensation to some later date, typically to retirement.

Election: Compensation usually is taxed when it is earned (some rules allow accrual basis businesses to deduct it currently even though it is not paid until early in the following year). However, compensation can be deferred to a future date if proper arrangements are made. The compensation is then taxed to owners when it is received in the future. Currently, deferred compensation is still to be subject to FICA in the year it is earned, which can be a good thing -- owners who are already at the Social Security wage base ($106,800 in 2010), won't owe any additional Social Security taxes on the deferred compensation in the year in which it is earned and there won't be any FICA when the deferred compensation is received.

When to make the election: Historically, deferred compensation arrangements have been devised where owners expect to be in lower tax brackets in retirement. However, given the likelihood of higher tax brackets in the future, the wisdom of deferring compensation is questionable. Still, for some owners, deferral may make sense from the perspective of providing fixed retirement income.

Net operating losses
Losses from business operations give rise to a net operating loss, which can be carried back to offset income in certain prior years. This can generate an immediate tax refund to provide cash for business operations.

Election: You can opt to waive the net operating loss carryback, which is usually two years, and instead carry the loss forward for up to 20 years. The loss in this case will be used to offset income in future years, saving you taxes down the road.

When to make the election: A carryback is an attractive strategy for generating immediate cash. However, it may not make sense to do this if you expect to be in a higher tax bracket in future years; a carryforward will effectively generate more bang for the buck.

Final word
Work with your tax or other financial advisor to make the right decisions about tax elections for your situation. Usually, you have to make a choice by the time you file your return and it cannot be changed without IRS consent in certain instances.

Barbara Weltman, author of several books including her most recent, 1001 Deductions & Tax Breaks 2009
Copyright 2010 Author retains ownership. All Rights Reserved.


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