Income tax reduction
Income tax reduction contributes to national prosperity by providing capital to business. Income tax reduction also provides additional discretionary income for consumers. Income tax reduction can be affected by either tax credits or tax deductions. Tax credits generate income tax reductions. Tax deductions effect income tax reduction by reducing taxable income. A $100,000 tax deduction provides a $35,000 income tax reduction (assuming a 35% marginal tax rate, $100,000 times 35%). Options for income tax reductions include 1) revising depreciation schedules, 2) reviewing fixed asset schedules, 3)casualty losses, 4) revising bad debts, 5) charitable contributions, 6) reviewing cash expenditures for expenses coded as capital expenses, 7) child labor, 8) tax deductible vacations, 9) reviewing personal expenditures and 10) growing your business while using a cash basis method of accounting. Following is a brief description of each of these options.
- Real estate depreciation offers substantial opportunity for income tax reductions. Most depreciation schedules are established by simply separating land and long-life improvements. This simple approach is lawful but sharply understates lawful depreciation. About 20-40% of improvements for most properties are short-life items. Short life items can be depreciated over 5, 7, or 15 years. There are about 130 short-life items that have been determined by legislation, tax court decisions and IRS rulings.
Congress has provided depreciation as a tax deduction to encourage real estate ownership and investment. Numerous court decisions have provided clear guidance for accurately and precisely depreciating real estate. Real estate depreciation can typically be increased by 50-100% for the first 5-7 years of ownership by obtaining a cost segregation study. A cost segregation study precisely values up to 130 components of real estate that can be valued as short-life property.
Owners can claim a tax deduction windfall for properties owned more than one year by "catching-up" previously under-reported depreciation. After obtaining a cost segregation report, you can "catch-up" depreciation without filing any amended tax returns.
- Reviewing fixed asset listings (of business personal property) can generate a meaningful amount of income tax reductions. They often include items that should have been expensed, which have been sold or thrown away or which have an excessive depreciation life. Items that should have been expensed include operating expenses (sometimes included by error) and maintenance or repairs (which was necessary but did not increase the life of the assets or component.) Section 179 allows business to use up to $108,000 of 2006 capital expenditures as tax deductions. Confirm you are not capitalizing assets that could be claimed as a tax deduction.
- Casualty losses also offer opportunity for income tax reductions. For a casualty loss, you can deduct: 1) the market value immediately before the casualty less 2) the market value immediately after the casualty less the amount covered by insurance. The portion that is not intuitive is: the market value after the casualty is much less than the value before plus the cost to renovate. Other factors which can and should be considered for tax deductions are: lost rent/usage, stigma (in some cases), construction management, construction risks, and entrepreneurial effort.
- Bad debts are a subjective matter. Judgment is required to accurately estimate the amount that should be claimed as a tax deduction. If bad debts have not been examined carefully for several years, they may offer a meaningful income tax reduction opportunity. (This applies to companies who utilize accrual accounting. Companies who use cash accounting can't claim a tax deduction for bad debt since they never recognized the revenue.)
- Do well by doing good. Charitable contributions are another income tax reduction strategy. For example, you purchased land 10 years ago for $200,000, and it is now worth $1,000,000. However, you now realize you will never use the land for the intended purpose. You can donate the land to a qualified charitable organization and take a tax deduction for $1,000,000. However, you do not have to pay capital gains taxes on the appreciation.
- Another meaningful source of income tax reductions is to scrutinize any cash expenditures which are being capitalized. Have minor repairs been capitalized in error? Are there more significant repairs which do not clearly extend the life of a component? Discussing these items with your accountant can yield additional tax deductions. Also review items which were capitalized in prior years; can you claim any of them as current year tax deductions?
- Child labor can be good when they are your children and you claim a tax deduction. Consult your accountant or CPA but this can generate additional income tax reductions.
- A tax-deductible vacation is an attractive option to make an expenditure deductible. Simply plan a vacation around a business trip for a meeting or seminar. Your airfare and hotel for the business period are deductible. Hotel before or after the business activity and your spouse's airfare (assuming that your spouse is not involved in business) are not deductible. Half of meals during period with business activity are deductible. This generates additional income tax reductions.
- Reviewing personal expenditures can generate additional income tax reductions through tax deductions. Items used for business such as computer, printer, office supplies, seminars, association dues, and business publications can be deducted. Long distance business phone calls can also be deducted. Self-employed persons can deduct the entire cost of health insurance premiums.
- Growing a business can generate expenses which are disproportionate to the revenue collected. When a business is growing, the level of accounts receivable tend to grow. An exception is a retail business. However, most service businesses or businesses dealing with other firms must offer credit to their clients. Cash expenditures are required to deliver services or goods but the payment is delayed for a period of time. This causes expenditures that are disproportionate to the level of revenue collected. Growing a business while using a cash basis method of accounting will generate a meaningful reduction in income taxes. This is really a deferral of income taxes. The income taxes will need to be paid when the business stops growing or reduces its size. However, many small businesses minimize or eliminate federal income taxes by maintaining a brisk rate of growth.
Tax deductions sometimes seem arcane and complicated. However, a knowledgeable team of advisors from several fields can federal income tax reductions. The complexity of the tax code makes it difficult for any one personal to be knowledgeable in all areas.
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