As you read this, you’re either relieved that your April 15 tax filings are behind you, or gripped tightly in the throes of yet another cycle of receipt-hunting, pencil-snapping tax frenzy.
Oddly enough, this is just the right time to begin thinking about next year’s tax filing, in April 2001.
While this year’s tax planning strategies are soon to become a distant memory, here are three suggestions to act on now, while tax season — and the cost of poor planning — are still fresh in your mind.
Component Depreciation. Is your company planning to put up a new building or complete a renovation this year? To avoid the cash flow crunch associated with large building projects, accelerate the depreciation schedules for certain portions of the job.
The basic principle of component depreciation is that the sum of the parts is greater than the whole. Component depreciation, also called cost segregation, is achieved by depreciating the components of a newly constructed building (HVAC system, elevators, lighting, roof, boiler, landscaping, etc.) over periods less than the 39-year life required by the IRS for buildings.
This makes it possible to accelerate depreciation deductions by segregating specific nonstructural building costs and depreciating them over their shorter lives (five, seven or 15 years).
By accelerating depreciation deductions, you reduce your taxable income, thereby reducing your income tax liability and increasing cash flow in the earlier years after a new or renovation building project. Say your company constructs a $5 million building, and without using component depreciation, schedules the full $5 million for depreciation over 39 years for federal tax purposes.
The depreciation deduction is approximately $130,000 annually. If you use the component method of depreciation and are able to identify $2 million of cost (for nonstructural building items) that can be depreciated over seven years instead of 39 years, the total depreciation is approximately $360,000 per year. Each year, you receive an additional deduction of $230,000 with a federal tax (40 percent) savings of $92,000. After-tax cash flow is increased by the tax savings.
Keep in mind that if you keep the property for its 39-year life, the total depreciation will be the same, but you will have depreciated more in the first 10 years than in the last 29 years and can invest and earn income on the tax savings.
100 percent deduction of self-employed health insurance premiums: Many who are self-employed or in a partnership only deduct a portion of their health insurance premiums. However, you can deduct 100 percent of your premiums (vs. deducting 60 percent as “above-the-line” deductions and 40 percent subject to the adjusted gross income limitation).
It’s simple. Hire your spouse.
If your spouse is a bona fide employee, your family’s medical coverage becomes a normal and necessary (read: deductible) business expense by the spouse-employer.
The spouse-employee must be a bona fide employee and meet the eligibility requirements of the accident and health plan. The requirements must be applied consistently to all employees, with no discrimination in favor of the spouse-employee.
The spouse-employee can be the only employee, but cannot maintain joint owner status at the same time. The insurance policy should be carried in the name of the business, not the spouse-employer.
Family Limited Partnerships. If you own rental real estate (including the land and building within which you operate your business), you might consider transferring it to a family limited partnership (FLP). An FLP is a limited partnership for federal income tax purposes (flow-through taxation results in only one level of tax).
FLPs offer tax advantages, such as lowering your tax rate by shifting income to your children in lower tax brackets. You can realize federal gift and estate tax savings by gradually transferring the partnership interest to your children or grandchildren via annual gifts.
Generally, the limited partnership interest is transferred while you continue to own the general partnership interest and retain total control of the assets.
The value of the limited interest transferred can be discounted for “lack of marketability” and “lack of control.” This allows you to transfer $50,000 in “actual” value property at a gift tax value of $35,000 because of the applicable discounts.
Consequently, you have transferred assets out of your federal taxable estate at a discounted value to the next generation while maintaining control of the assets through your ownership of the general partner interest.
Mary Taylor, CPA, is the manager of Taxation Services at Bober, Markey & Co. in Akron. She can be reached via e-mail at [email protected]
