Avoiding Year-End Tax Traps

Making the right moves before December 31 can shave thousands off your bill to Uncle Sam

of Business. “I’m trying to take advantage of this as long as it makes sense,” says Chapman, who plans to retire in 11 years. “I recognize the tax law can change again, so I don’t want to lose time or miss opportunities.” Indeed, the lower investment income rates are only temporary. Without further congressional action, they’re scheduled to expire in 2009.

One of the stocks Chapman says he plans to sell is Cisco (Nasdaq: CSCO), which he bought in 1996 at $6 a share. The new lower capital gain rate can shave $565 off his tax bill. Chapman is also considering gifting the stock to one of his daughters who will use it toward graduate school expenses. Because she is in the 15% tax bracket, she would only pay 5% capital gains tax on the proceeds and can qualify for Lifetime Learning Credit (a tax credit of up to $2,000 per family toward post-secondary expenses), says Fulbright. The family would save $1,500 to $2,000 in taxes.

Steps for Today’s Business Owner
Today’s business owner can also benefit from the new tax laws in an effort to reduce his or her taxes. “It’s a great time to replace old equipment,” explains Patrick Largie, principal with Watson Rice, a New York-based national accounting firm.

While it usually makes sense for business owners to purchase business equipment before year-end, this year, thanks to the new tax law’s attempts to spur business growth, there’s an even bigger tax incentive (see Enterprise, this issue). The two biggest benefits for businesses under the new law are increases in the small business expensing election, commonly known as the Section 179 deduction, and the 50% bonus depreciation deduction.

Family practitioner and public health physician Dr. Robert Adair says he plans to make the most of the new tax benefits by making purchases for his New York and New Jersey medical offices. “Surgical supply houses are informing doctors that their
purchases may be tax deductible and are even providing extra incentives such as buy-two-and-get-one-free specials on certain equipment,” he says.

The Section 179 deduction allows a small business to deduct up front the cost of new equipment bought, delivered, and put into service (but not necessarily paid for) before Dec. 31 rather than depreciate it over a period of years. The maximum deduction under Section 179 of the Internal Revenue Code has also been increased to $100,000 in 2003 and 2004 — up from $25,000 the previous year. In other words, companies can reduce their taxable income by up to $100,000 a year. Also, the maximum investment for qualifying equipment has been doubled to $400,000.

Another tax strategy for business owners might be to reduce taxes by electing to take bonus depreciation. Certain types of equipment purchased after May 5 qualify for bonus depreciation of 50% of the value in addition to normal depreciation deductions.

According to Largie, employing this end-of-year strategy makes for significant tax savings. Dr. Adair, for example, plans to spend $5,000 on office furniture and $15,000 on medical equipment. The busy doctor, who is

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