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Tax Planning

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by Mary Anne Pipkin

Whether you're a professional service provider, retailer, manufacturer or owner of any small business, understanding the tax rules regarding business deductions can lead to some hefty savings down the road. In fact, learning all you can about the tax law now will give you time to take some tax-reducing actions before the end of the year.

Ordinary and necessary expenses. Determining if a business expense is "ordinary and necessary" in the eyes of the Internal Revenue Service is the key factor in deducting a business expense.

Although the tax code doesn't define these terms, an ordinary expense generally is one that is common and accepted in your business, and a necessary expense is one that is helpful and appropriate for your business. Numerous expenses fall into these categories:

?Costs for business-related insurance.

?Up to 45 percent of health insurance premiums if you are self-employed (60 percent in 1999).

?Travel and lodging.

?Automobile (to the extent it is used for business).

?Real estate taxes.


?Business gifts of up to $25 per recipient per year.

?50 percent of most business-related meals.

?Professional publications.

Tracking what you spend in these areas will help you to claim all the deductions you deserve. What's more, if you think 1998 will be a banner year for your business, you can offset some of your income by accelerating deductible expenses into 1998.

Currently deductible vs. capital expenses. Since tax rules cover not only what expenses you can deduct but when you can deduct them, it's also important to understand the difference between currently deductible and capital expenses.

Generally, currently deductible expenses, those day-to-day costs of keeping your business going, such as many of the expenses mentioned above, are deductible in the year the expenses are incurred. Cash-basis taxpayers can deduct such expenses in the year they are paid.

Capital business expenditures, for things like machinery and equipment expected to generate revenue in future years, are treated as investments in your business. The general rule is that costs for items with a "useful life" of more than a year must be deducted or depreciated over a number of years.

As a small-business owner, there's an important tax-savings exception to this rule. Instead of depreciating the cost of tangible property over a number of years, an expensing provision permits you to write off the entire cost of qualifying property in the first year, rather than depreciating it over a number of years.

For 1998, a business owner can deduct up to $18,500 of asset purchases as current expenses. The amount increases to $19,000 next year. This gives you an immediate write-off of capital assets, which in most cases is more valuable than depreciating those same assets.

If you've been thinking about upgrading or adding new equipment, be sure you put it in service before the end of the year if you want to qualify for a tax deduction.

Keep in mind that this expensing deduction is reduced on a dollar-for-dollar basis to the extent the total cost of qualified property placed in service exceeds $200,000 during the tax year.

Tax incentives for retirement. As a business owner, you can personally deduct contributions to your own qualified retirement plan, and your company can deduct contributions made on behalf of its employees. Retirement plans are available to sole proprietors, partners, corporations, and limited liability company members under a variety of names.

For example, a sole proprietor, partner or limited liability corporation member can set up a Keogh plan. Keogh plans allow the largest tax-deductible contributions. However, they can be costly because they must cover employees of a self-employed person on a nondiscriminatory basis.

Small-business owners looking for a retirement plan that is relatively simple to set up and administer can choose a Simplified Employee Pension Plan (SEP) or the new Savings Incentive Match Plan for Employees, or SIMPLE.

Contributions to both plans are deductible and grow tax-deferred until withdrawn. Any employer can set up an SEP, but SIMPLEs are allowed only if you have 100 or fewer employees. The new SIMPLE requires low (or no) contributions by the business owner for employees.

Don't overlook the popular 401(k) plan, in which employees voluntarily contribute a percentage of their pre-tax income. You can match all, none or a portion of the employees' contributions and deduct what the company contributes.

(Mary Anne Pipkin is a CPA and associate with the Springfield office of Baird, Kurtz & Dobson, certified public accountants.)

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