5 Year-End Actions to Improve Your Business

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Most small businesses will be closing their books on December 31. That means there’s only a short time to take actions that can improve the operations of your company going forward and trim your federal income taxes now. 

1. Work with Your CPA or Financial Advisor

Schedule a meeting as soon as possible to review your financial picture for 2010 so you can decide which actions to take now. For example, if you have a C corporation that’s been profitable this year, the business may want to pay out some of its profits to shareholders in the form of dividends. While not deductible by the corporation, shareholder-employees pay taxes at no more than 15% and the corporation saves on payroll taxes that would otherwise be due if these payouts had been compensation instead of dividends.

2. Purchase Equipment

If you need new computers, furniture, machinery, and other business equipment, buy them now. As long as the item is placed in service by December 31, you can opt to expense the cost (immediately deduct) up to $500,000 instead of depreciating it over five or seven years or even longer periods. This is called the “Section 179 deduction” and it applies not only to equipment, but also to off-the-shelf software and to qualified leasehold, restaurant, and retail improvements that would otherwise be depreciated over 39 years (although there’s a $250,000 limit for improvement).

This expensing option applies to both new and pre-owned equipment (as long as it’s new to your business). It applies whether you finance the purchase in whole or in part.

Caution: If you must replace or obtain equipment but aren’t profitable, don’t make this expensing election. Instead, merely rely on the 50% bonus depreciation allowance for this year to claim a sizable write-off for purchases; only new property qualifies. Bonus depreciation can be used to create or increase a net operating loss that can be carried back for a certain number of years (generally two) to generate a tax refund.

3. Set Up a Retirement Plan

If you’ve been profitable and want to share your good fortune with staff, you can set up a qualified retirement plan, such as a 401(k), for 2010. You’ll be able to use the plan as a way to attract and retain qualified employees while sheltering your business profits. Even if you work alone, you can use a solo 401(k) or other type of qualified plan for yourself.

As long as you sign the paperwork with a financial institution by December 31 to create the plan, you then have until the extended due date of the 2010 income tax return to make tax-deductible contributions.

If you miss the December 31 deadline, you will still be able to set up and fund a Simplified Employee Pension (SEP) plan for 2010 up to the extended due date of the 2010 return (e.g., October 15, 2011 for a sole proprietor’s plan).

4. Hire New Employees

If your business is growing, you can improve operations by expanding your staff. If you hire certain workers, you’ll gain special tax breaks.

• Unemployed worker. If you hire someone who has not worked more than 40 hours during the 60-day period preceding the date you put them on your payroll (and is not related to you), you’ll enjoy a payroll tax holiday for the rest of the year. This means you won’t have to pay the Social Security portion of FICA, a 6.2% employment tax savings. You’ll still pay the Medicare portion and withhold the employee’s full share of FICA. Make sure the new employee signs an affidavit that he or she meets the unemployment requirement; this can be done using new IRS Form W-11 (PDF). Then, if you keep this worker on the payroll for 52 consecutive weeks, you’ll be able to claim a tax credit of up to $1,000 on your 2011 tax return.
   
• Disadvantaged worker. If you hire a worker from one of about a dozen targeted groups of economically disadvantaged workers, you can take a work opportunity tax credit. The credit generally is 40% of first-year wages up to a top credit of $2,400, but it may be higher or lower for certain workers. To claim the credit, the worker must complete IRS Form 8850 (PDF) when hired and you must submit it to the state labor department within 28 days of the hire date. If you don’t, you can’t correct this mistake and will lose out even if the worker is in a targeted group. Note: You cannot claim this credit and the payroll tax holiday with respect to the same worker, so choose the tax break that is better for your business.

5. Give Year-End Bonuses

If your business has survived and thrived in this economic downturn, you may want to reward your staff by paying year-end bonuses. The business can deduct bonuses (and related payroll taxes).

Businesses using the cash method of accounting deduct the bonuses when they are paid. Businesses using the accrual method of accounting have some leeway. They can deduct bonuses declared before the end of the year as long as they are paid by March 15, 2011.

Exception: Bonus payments to employees who are more than 50% C corporation shareholders and payments to owners of S corporation shareholders, regardless of their ownership percentage, are not deductible until actually paid to the shareholder-employees.