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Business & Tax Planning Ideas for Our Clients and Friends

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Section 179: A Good Expensing Opportunity for Small Businesses
IRS Update
Estimated Tax Payments Basics
October 15 Deadline  for Recharacterizing Roth IRAs
Proposed Increase for EFTPS Threshold
Tax Calendar
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Section 179: A Good Expensing Opportunity for Small Businesses

With a little planning now, a small business can save some tax dollars by buying equipment. Under Section 179, the cost of tangible depreciable personal property may be deducted for the taxable year in which it is placed in service, rather than depreciated under the regular depreciation rules of Section 168.

Section requirements

Tangible personal property is property that meets the definition in Section 1245(a)(3) (which includes most personal property) and is acquired by purchase for use in the conduct of an active trade or business. Section 179 property does not include any property described in Section 50(b) or air conditioning or heating units. For 1999, the maximum amount allowed as a deduction is $19,000. (The deduction increases through a phase-in schedule until it reaches $25,000 in 2003. See the chart on page 2.) Any remaining cost after expensing is depreciated according to the normal applicable rules. (Limitations on the deduction under Section 179 are modified for enterprise zone businesses.)
    The allowable amount of $19,000 must be reduced by the excess of the cost of property placed in service during the taxable year that is above $200,000; i.e., once your total investment exceeds $200,000, the deduction is phased out dollar-for-dollar. This lost deduction is permanent and cannot be carried forward. The phase-out is intended to limit this expense deduction to smaller businesses, because larger ones often place more than $200,000 worth of equipment in service in any given year.
    The deduction is further limited to the amount of taxable income derived from the taxpayer's active trade or business. The nondeductible portion is carried forward indefinitely until it can be deducted.

 
PHASE-IN SCHEDULE FOR INCREASE
IN SECTION 179 DEDUCTION
For Taxable Years
Beginning in:
1999
2000
2001 and 2002
2003 and thereafter
Maximum Amount
Deductible:
$19,000
$20,000
$24,000
$25,000

Making the election

An election for this deduction must be made on a taxpayer's original return for the taxable year or on a timely filed amended return. The election must state the property to which the election applies and the portion of the cost of each item that is to be taken into account under the election. Once a taxpayer makes the election, it can be revoked only with the IRS's consent; consent requests are subject to a user fee that varies with the taxpayer's gross income.

Factors to consider

When looking at whether to use the Section 179 election, several factors should be considered. First, the individual's or business's tax bracket should be examined. If an individual is in a tax bracket higher than 15%, it is probably worth considering. Below 15%, it may be better for an individual not to take the deduction, especially if he or she expects to have higher income in the following years; depreciation may be more valuable in later years to offset higher tax rates.
    The second factor to consider is the timing of the purchase of the property. If a business is going to be purchasing equipment consistently over several years, it should consider spreading out the acquisitions so that they don't exceed the $200,000 limitation in any given year.
    A third factor to consider is the useful life of the asset. If some assets purchased have a five-year life and others have a seven-year life, it is better to take the Section 179 deduction on the longest-lived assets first.

Depreciation advantage

You can also use Section 179 to prevent the mid-quarter rule under Section 168 from taking effect. Generally, under this rule, if more than 40% of tangible personal property that is placed in service throughout the year is placed in service during the last quarter, then Section 168(d)(3) will apply to all the property placed in service during the year and limit the depreciation otherwise available.
    By using Section 179 on those assets that are acquired in the last quarter, you may be able to prevent that mid-quarter convention from applying, because it may reduce the basis of those assets below the 40% threshold.

Recapture considerations

If you decide to take a Section 179 deduction, you should be aware of the recapture possibilities. If the Section 179 property is no longer used "Predominantly" in a trade or business at any time before the end of the property's recovery period, then in the taxable year in which the property is not so used, any benefit derived from expensing the property must be recaptured. The amount to be recaptured will be treated as ordinary income for the taxable year in which the property is no longer used predominantly in a trade or business.
    Property is treated as "not predominantly used" in a trade or business if 50% or more of the use of such property during any taxable year within the recapture period is for a use other than in a trade or business of the taxpayer.

Other issues

Finally, the election may be worth while for small businesses simply because of its convenience. If you have several items that cost a few hundred dollars each, it's a lot easier for record keeping and calculation purposes to be able to expense all of the items instead of writing them off over a period of time.
    The Section 179 deduction can be advantageous if used properly and considered before property purchases are made. If you would like to discuss whether a Section 179 deduction might be worthwhile for your business, please contact our office.

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IRS Update

Interest payment error

On June 11, 1999, the Treasury sent out more than 31,000 refunds that included an incorrect interest amount of $9.55. This error was caused by a computer-programming feature and was not related to any Y2K changes. The IRS discovered the error before the refunds went out, but issued the refunds so that taxpayers would receive the principal amount and some interest in a timely manner. Stopping the refunds to correct them would have excessively delayed the payments.
    This error affects around 31,000 business taxpayers who received refunds with interest payments within a few days of June 11. Nearly 25,000 should have received less interest than they did. The remaining taxpayers should have received larger interest amounts.
    Because of the small amounts involved, the IRS will not seek repayments from the taxpayers who received too much interest, The taxpayers who should have gotten more interest will receive an additional payment for the remaining interest amount the first week of July and an apology letter from the IRS explaining the matter. The IRS has changed the computer software so that the problem will not recur.

IRS implements new power-of-attorney database

The IRS announced the implementation of a new, universally accessible, power-of-attorney (POA) electronic database. This new database will allow taxpayers to file their POA at any IRS service center, and the POA will be available to IRS employees at any location. The new database was created to eliminate the need to send paper documents from one IRS office to another and to eliminate repeat requests for faxes or mailings from taxpayers or their representatives.

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Estimated Tax Payment Basics

The IRS requires individuals to pay tax throughout the year as income is earned. This can be done either through withholding taxes, which are taken out of an individual's paycheck, or through estimated tax payments. Estimated tax payments are made quarterly, but are generally not required if the individual taxpayer expects to owe less than $1,000 in taxes after withholding, or had no tax liability in the prior 12-month period. If the correct amount of estimated tax is not paid during the year, the IRS may assess an underpayment penalty.

Payment method

The amount that must be paid to the IRS can be determined using one of three methods: prior-year method, current-year method, or annualization method. An underpayment penalty won't be assessed if estimated payments and withholdings equal the amount determined under one of the methods.

  • Prior-year method. Under this method, payments for 1999 must equal the 1998 total tax liability, provided the taxpayer's 1998 adjusted gross income (AGI) was $150,000 or less. For individuals with AGI over $150,000, estimated payments and withholdings must equal 105% of the 1998 tax liability. (This amount will increase over the next several years, to 106% for 2000 and 2001, 112% for 2002, and 110% for 2003.)

  • Current-year method. Payments under this method must equal 90% of the 1999 tax liability.

  • Annualization method . Under this method, 90% of the 1999 tax liability is based on annualization of actual year-to-date income for each quarter of 1999, This method is best used when an individual taxpayer's earnings fluctuate during the year (For example, when there is an unexpected capital gain, or your income fluctuates with the yearly business cycle.)

Choosing a method

If estimated taxes are overpaid, the taxpayer has made an interest-free loan to the govemment. The goal in figuring estimated taxes is to pay the minimum amount necessary to avoid underpayment penalties. Each method has its advantages and disadvantages. For most individuals, the easiest way to calculate estimated tax payments is by using the prior-year method. This may not be possible for someone in a partnership or S corporation who may not have all of the prior year information in time for the first estimated tax payment. The current year method is also easy to use but requires the tax payer to be fairly accurate in figuring his or her tax liability, which may not be possible for the first three-quarters of the year. This may pose a problem for someone whose salary is partly or wholly comprised of commissions or year-end bonuses.

Underpayment penalty

The penalty for underpaying estimated taxes is a nondeductible interest charge on the underpayment amount. It is computed using the Federal short-term interest rate plus three percentage points. The penalty is computed for each quarterly installment; therefore, a penalty could be assessed even though a taxpayer made up the underpayment in a later quarter. The penalty interest rate is determined during the first month of each calendar quarter and becomes effective during the following quarter. The penalty is assessed from the due date of the installment payment until either the date the tax is paid, or the regular due date for filing the tax return, whichever is earlier.
     Although withheld income tax payments are considered as being paid equally throughout the year, this rule does not apply to quarterly estimated tax payments. But if a taxpayer finds that previous est! mated payments were not sufficient, he or she could avoid an underpayment penalty by adjusting withholdings for the remainder of the year. The taxpayer would have to file an amended Form W-4 with his or her employer.

Calculating payments and due dates

When calculating the estimated tax payments, taxpayers must include all sources of earned income, including income from pass through entities such as partnerships, S corporations, and trusts. In addition, employment taxes for household employees and self-employment taxes must be included in your withholdings or estimated tax payments. Estimated payments are due April 15, June 15, September 15, and January 15.

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October 15 Deadline For Recharacterizing Roth IRAs

The IRS has announced  that taxpayers who made a 1998 conversion of individual retirement accounts (IRAs) into Roth IRAs, have until October 15, 1999 to recharacterize then back into trditional IRas, if they so choose. To be eligible, taxpayers must have filed a 1998 tax return. This announcement is the latest in a series of guidelines and announcements by the IRS on the subject. The IRS has concluded that the deadline for reconversion is extended by Treasury Regulation S. 301.9100-2(b), which provides for automatic six-month extension for most tax elections. In order to receive the six-month extension, a taxpayer must reflect the characterization election on his or her 1998 return (Form 8606, Nondeductible IRAs). Tapayers who did not reflect the recharacterization on their orginal 1998 returns must file amended returns.

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Proposed Increase for EFTPS Threshold

The IRS recently issued proposed regulations that will raise the threshold requiring the use of the Electronic Federal Tax Payment System (EFTPS) from $50,000 to $200,000, beginning January 2000. This means that 91% of all businesses will be able to choose which method to use to pay their taxes. Once the regulations are finalized, those businesses that were previously required to use EFTPS but did not make more than $200,000 in aggregate deposits last year will not be required to use EFTPS on January 1, 2000. "Aggregate deposits" means that businesses must consider deposits for all types of taxes, made during the year to see if they are required to use EFTPS. If a business makes more than $200,000 in aggregate deposits for a calendar year, then it must use EFTPS starting January 1 of the second succeeding calendar year. If a business does not make more than $200,000 in aggregate deposits in a calendar year, it is not required to use EFTPS, but still may do so.
    In addition, the IRS will continue to waive penalties for smaller businesses required to use EFTPS that make timely deposits using paper deposit coupons. The waiver is effective from July 1 through December 31, 1999.

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Tax Calendar

  • September 10
    Employees who work for tips. If you received $20 or more in tips during August, report then to your employer. You can use Form 4070.

  • September 15
    Individuals. Make a payment of your 1999 estimated tax if you are not paying your income tax for the year through withholding(or will not pay enough tax that way). Use form 1040-ES. This is the third installment of estimated income tax for 1999.

Corporations. File a 1998 calendar-year income tax return (Form 1120 or 1120-A) and pay any tax due. This due date applies only if you timely requested an automatic six-month extension. Deposit the third installment of exstimated income tax for 1999.

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in August if the monthly deposit rule applies.

  • October 12
    Employees who work for tips. If you received $20 or more in tips during Semtember, report then to your employer. You can use Form 4070.

  • October 15
    Individuals. If you were given an addtional two-month extension on your 1998 income tax return, file the return and pay any tax due.

Patnerships. File a 1998 calendar-year return (Form 1065). This due date applies only if you were given an addtional three-month extension. Provide each partner with a copy of Schedule K-1 (Form 1065), or a substitute K-1.

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in Semtember if the monthly deposit rule applies.

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