Masonry Magazine December 1998 Page. 32
Year End Tax Planning
Continued from page 27
The cash basis (cash receipts and disbursements) is the method of accounting used by most individuals and many small mason contractors. Income is generally reported in the year that it is actually or constructively received in the form of cash, its equivalent or other property.
Deductions or credits are generally taken for the year in which the related expenditures were actually paid, unless they should be taken in a different period to more clearly reflect income. A good example of this is provided by the depreciation deductions that are permitted over the tax life of property and equipment. Deducting the full cost of those assets would, obviously, distort income in the year acquired. Under the accrual method of accounting, income is accounted for when the right to receive it comes into being -- i.e., when all the events that determine the right have occurred. It is not the actual receipt but, rather, the right to receive that income that governs.
Expenses are deductible on the accrual basis in the year incurred i.e., when all the events have occurred that fix the amount of the item and determine the liability of the masonry contractor to pay it.
Keeping in mind our goal of shifting income and/or deductions around, wherever legally possible, in order to produce income that will be taxed in the same bracket, year-after-year, consider an area with more than its share of headaches: interest.
All cash-basis mason contractors are required to deduct prepaid interest over the period of the loan to the extent that the interest represents the cost of using the borrowed funds during each tax year in the period.
Those contractors who use the accrual method accrue interest ratable over the loan period and must deduct it ratable over such period, regardless of whether the interest is prepaid. Obviously, not much flexibility.
On the other side of the ledger, those amounts received or accrued as rents in payment for the use of property must be included in gross income. As a rule, the payment by a lessee of any expenses of a lessor is additional rental income to the.
Both early billing (where possible) and increased collections can increase income when needed. Similarly, paying outstanding bills before they are actually due can be accomplished as part of the year-end planning process so long as those payments do not fall into the category of prepaid expenses.
Remember TRA 197
The Taxpayer Relief Act of 1997 contained a number of tax planning strategies and benefits, many of which only became effective this year. That deduction for the health insurance expenses of self-employed mason contractors, for example, has been increased incrementally from a 40 percent level to 100 percent over a nine-year phase-in period that ends in the year 2007.
Another victory, at least for those mason contractors who utilize a home office, TRA '97 overturned an earlier U.S. Supreme Court decision by broadening the availabillty of the home office tax deduction. That deduction will soon be available in situations where a home office is used for administrative and management functions.
Family-owned masonry businesses received a new exclusion from estate and gift taxes that may, in effect, reward those contractors who choose to ignore the thorny question of business succession. The new exclusion is generally equal to the difference between $1.3 million and the standard estate tax exclusion for the year in question. This year's Act contained a provision tying this exclusion into the increasing estate tax exemption.
Choosing the S Corporation Entity
If it is "tax time" it must also be time to think about choosing S corporation status to operate your masonry business. The S corporation provides the security of a corporation while passing all income and deductions on to the shareholders much in the manner of a partnership.
The election of S corporation status must be made by a qualified corporation, with the unanimous consent of all shareholders, on or before the 15th day of the 3rd month of this tax year in order for the election to be effective beginning with the year when made.
Year-end tax planning, conducted with one eye on any changes that might come to pass, can substantially reduce the tax bills, year-after-year, of every mason contractor who understand not only the strategies but also the goal: shifting income and deductions as well as maximizing losses when they are inevitable in order to produce a consistently low tax bill. And, to do so legally!
Editor's Note: Mark E. Battersby is a tax and financial advisor, freelance writer and columnist