How Being Politically Active Can Help Your Business

I went to a small liberal arts school in college and, as a result, I have a lot of friends that are very interested in politics.  When I scroll through my Twitter feed or my Facebook timeline, there is no shortage of opinions on everything from taxes to immigration to funding for the local library.  I have never been heavily active in politics, meaning I have done the bare minimum in keeping myself up to date from whatever Matt Lauer says in the first 10 minutes of the Today show in the mornings.  But, in my career both as a CPA advising clients and as a small business owner, I have found myself paying more attention not to what elected officials are saying, but to how new laws could affect businesses, both mine and my client's.  

I heard a speaker a few weeks ago tell a story about a state legislator here in Arkansas.  The legislator said that all it took was 10 people from his district to voice an opinion on a matter to cause him to vote one way or another.  Legislators are meant to be guided by the people that they represent, which is the exact reason why business owners should stay on top of legislative issues, both at the Federal level and in their local communities.  

At the Federal level, the biggest issue I have is the delay in extending tax law.  Because I serve many small business clients, I am a huge proponent of Section 179 and Bonus depreciation.  In 2014, they passed this extender in late December.  What was the business supposed to do?  I'm not a huge fan of saying "I don't know" to a client (unless I really don't know), but last October and November I had to say that a lot when clients asked if they should buy their new truck/x-ray machine/tractor.  I could not advise them one way or another because I did not know what the depreciation benefit would be.  

States also have a tricky way of garnering more tax revenue through a well known method called sales tax.  Here's a good example: the sales tax rate in Little Rock is a cumulative 9% (6.5% state, 1.5% city, 1% county).  The sales tax in Bryant, which is a whopping 10 miles down the road is 9.5% (6.5% state, 3% city, 0% county).  That means that buying a product in Bryant will cost 0.5% more than buying a product in Little Rock.  If you're a business owner trying to decide where to open your next store, isn't Little Rock the more attractive option?  

As a business owner, it is important to stay up to date on what your Federal and local legislators are up to.  A sudden change in Federal tax law or an incremental increase in a sales tax rate could have a big impact on the business's bottom line.  Keep up with changes that are in the works and write to your legislators.  They have a responsibility to vote with the voice of the people, so let your voice be heard.  

Unreimbursed expenses as an employee

If you work for an employer that you have a moderate level of respect for, then most likely you have gone out-of-pocket to buy something to benefit your company without getting reimbursed.  This can be a range of expenses, from mileage to birthday cakes, but there are certain rules regarding how these unreimbursed expenses can be treated on an employee's individual tax return.  

Before diving into this, there is one big catch.  For an expense to be considered unreimbursed, they must not be eligible for reimbursement or actually reimbursed by the employer.  For example, if your employer has a policy to reimburse an employee for mileage, but you choose not to seek reimbursement, the mileage is not technically an unreimbursed business expense.  Only expenses incurred above and beyond a set reimbursement policy should be considered.

Common expenses that an employee pays out of pocket that could be considered deductible include:

• Professional dues and licenses
• Depreciation on a computer you pay for yourself and required for your job
• Mileage
• Medical exams required by your employer
• Necessary tools and supplies used for work
• Work-related education
• Specific uniforms or clothing not suitable for everyday use

Of course, there is always a catch.  Here are some expenses that are, by rule, nondeductible:

• Social club dues
• Home repairs or rent
• Lobbying expenses and political contributions
• Expenses related to attendance of board meetings
• Lost vacation time

Unreimbursed business expenses are included as a miscellaneous deduction on Schedule A, and they are subject to a 2% of income limitation.  This means that only miscellaneous deductions exceeding 2% of your income will be deductible.  

All I Want for Christmas is Another Bulldozer

Last year I wrote a post discussing the tax benefit of buying a piece of equipment by 12/31.  As I predicted, the depreciation rules were not extended at the end of 2013, and taxpayers marched into 2014 with no provision for bonus depreciation and only $25,000 of Section 179 available.  But, thanks to Congress' call to action with the Tax Extenders bill signed into law December 19th, these great depreciation provisions are back for 2014.  

Although it might not be too late to ring the register on a new capital acquisition for 2014 if you both need and have the funds to purchase equipment or other assets, the following information can help determine the impact bonus and Section 179 depreciation will have on your tax situation for 2014.  

50% Bonus Depreciation

Bonus depreciation permits a taxpayer to expense 50% of the cost of an asset in the first year, plus normal depreciation on the remaining 50%.  Bonus depreciation can only be taken on assets that are new or being used in a new way in the hands of the user.  Simply, a new computer is eligible for bonus, but a used delivery truck that is purchased to be used as a delivery truck is not eligible for bonus.  Bonus is "automatic", meaning that in order to not take bonus on new assets you must classify the asset as "used" or elect out of bonus, which must be done by class life.  Bonus cannot be limited either by income or other factors, and bonus can put the taxpayer into a loss.

Section 179

For 2014, taxpayers can elect to expense 100% of an asset in 2014 using Section 179.  Taxpayer's can elect up to $500,000 of Section 179, but this amount is limited by taxable income and also by the amount of purchases eligible for Section 179 made during the year.  The asset can be new or used.  Section 179 cannot be utilized if the taxpayer does not have a profit, and any elected 179 that is unused is carried forward to future periods.  Once a taxpayer has made $2 million worth of eligible purchases, the amount of 179 available is reduced.  Unlike bonus depreciation, Section 179 is an election the taxpayer must make.  

Special considerations

One of the methods above is not necessarily better than the other, because all taxpayers have different motives.  But there are a few things to consider when accelerating depreciation:

• Depreciation taken now cannot be taken later.  Taxpayers should consider their 2015 income and capital acquisition budget when determining how much accelerated depreciation to take in 2014.  
• Cars are special, especially luxury cars, SUV's or trucks.  The amounts of bonus and 179 in some cases are limited.  
• Cash flow planning is essential.  Utilize credit cards or short-term financing to purchase the asset before 12/31 and pay it off in January or in 2015.  
• Don't purchase new equipment simply to avoid taxes.  If you were planning to purchase the new equipment then do it before 12/31 to take advantage of the depreciation rules.  But remember some deductions do not create a dollar-for-dollar reduction in taxes.

Renting to yourself

A common source of investment income is owning rental properties.  Rental properties can be tax advantageous in that, after considering depreciation, the property can have positive cash flow with little to no taxable profit.  Rental activities can also be tax beneficial because they are by definition "passive", and their losses in most cases can be used to offset other passive income.  This can be very helpful for taxpayers subject to the Net Investment Income Tax (NIIT), also known as the 3.8% Medicare surtax because passive income is considered Net Investment Income (NII).  

But, there is a situation where this is not applicable which involves "self-rental" activities.  A taxpayer is engaged in self-rental when a property is rented for use in a trade or business activity in which the taxpayer materially participates.  For example, a taxpayer owns a building personally.  The taxpayer rents that building to their business, a corporation, in which they are a majority stockholder and work full time.  This would be characterized as a self-rental activity because the taxpayer is renting the building to a business in which they materially participate.  

Self-rental activities are treated differently than normal rental activities when it comes to passive activity losses.  By rule, income generated from self-rental activities is treated as nonpassive, but losses are treated as passive.  The treatment of income or loss from the self-rental activities can have a significant impact on the taxpayer's tax situation as a whole.  If the taxpayer has a $1,000 income from a self-rental activity, and a $1,000 loss from a normal rental activity, those two activities do not "offset" under the passive income rules as they would if both activities were normal rentals.  The impact is instead of having a net $0 rental income on their tax return, the taxpayer ends up with a $1,000 net rental income and a $1,000 passive activity loss, which will most likely be suspended until future years when the taxpayer has other passive income.  

This is a big point of contention for taxpayers engaged in rental activities, because tax law defines all rental activities as passive no matter what, then in the fine print excepts self-rental activities.  The rule also unjustly penalizes taxpayers that, for tax or estate planning purposes, want to keep real estate assets from their businesses.  The business can be sold, merged, or closed but the taxpayer will always own the building.  

This has been a rule for many years, however has resurfaced under new scrutiny in 2013 in conjunction with the NIIT.  By treating income from self-rental activities as passive instead of nonpassive, a taxpayer can mistakenly reduce their NII subject to the NIIT and also their taxable income as a whole.  When a taxpayer reduces their NII by passive losses, they should be prepared to justify how they are treating their rental activities in the event that the IRS inquires as to whether the activity is self-rental or normal rental.  Taxpayers should also reevaluate their rental arrangements between themselves, businesses they work in, or other partnerships where they have ownership interest to ensure they are in compliance with the self-rental rules.  

Outsourced accounting

Small business owners are predominantly known for "doing it all".  In most small businesses, the owners are responsible for all aspects of the business, from customer relations to product delivery.  Yet, one of the most important business management tasks, commonly known as "the books" is often overlooked or thrown together quickly.  There are a variety of reasons for this lack of attention.  

First, most small business owners do not have sophisticated financial knowledge, which makes "the books" cumbersome and intimidating.  These are the clients that come to a CPA and hand over their books with the disclaimer "well, I'm not an accountant, so I apologize for the shape the books are in".  Well of course you're not an accountant!  If you were, you probably would have gotten a job in accounting, not have started your business.  

Second, most small business owners run relatively simple, cash-basis operations that do not require accruals and adjustments on a monthly basis.  These are the clients that determine the success of their business based on how much money is in their bank account.  

Third, most small business owners simply do not have time to focus on the financial side of their business.  By the time they are done dealing with customers and vendors, filling orders, managing employees and putting out other fires that come up during the day, the last thing most small business owners want to do is reconcile their bank statement.  

All of these reasons, albeit legitimate, can wreak havoc in a small business if left unchecked for a long period of time.  This is where small business owners can most benefit from outsourced bookkeeping and accounting services.  By outsourcing, the business owner is getting another set of eyes on the books.  This set of eyes can point out unusual charges, identify trends in the business finances, reconcile bank accounts and advise the business owner on their cash position.  

Outsourcing is most effective when combined with tax planning and preparation.  When the business owner's CPA can advise the client monthly or quarterly then the year-end planning and preparation are much less complicated and time consuming.  Outsourcing typically has a lower cost impact than hiring a part- or full-time bookkeeper.  Having the books analyzed by an accounting professional for a few hours each month, and then the tax return prepared by the same professional at the end of the year is more cost effective than only allowing the accountant to look at the books once a year.  Furthermore, the accounting professional will most likely set the accounting records up in a formal accounting software such as Quickbooks or Peachtree, which will give the business owner historical data going forward.  

If you are a small business owner and the burden of "the books" has become too much for you to handle, consider outsourcing your monthly accounting function.  This will free up more time for you to focus or running your business, which is why you started it in the first place!