1. Prepay Your Expenses, Using the Safe Harbor
Safe-harbor prepayments you make for calendar year 2010 may not go into 2012. This makes sense, since you may prepay only 12 months of 2010 qualifying expenses under the safe-harbor rule. For a cash-basis taxpayer, qualifying expenses include lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance.
Example 1. Sam Krueger, a cash-basis taxpayer, pays office rent of $1,500 a month. Today, he pays 12 months' rent in advance. Mr. Krueger deducts $18,000 this year.
Example 2. Jim Ford dates and mails his $24,000 rent prepayment for 2011 on Friday, December 31, 2010. His landlord does not receive the payment in the mail until Tuesday, January 4, 2011. Here are the results:
Mr. Ford deducts $24,000 in 2010.
The landlord reports the income in 2011.
Mr. Ford gets what he wants--the deduction this year.
The landlord gets what he wants--next year's 12 months' rent in advance but taxable in the year he expected it to be taxable.
Had the landlord received the $24,000 rent in 2010, he would have paid taxes on the rent money in 2010.
Before sending a big rent check to the landlord, make sure the landlord understands the strategy. Otherwise, he might not deposit the rent check and, instead, return it to you. This could put a crimp in the strategy, since you operate on a cash basis.
Also, think proof. Remember, the burden of proof is on you. How do you prove that you mailed the check on December 31?
Answer: Send the check by certified or registered mail. The postal receipt shows the date it was mailed. The delivery receipt shows the date the landlord received the check.
2. Stop Collecting Income
This simple strategy is great for the cash-basis taxpayer and is rock-solid easy.
Want to pay less tax this year? Collect less income this year. How? Simply stop sending bills to your customers, clients, or patients until after December 31.
Example. Bill Bradley, a dentist, usually bills his patients and the insurance companies at the end of each week. During December, he does not send the bills. Instead, he accumulates the December bills and mails them the first week of January. Presto! He just avoided paying taxes on his December income by moving it to next year.
If Dr. Bradley invests his savings this year and then continues using this strategy and investing year after year, he can accumulate a significant new nest egg (realistically, tens of thousands of dollars), thanks solely to planning his cash receipts.
Dr. Bradley could combine this putting-off-his-cash-receipts strategy with a paying-his-bills-in-advance strategy to accumulate even more cash.
3. Buy Office Equipment
The overall 2010 limit on Section 179 expensing is $500,000. Qualifying items include personal property such as equipment, computers, desks, and chairs.
Lawmakers designed Section 179 expensing for the small business.
If you buy and place in service more than $2 million of qualifying Section 179 property during the year, you must reduce the $500,000 maximum benefit by one dollar for each dollar in excess of $2 million. If you are buying more than $500,000 in Section 179 assets, don't worry too much about the fact that you can't deduct all the assets in total. Remember, for 2010, you also have 50 percent bonus depreciation available.
Assuming you want deductions this year, the combination of Section 179 expensing and the newly reenacted 50 percent bonus depreciation makes this a very good year to buy Section 179 assets.
4. Pay Your Children for Business Chores
Did your under-age-18 children help you in your business this year? Did you pay them for their work?
Why? First, wages paid by the parent to the parent's under-age-18 child for work done in the parent's business are both deductible by the parent, and exempt from payroll taxes.
Thus, if you operate your business as a proprietorship or a single-member LLC, you face no payroll taxes on the W-2 wages you pay your under-age-18 child.
Second, your child can use the 2010 standard deduction to eliminate taxes on up to $5,700 in wages.
Third, your child can contribute up to $5,000 to a tax-deductible IRA and exclude that amount from taxable wages.
Example. Your child is age 14, and she has no earned income other than what she earns from you. You pay her $10,700 in fair market wages for work she actually does during the year. You deduct the $10,700 and pocket $4,280 because of your 40 percent tax bracket.
Your daughter collects the $10,700 and pays zero federal income taxes because the IRA deduction removes $5,000 from taxable income, and the standard deduction removes $5,700 from taxable income.
Your family unit has $4,280 in additional spendable cash.
Key point. To avoid payroll taxes, the wages paid by the parent to the child must be on a W-2. If you use a 1099, you destroy payroll tax benefits because your recipient child will pay self-employment taxes on the 1099 income.
Corporation. If a corporation does the hiring, both your corporation and your child face payroll taxes. This is not a deal breaker for the strategy, but it does reduce the net family benefit. It is also a negative when considering the corporation as a possible choice of business entity.
Planning note. The kiddie tax does not apply to the child's wages. The kiddie tax applies to unearned income, such as dividends, interest, rents, etc.