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Year-end tax tips for consultants

Consultants who run their own business can find tax relief in a variety of ways. Here's a look at how you can still reduce your tax liability for 2001.


Right now, holiday preparations probably have a higher priority for you than preparing for April 15. After all, tax time is four months away. But you can brighten up the ides of April by taking action before December 31.

For fiscal-year filers, that’s the last day to take most of the actions that can reduce your obligation to the U.S. Treasury for 2001. If you’re a self-employed consultant, your savings extend beyond just the percentage of personal income tax you’ll owe: For every tax deduction that you can take for your business, you also reduce your liability for the self-employment tax or for corporate taxes.

In this article, I’ll outline what you can do this month to reduce your tax burden. Unless otherwise specified, the deadline for all these is December 31, so get cracking! I’ll refer you to a number of IRS tax publications for additional information, which you can download from the IRS’s Find Files page.

Sketch out your tax forms now
The first thing to do is fill out your tax forms now to learn what sort of tax liability you may be facing. Don’t groan yet: I know you don’t have any 1099s, you don’t know how much you’ll make, and your records aren’t in order. Look at this tax run as a rough draft.

Here are a couple of tips to make this easier:
  • If you don’t want to do the math yourself, use tax-preparation software, such as one of Intuit’s TurboTax products. Both Business (for corporations) or Home and Business (for sole proprietors) are good choices. The purchase is tax-deductible.
  • Don’t worry about exact figures. Round off your deductions and estimate what your income and expenses are for the year.

First, match up the tax it looks like you’ll owe with the estimated taxes you’ve already paid. Although you always want to minimize tax payments, finding out now how much you’ll owe will energize your deduction hunt.

Next, look at where your adjusted gross income falls relative to the tax bracket cutoffs. You can find 2001 tax rate schedules in a number of IRS tax publications, such as Publication 505: Tax Withholding and Estimated Tax, which you should already have. If you’re close to moving into a higher tax bracket, you want to make sure that doesn’t happen.

Take advantage of falling tax rates
Unless IRS documents have been revised by the time you read this, remember to discount all 2001 tax rate schedules for brackets higher than 15 percent by half of one percent. For example, the published 28-percent bracket will be revised to 27.5 percent for 2001, thanks to last summer’s tax relief package. Tax rates will continue to fall over the next several years, so you’ll save more money—albeit a fairly small amount—by taking deductions sooner rather than later.

Now that you know where your income falls, decide which of the following scenarios better describes your situation for this year:
  • This year’s income is atypically low, so you want to shift deductions into next year and income into this year to take advantage of the lower tax bracket.
  • This year’s income is average or high, so consider shifting deductions from next year to this year and vice versa for income.

Reducing tax liability this year
Let’s look at what you can do now to reduce your tax liability for 2001.

Set up a SEP-IRA
One way to sock away a lot of your money tax-free is to set up a SEP-IRA, short for Simplified Employee Pension IRA. Although there are other retirement plans for businesses, the SEP is usually best for small business and the self-employed.

Generally, you can contribute the lesser of $15,000 or 30 percent of your business income—far more than a standard IRA allows.

You must set up the account before the end of this year. However, you don’t have to decide right now how much to contribute—you have until your tax-filing deadline to make your actual contribution.

The key is to have the account up and running by the end of December. For more information, download Publication 560: Retirement Plans for Small Business from the IRS.

Make big purchases now
If you’re thinking about buying a new PC or some other equipment, do so this year instead of next. This applies mainly to expenses you can deduct under Section 179, which allows you to deduct most or all of an item’s expense in the year you buy it instead of depreciating it over a number of years. The maximum allowable Section 179 deduction for 2001 has increased to $24,000.

The guidelines for property you will depreciate are more complex, especially for purchases like automobiles. If you’re thinking about buying an automobile to place into service for your business and you plan to claim actual expenses instead of the standard mileage deduction, wait until next year: You can claim a higher deprecation amount for a vehicle placed into service before the end of September of the year in which you buy it.

This higher depreciation amount remains in effect for as long as you use that vehicle for your business. To learn more, download Publication 463: Travel, Entertainment, Gift, and Car Expenses.

Reduce inventory in your business name
Instead of making your charitable contributions as an individual, make them gifts from your company if at all possible. Unfortunately, sole proprietors, partnerships, and S corporations cannot deduct the most common type of contribution—a check to a worthy nonprofit organization. Non–S-corporations can write checks and deduct them, but most self-employed consultants don’t use those types of setups.

You can deduct donations of inventory, defined as property you sell in the course of your business. For example, if you sell PCs and have a lot of stuff sitting around at the end of the year that you know you won’t be able to sell for a while, consider donating it if you need the tax break this year.

For guidelines, see IRS Publication 535: Business Expenses. If you run your business as a corporation, also see Publication 542: Corporations.

Pay your dues
You can deduct dues and fees paid by your business to any club or organization whose primary purpose is business, not recreation or social purposes. Depending on the accounting method you use, if you write the check this year, you can deduct it this year. The following types of organizations qualify:
  • Trade and professional organizations
  • Chambers of commerce
  • Business leagues
  • Boards of trade

You can also deduct the expense of subscriptions to business, technical, and trade journals that cover your business field.

Pay your state taxes
You deduct state and local taxes in the year you pay them, not the year you pay them for. So, if you make your fourth-quarter estimated state or local tax payment this year instead of on the deadline of Jan. 15, you can deduct them for 2001.

Delay income
If you’re close to edging into the next tax bracket, consider asking some of your clients to wait until next year before cutting your checks. Chances are good that they’ll be more than happy to delay paying you! This will help you take advantage of tax rates that may fall further, depending on what stimulus plan Congress approves.

Shifting tax liability to next year
Most people want to take as many deductions as soon as possible. However, you may want to shift some of your tax liability to next year, for example, to offset the gains from a year you anticipate to be more lucrative. If you break into a higher tax bracket next year, taking the deduction then will save you more money.

You can also run what I’ve already recommended backwards: postpone deductible purchases and paying dues, fees, and state and local estimated taxes until after January 1.

However, also think about what you can do this year that you might not do in more prosperous times. For example, depending on your age and retirement goals, you may want to contribute this year to a tax-free Roth IRA, for which you don’t get a tax deduction, instead of to a tax-deferred SEP-IRA.

What other ways have you lessened your tax liability?
As an independent consultant, have you taken deductions that other consultants might find beneficial? Post your suggestions below.

 

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