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Bar News - October 17, 2003 Tax-Planning for Your Law Firm for Year-End 2003 By: Mark Witaschek and Vickie T. Worrad ALTHOUGH YEAR-END 2003 is fast approaching, there is still time to do tax-planning for your law firm. Here are a few pointers to get you started. Health Insurance Health insurance premiums paid by self-employed individuals may be deducted 100 percent. The deduction takes the form of an adjustment to income on Form 1040. Be careful, though - the deduction cannot exceed the net earnings from the business. Also, the deduction isn't allowed if either the individual or his/her spouse could have participated in a subsidized health plan offered by his/her employer. To obtain an even greater benefit from the deduction, consider taking it as a business expense. How? Employ the spouse in the business. Remember, this means a "real" job. Then provide the spouse a medical benefits package, including a Section 105e Medical Reimbursement Plan for medical and dental expenses not reimbursed by insurance. The expense could be deductible, resulting in a reduction in the self-employment tax. Code Section 179 Expensing Many small-business owners are accustomed to making the Code Section 179 election that allows their businesses to deduct certain assets rather than capitalize and depreciate them over time. The 2003 Tax Act increased the expensing amount from $25,000 to $100,000. The annual investment limit was also increased, from $200,000 to $400,000. Note that these limits apply for years 2003, 2004 and 2005. Section 179 assets are generally tangible, personal property used in the active conduct of a trade or business. To make the most of the Section 179 expense, consider that any asset treated in this manner is not considered when determining if assets need to be depreciated using the mid-quarter convention for that particular year. If it is beneficial to the business to avoid depreciating assets under the mid-quarter convention, then Section 179 expensing those assets bought in the last quarter may be considered. It is also generally beneficial to expense the assets with the longest recovery periods. The 2003 Tax Act allows Section 179 expensing for off-the-shelf computer software purchased in 2003, 2004 and 2005. While we're on the subject of software - the IRS has not provided any definitive answers as to the tax treatment of Web site development that we are aware of. We suggest you consult your tax advisor for guidance in that area. Bonus Depreciation Under the 2003 Tax Act, bonus depreciation jumps from 30 percent to 50 percent for new property acquired after May 5, 2003 and placed in service before Jan. 1, 2005. Note: The bonus depreciation is treated as depreciation expense and is subject to recapture as ordinary income under Code Section 1245 if the property is sold at a gain before its recovery period has ended. Retirement Plans Now is a good time to review retirement plans for your law firm. One option is a Simplified Employee Plan (SEP), which is easy to administer. Contributions of up to 25 percent of net earnings or $40,000, whichever is smaller, can be made. Contributions can be made up to the time of filing the tax return, including extensions. This is the only plan that can also be established any time up to the return filing. Other plans to consider are Keogh, Profit Sharing and SIMPLE plans. The maximum contribution to a Keogh or Profit Sharing plan is $40,000 or 100 percent of the participant's compensation, to a maximum employer deduction of 25 percent of gross or 20 percent of net business income. The maximum compensation that can be considered is $200,000. While the plan must be established before year-end, the contribution can be made any time until the income tax filing deadline. SIMPLE plans are available to employers with 100 or fewer employees who receive at least $5,000 in compensation for the previous year. The business can have no other retirement plan. The maximum employee contribution is $8,000. Catch-up contributions of $1,000 are allowed for those employees reaching age 50 by year-end. The employer matches the employee contribution in amounts of 1 to 3 percent of compensation. These plans are in many cases good alternatives to Keogh or Profit Sharing plans because business owners can contribute more to SIMPLE plans than the effective deductible limit of those Keogh or Profit Sharing plans. Miscellaneous IR-2003-77 announced that the Internal Revenue Service will now let businesses obtain identification numbers from its Web site. IR-2003-108 announced that over-the-counter drugs could be paid for with pre-tax dollars through health care flexible spending accounts. For more information, go to www.irs.gov. Finally, for lawyers who can request reimbursement of expenses from their employers but fail to do so, deducting the expenses as itemized deductions on Schedule A, Form 1040 is not an option. Employee business expenses are allowed as an itemized deduction if the employer has a policy of not reimbursing the employee for the expenses. In Alex B. Rhodes (T.C. Memo. 2003-133), the court noted that where employees would have been reimbursed by their employers for their business expenses but didn't request reimbursement, the expenses would not be considered "necessary" and, as a result, would not be personally deductible by the employee. Optimum use of the planning opportunities cited above depends on the tax structure of your practice. For the best tax results, we suggest a consultation with a qualified tax advisor. Mark A. Witaschek, CFP, and Vickie T. Worrad, CPA, CFP, are members of the Harbor Group, Inc., a financial-planning firm in Bedford.
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