Getting A Hold Of Ongoing Tax Debate

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Christine Selzer
Special To The Dispatch

OCEAN CITY – There seem to be lots of conflicting reports. Are taxes going up for higher-income earners next year or not?

"It’s impossible to know for sure, but I’d still say ‘yes,’" says Andrew Friedman, principal of The Washington Update and a tax policy expert.

Friedman points out that the federal tax cuts enacted in 2001 and 2003 are set to expire on their own at the end of this year. And while the slowing pace of the economic recovery has thrown more support behind extending the cuts, there also remains concern about the mushrooming federal deficit. That’s why Friedman still thinks a more likely scenario is for the cuts to be extended for lower- and middle-income taxpayers but for rates to revert to pre-2001 levels for taxpayers in the top income brackets. If that happens, it’s possible that small business owners with more than $250,000 a year in combined household income (or more than $200,000 if they file as a single person) would see their personal income tax rate rise from 33% to 36% in 2011, and their capital gains tax rate increase from 15% to 20%. And those with combined income of more $375,000 would see their personal income tax rate go from 35% to 39.6%.

A few questions to consider:
(BULLET)If my business is set up as an S-Corp, how will the proposed changes affect the taxes I pay?

Small businesses — whether they’re S-Corps, partnerships or limited liability corporations — are often pass-through entities. That means the businesses’ net income passes through to you, the owner, and you include it on your personal tax return. So if current tax rates are extended for only lower- and middle-income taxpayers and you fall into one of the top brackets, you’ll likely be subject to the proposed increases in personal income taxes.

(BULLET)Are there other business taxes that could rise?

The health care reform law passed earlier this year will subject taxpayers earning more than $250,000 in household income (or single filers earning more than $200,000) to an increase in the Medicare payroll tax to 2.35% from 1.45%. The change doesn’t take effect until 2013, but when it does, it will increase the amounts both employers and employees pay.

(BULLET)What can I do to minimize the impact of all these changes?

You could consider accelerating income into this year. If you were planning to close a big sale in January, for example, you could offer customers a discount to move it up to December, Friedman suggests. Next, consider deferring deductions where possible. Although you can’t put off the rent, you can probably delay buying certain supplies until 2011.

That said, "Taxes should not dictate how you run your business," says Vinay Navani, a tax advisor with Wilkin & Guttenplan, a New Jersey accounting firm. "You have to do what’s going to maximize your return." For example, if you need to be well stocked for the holiday season, it makes no sense to delay an inventory purchase for tax purposes.

Work with your tax advisor to compute the bottom-line pros and cons to see if the tax differential is significant enough to change your plans. "Most of the time, it won’t be," says Scott Cooper, Managing Director of Merrill Lynch’s Wealth Structuring Group. Also, keep in mind that under the cash-basis accounting method used by many businesses, you get the deduction only when your products are sold, so any expenses that generate sales made after Jan. 1 would count against 2011 income anyway.

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)

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