New Tax Breaks Offer a Lifeline to Businesses

Businesses can claim several new tax deductions and credits this filing season, thanks to a recent law aimed at boosting the economy.

Richard J. Oster, controller of Air Logistics Corp. in Pasadena, learned from experience how beneficial these new savings can be. “The tax breaks gave us cash to operate and fight another day,” he said.

Air Logistics was able to reclaim taxes paid in past years, when the small manufacturing concern was riding the telecom boom. The money the firm got back from the federal government allowed Air Logistics to finance its latest creation -- lightweight composite rigging for sailboats.

Before it learned about the new law, Air Logistics was ready to shelve the expensive project, Oster said. Now it is trying to get its lightweight rigging certified by the organizers of the America’s Cup.

Many U.S. businesses are in the same boat, struggling through the recession and hard-pressed for cash, tax professionals said. Fortunately, the Job Creation and Worker Assistance Act, passed early last year, provides retroactive tax relief, providing write-offs for equipment purchased in late 2001 and loss “carry-backs” that can allow business owners to recover taxes paid up to five years ago.

“If you lost money in 2002, you could carry that loss back five years -- back to 1997 -- and get a refund,” said Philip J. Holthouse, partner in the Santa Monica accounting firm of Holthouse Carlin & Van Trigt.

“We’ve got a lot of clients taking advantage of these breaks. It’s a pretty big deal.”

The new tax breaks for businesses, including those in the new job creation law, fall into three categories: depreciation, net operating losses and retirement plan changes.

Depreciation

Normally, companies that buy expensive equipment can’t write off the equipment’s cost all in one year. Instead, these companies are expected to depreciate, or write off, the cost over the course of its estimated life, which could range from three to 39 years. Depreciation can cut a business’ taxes by reducing its taxable income.

There’s one standing exception to the depreciation rules. The tax code allows up to $24,000 of certain costs to be written off in the year of purchase. (This figure rises to $25,000 in 2003.)

However, last year’s job creation law created a second exception for business assets -- from planes to furniture -- purchased from Sept. 11, 2001, to Sept. 10, 2004, said Diane Kennedy, a Phoenix-based certified public accountant.

This property qualifies for so-called bonus depreciation, allowing the business owner to write off 30% of the cost, plus a percentage of the remaining amount. That percentage will depend on whether the code defines the asset as something that needs to be written off in three years or 39.

The calculation determining exactly how much can be depreciated in the first year can get pretty complex because some assets qualify for both exceptions -- the $24,000 “expensing” plus the bonus depreciation -- while others don’t.

In sum, a business owner can now deduct 33% to 100% of the cost of business purchases in the first year the asset is put into service, Holthouse said.

California laws don’t conform to the new federal depreciation rules. That means any bonus depreciation that business owners took on their federal returns would have to be added back into income on state returns.

Net Operating Losses

Companies that lost money in 2002 can retroactively apply those current-year losses to past tax returns, allowing them to recover taxes paid up to five years ago -- the move Air Logistics used to boost its immediate-term finances.

Again, there’s a glitch in California. For tax years 2002 and 2003, so-called net operating loss carry-over deductions have been temporarily suspended.

Companies may continue to compute and carry over losses during this suspension period. But they can’t claim them in the current tax year, according to the Franchise Tax Board.

The bottom line: California small businesses -- profitable or not -- should consult a tax advisor on this issue.

“With normal tax planning, you’d figure out whether you’d want to accelerate income or deductions based on where tax rates are going,” Holthouse said.

But with federal rates headed down and California rates possibly headed up, tax planning may require complicated mathematical calculations to come up with the best answer.

Retirement Rules

A little-known retirement break also went into effect during 2002 for companies with fewer than 100 employees, said Mark Luscombe, principal tax analyst with Illinois-based CCH Inc., which publishes tax information.

It allows these employers to claim a credit equal to 50% of the cost of starting or maintaining an employee retirement plan.

The credit can be applied only to $1,000 in costs a year and can be claimed for a maximum of three years per company, Luscombe said. Credits reduce tax on a dollar-for-dollar basis, unlike deductions, which simply reduce taxable income.

Miscellaneous

Although not a rule change, there’s another significant issue for small businesses this year, said Kimpa Moss, executive vice president of tax services at RSM McGladrey Inc. in Bloomington, Minn.

The IRS recently issued guidance on when companies can make certain “elections,” which determine, among other things, when they have to pay income tax. The new IRS rules allow companies far more flexibility to make these elections up to the date that they file their returns. Moss said that it gives them the ability to do some retroactive tax planning.

That can dramatically improve a company’s cash flow, she said, which is pivotal to small concerns struggling through the recession. “That can allow you to innovate and invest in your business.”

Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes .com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com/perfin.