Tax law changes from the Stimulus Act could affect how you file in April.

On February 17, 2009 the American Recovery and Re investment Act (ARRA) of 2009 (the Stimulus Act) was signed into law by President Obama. The law was designed to get money into the hands of taxpayers to help stimulate the floundering economy. Time will tell whether it is the catalyst the politicians hoped it would be.

However, there are some potential tax savings for small- to medium-sized business owners, both on an individual and business level, that could help out as April approaches. While reviewing your financial documents, here are some things to keep in mind.

Congress once again instituted an AMT (Alternative Minimum Tax) Patch. This patch was designed to insulate millions of middle-income taxpayers from AMT. In past years the government has waited until the last minute to save Middle America from the dreaded AMT. In 2009, they were proactive. This does not necessarily mean that if you were in AMT for 2008 you are no longer in AMT in 2009, however.

Congress also tweaked an already existing First Time Home buyer Credit. This allows a first-time homebuyer that purchased a principal residence a credit of $8,000. This credit does phase out at AGI (adjusted gross income) in excess of $75,000 ($150,000 for joint filers). This is a better credit than before because there is no “payback” provision as with the credit implemented in 2008.

There is a New Automobile Sales Tax Deduction that was created by ARRA. The credit is equal to the sales tax attributable to the first $49,500 of the purchase price, but phases out at AGI in excess of $125,000 ($250,000 for joint fil ers). Qualifying vehicles are passenger vehicles and light trucks with gross vehicle weight under 8,500 pounds. Motorcycles and motor homes qualify as well. Sales taxes on leased vehicles are not allowed for this credit. Non-item­izers can add this amount to their standard deduction if they qualify for the credit.

As in previous years, itemizers must decide whether they deduct state and local income taxes or state and local sales taxes. They cannot take both.

The name of the Hope Education Credit has been changed to the American Opportunity Tax Credit, but that is not the only thing that has changed. The credit now allows for a maximum of $2,500 per year based on $4,000 in qualifying educational payments. The credit is calculated at 100% on the first $2,000 of qualifying education expenses and 25% on the next $2,000. The new law extends to all four years of college, where before it was only the first two years of higher education. There are phase-outs at an AGI of $80,000 to $90,000 and $160,000 to $180,000 for joint filers.

The Stimulus Act allows taxpayers to temporarily exclude the first $2,400 of unemployment compensation received in 2009 from the recipient’s gross taxable income.

The Non-Business Energy Property Credit has been updated. The new law extends and liberalizes the nonrefundable credit for expenditures to install energy-efficient insulation, windows, doors, roofs, and heating and cooling equipment in a U.S. principal residence. The credit has been extended through 12/31/10. The credit is now 30% of any qualifying expenditure placed into service during 2009 and 2010, with a lifetime cap on aggregate claims in 2009 and 2010 limited to $1,500. This cap is regardless of any energy credits the taxpayer has taken in the past under the old law.

Taxpayers who do not itemize deductions can deduct an additional $500 ($1,000 if married filing jointly) standard deduction for state and local real property taxes.

Anyone who is at least 70½ years of age must distribute a minimum amount from their IRAs or defined contribution pension holdings based on mortality tables. Because of the downturn in the stock market and the decline in many retirees’ retirement holdings, the Required Minimum Distribution (RMD) rules for IRAs and defined contribution retirement plans were waived for 2009. This means that retirees do not have to distribute the minimum required distributions during 2009. The previous RMD rules will be reinstated for 2010.

The safe harbor rules for small business owners changed for 2009 under certain circumstances. This rule is all about paying the least amount of taxes at the latest possible time. Use the tax law to your advantage. Under the old rules, the government allowed taxpayers to pay the lesser of 100% (110% if AGI > $150K) of the prior year’s tax or 90% of current year’s tax, whichever is smaller, by January 15th of the subsequent tax year without incurring any penalty or interest, if paid timely. If your income took a sudden turn upward, pay only 100% or 110% of last year’s taxes. Hold onto the money, put it in a safe investment and pay the taxes due in April of the following year, interest and penalty free. If you own your own business, you should be using the concept of safe harbor to pay the least amount of taxes at the latest possible time.

The new law decreases the safe harbor for estimated tax payments for individuals whose income was primarily derived from a small business (defined as a business with an average number of employees of 500 or fewer) in 2009. The taxpayer must also have AGI of less than $500,000 ($250,000 if married filing separately is used for 2009 return) for 2008. The new law allows the taxpayer who meets the criterion above to pay only 90% of last year’s tax liability instead of 100% (110% if prior year AGI is over $150,000).

This could be a cash flow windfall for the owners of small businesses, but be careful. If profits are up, the owner could be in for a rude awakening this spring when a large tax bill arrives because they paid too little to the government.

On the horizon for 2010, is the ability to convert Regular IRAs into Roth IRAs. Contributions to a Roth IRA are made only from earned income that has already been taxed. The contributions are not tax deductible, but withdrawals, including earnings after age 59 ½, are income tax free. Currently, taxpayers can contribute to a Roth IRA only if their income falls below specified adjusted gross income (AGI) levels.

In 2010, taxpayers can contribute to a Roth IRA regardless of their AGI level. Additionally, taxpayers can convert an existing IRA into a Roth IRA by paying the applicable taxes on conversion over a two-year period, if converted in 2010. By performing this conversion the taxpayer will lock in tax-free distributions from the Roth IRA in the future, as well as potentially advantageous estate planning tools.

Business Changes Created by the Stimulus Act

The maximum Section 179 deduction remains at $250,000 per year. For 2010 it reverts back to $125,000, unless Congress takes further action. There was a phase ­out for 2009 of $800,000 of asset purchases; in 2010 the phase out will revert back to $500,000.

Bonus depreciation of 50% was extended through 12/31/10. To be eligible an asset must pass all three of the following tests:

1. The asset must be qualified property (most property with a recovery period of 20 years or less, purchased software and qualified leasehold improvements).
2. The asset must be acquired and placed into service by 12/31/09.
3. The original use of the asset generally must commence with the taxpayer after 12/31/07.

Depreciation of new autos and light trucks increased for 2009. For a new passenger auto or light truck that was used for busi­ness and was subject to the luxury auto depreciation limitation, the first year depreciation limits in­creased by $8,000 to $10,960 for new cars and $11,060 for light trucks. The light truck or car must have been acquired and placed into service by 12/31/09.

The Stimulus Act created a Longer Net Operating Loss (NOL) Carryback for 2008 Loss­es (Small and Medium-Sized Businesses Only). The Stimu­lus Act allows eligible businesses (businesses with annual gross re­ceipts of $15 million or less for the three-year period, ending with the NOL year for which the election is made) to carry back 2008 NOLs for up to five years to obtain re­funds of taxes for those years. This changed the carryback period of an NOL from three to five years.

“Oldies but Goodies” — Planning for 2010

There are several tried and true tax planning techniques that still work in today’s complex world. Here are the top four:

• Defer income

Delay sending out end-of-year billings until the last week of the year. Since most taxpayers are on the cash basis method of revenue recognition (taxes paid on cash received), this enables you to defer recognition of income into the next year when the cash is received, while allow­ing customers to take the expense in the current year.

• Bunch expenses

Taxpayers who are close to the threshold for itemizing should “bunch” expens­es. The object is to plan itemized deductions on a two-year cycle. One year take the standard deduc­tion. The next, prepay doctors for procedures to be performed; pre­pay your January property tax bill in December; and make an extra mortgage payment in December.

• Hire family members

Hiring your child can be a great way to shift some income at lower tax rates to your kids. Also, a child with earned income can invest in a Roth IRA. The taxes can be fairly inconsequential. For example, a twelve-year-old can work in your office stuffing envelopes, filing papers, and running errands, earning $2,000 per year. If you invest that money for the child in a Roth IRA, with average returns of 8% per annum, that investment during the teen-age years will turn into approximately $500,000 of tax-free funds by retirement age. That’s not a bad way to fund your child’s inheritance while taking a tax write-off in your business.

• Safe Harbor — See above for an explanation of this planning tool.

While recent tax law changes have been marginally helpful in reducing many taxpayers’ federal income tax bills, it has pushed many others into the dreaded Alternative Minimum Tax (AMT). AMT is the bane of every tax professional’s existence. It often prevents them from planning for tax consequences for their clients because the outcome will be changed due to AMT. AMT could void some of these planning techniques.

It is critical to constantly communicate and plan with your tax professional prior to taking advantage of any possible tax law changes. These deductions could backfire and create more tax liabilities due to the pervasive applicability of AMT.

Assisting with the editing of this article were William A. Dylewsky and Larry S. Goldberg.