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Act now to lower your unemployment tax next year

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in Small Business Tax Deduction Strategies

Your company is generally required to pay tax into a state unemployment-insurance fund. Although the figures vary from state to state, the pay-in is usually determined by the ratio of your payroll to the reserve in your account.

Strategy: Make a voluntary contribution to your account this year. By taking this proactive approach, you’ll increase the amount of the reserve in your account. And, if you’ve figured things right, you can push up the reserve just enough to drop your company into a lower tax bracket next year.

In fact, you can save literally hundreds of tax dollars with this push/pull strategy.

Example: Pay now, benefit later

Say your company has a taxable annual payroll of $250,000 and a net credit of $24,900 in its unemployment tax account. At the current payroll-to-credit ratio, your company must pay unemployment tax of $1,500 a year. But if your company had a credit of $25,000 — or just $100 more — your tax bill would be cut in half to $750.

So, assuming your state permits voluntary contributions, you should kick in an extra $100 to qualify for the lower tax rate. Result: You save $650 ($750 tax savings minus $100 additional contribution).

How can you tell how much you need to contribute to the unemployment fund to reduce the tax rate? Your state will notify you about the reserve balance in your unemployment insurance account. When you compare that figure to your average payroll (in some states, the average taxable payroll is the critical figure), you can determine your reserve ratio. The states regularly publish tables indicating how the tax rates line up for employers with different reserve ratios.

Crunch the numbers first

Of course, this tax strategy works only if your account is near the bottom of a tax bracket. In our example above, if your company had to contribute an extra $1,000 to drop it into a lower tax bracket, it wouldn’t be worth it. You’d lose $250 overall ($1,000 additional contribution minus $750 tax savings).

Another potential downside: By reducing your tax rate for next year, you may end up paying a higher tax rate in future years. That’s because the additional funds will reduce the flow of funds into your unemployment-insurance account. Still, you’re usually better off paying less tax now and using the savings for working capital.

If your state law allows it, condition acceptance of the voluntary contribution on an actual decrease in your unemployment- insurance tax rate. To be deductible for federal income taxes, the extra contribution must reduce your tax rate.

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