The last two years have been a challenging period for most businesses. Even though the credit crisis and general economic downturn has placed significant pressure on corporate earnings, there are numerous tax provisions that can minimize current-year taxes and maximize after-tax cash-flow.
Since federal and state tax rates are likely to rise in the coming years, taxpayers must evaluate both the 2009 and future impact from deferring income or accelerating deductions. With that said, it will still generally be advisable to pay less tax now and then plan for future years.
Following are some examples of the myriad of tax-planning opportunities that should be evaluated at year-end to mitigate the economic challenges facing businesses:
- Bad Debt Expenses. While wholly worthless bad debts may be difficult to document until there is no reasonable expectation of collectability, partially worthless bad debts can generally be claimed in the year in which the taxpayer writes off (versus simply recording a reserve) the bad debt on their financial statements and tax return. See Treas. Reg. Section 1.166-3. Therefore, a full evaluation of year-end trade and non-trade receivables is advisable. View Bad Debt Deductions in a World of Uncertainty for more information on bad debt deductibility.
- Inventory Write-Offs. Inventory comprises a significant asset for many taxpayers. To the extent the taxpayer owns, “subnormal goods.” See Treas. Reg. Section 1.471-2(c) including inventory items that have become obsolete or subject to design changes, etc and that have been offered for sale to third-parties at prices below the owner’s tax basis in such items before year-end, the spread between tax basis and the fair market value of the inventory may be deductible to the extent the value of the inventory items are offered for sale prior to year-end, even if not actually sold. Consideration should also be given to scrapping or donating certain inventory items.
- Eco-Tax Credits. An often overlooked federal and state tax benefit involves the various energy and pollution control “eco-credits.” A review of federal IRS Form 3800 provides details regarding the various business tax credits available for energy and pollution control. Such credits include alternative-fuel vehicles, certain, cogeneration units, bio-mass equipment, wind, solar and geo-thermal equipment and alternative-fuel stations. These credits can range from 10 percent to 50 percent of the cost of the qualified equipment and can make such investments more cost-effective for those “early adopters” of green technologies. Most states also have some form of tax credits for specified equipment. See Tax Incentives "Energized" in 2009 Stimulus Package for additional information.
- Cash-Basis Taxpayers. Year-end planning for cash-basis taxpayers is even more critical since action must generally be taken prior to year-end to secure deductions. Therefore, a full assessment of tax deductible liabilities should be undertaken and such payments should be made by year-end. Exceptions to this rule, whereby deductions can be claimed in 2009 even though payment does not occur until 2010, include “payment” of tax deductible expenses via a credit-card charge prior to year-end. The acquisition of business assets by year-end — even though such property will be financed on an installment basis — can still yield bonus depreciation and Section 179 expense benefits in excess of any 2009 cash payments made. Often the largest accelerated tax deduction and longest deferred payment option involves funding of qualified retirement plans such as pension and profit-sharing plans, which can be delayed up to eight and one-half months after year-end for those taxpayers that make valid extensions of time to file their related income tax returns.
- Forms of Doing Business. The legal structure of business operations should also be evaluated at least once a year. We still find closely-held businesses operating as C Corporations (C Corps), which may not make the most sense for the long-haul. In addition to complicating future business sale transactions, the double-taxation applicable to C Corps can be very costly to the owners over the years of operations. With the general decrease in asset and company values over the last two years, a conversion to S Corporation (S Corp) status may make sense because the “built-in gains” exposure may be less now as compared to a future election. See IRC Section 1374. Such a conversion can generally be made for calendar 2010 provided the corporation meets the various S Corp requirements and IRS Form 2553 is filed by March 15, 2010, for calendar-year taxpayers.Business owners should also evaluate whether new business divisions/ventures should be operated in separate legal entities, such as an LLC, partnership or S or C Corp. For example, a leveraged real-estate venture will often be better positioned in an LLC or partnership versus an S Corp or C Corp, in order to ensure that the equity owners have adequate tax basis in their equity interests and also to allow for more tax-efficient transfers of equity interests.
- Incentive Tax Credits. There are over 8,500 distinct federal and state incentive-tax zones throughout the state. These zones provide for hiring-tax credits and occasionally other incentives ranging from equipment credits, sales-tax exemptions, property-tax reductions, “tax holidays,” grants/low-interest loans. These programs include state Enterprise Zone Programs (hiring credits ranging from $500 to $15,000 per “qualified” employee), Federal Renewal Communities ($1,500), Federal Empowerment Zones ($3,000), Indian Tribal Lands ($4,000), Rural Renewal County ($4,800) as well as an assortment of other programs. These programs are fairly easy to access, yet a large percentage of companies completely overlook these valuable benefits. Federal credits can be claimed for the current year, plus up to three years back. Many of the state programs can also be claimed retroactively. See Have Your Clients Taken All the Credits They Deserve? Better Look Again for more details.
- Compensating Employees. Even during these challenging times, employers strive to fairly compensate their top-performing workers. Accrual basis taxpayers can claim 2009 deductions for accrued bonuses that are paid to non-equity owners within two-and-one-half months of year-end. Employers can also claim deductions for the value of the property given to employees in exchange for their services. IRC Section 83 generally allows an employer deduction in the year the employee obtains a “vested” interest in the property or when the employee makes an affirmative election to include the value of the property in their taxable income. This provision can work well for either an accrual basis or cash-basis employer who wants to claim a noncash deduction. Transferred assets can include a vehicle given to an employee, company stock, an interest in an LLC or piece of real estate, etc. Additional information can be obtained by reading Section 83: Property in Exchange for Services.
- Alternative Minimum Tax (AMT) Planning. Every year more taxpayers find themselves subject to the AMT. While this is not necessarily good news, there are many tax-planning strategies to mitigate the impact from AMT. Since the maximum AMT rate is 28 percent and the maximum regular income tax rate is 35 percent (before factoring in various deduction scale-backs), taxpayers finding themselves in the AMT world should consider:
- Accelerating income into the AMT year, particularly since tax rate may increase in 2010 and later years,
- Deferring deductions (or opting for other tax accounting methods) which represent add-backs for AMT purposes. For example accelerated depreciation (other than bonus depreciation), statutory depletion for oil and gas, etc.
- Accelerating deductions that do not generate AMT preferences, such as bonuses, inventory write-downs, expensing of supplies, etc.
Additional AMT strategies are discussed in Six Counter-Intuitive Tax Planning Tips Revealed.
Gifting and Estate planning should also be considered during the overall year-end tax-planning process. By planning before year-end or shortly after year-end, taxpayers can minimize their 2009 tax liabilities and retain more of their hard-earned dollars for the holidays.
Blake Christian, CPA/MBT, is a tax partner in the Long Beach, California office of HCVT, LLP. Christian is also co-founder of National Tax Credit Group, LLC.