Strategies to keep your tax bill at its legal minimum, year after year.
By Mark E. Battersby
Now is the best time to think about reducing your operation’s tax bill—even lower than the point the economy may have driven it to. And, of course, to keep that tax bill at its legal minimum for many years to come.
While many of us rely on the advice and help provided by tax professionals or utilize software programs to ensure a low tax bill, the real goal should be a low tax bill not just for this tax year but year after year. The best guarantee of consistently low tax bills, this year, next year and down the road is, of course, careful tax planning.
Tax planning is easy, on the face of it: the more tax deductions taken, the lower your businesses’s taxable income will be—at least for this tax year. Of course, ignoring potential tax deductions this year might mean significant savings in later years when profits—and tax bills—could be higher. Either way, in order to count, the time to make the moves necessary to ensure those low tax bills is before the end of the tax year.
Tax planning basics
When thinking about any type of tax planning, every fabricator should keep in mind that, although the IRS may occasionally disagree, the courts strongly back every taxpayer’s right to choose the course of action that will result in the lowest legal tax liability. As the end of this tax year fast approaches, that gives every business several different options as to how to complete certain taxable transactions.
Our tax system has graduated rates that increase along with income at various tax rates. One obvious strategy for saving taxes means reducing the tax bracket of your operation. Getting the most from the temporary 15 percent tax rate for dividends means finding another way to reduce corporate level income, and thereby taxes.
Obviously, neither a specialty fabric products business nor any business owner can literally reduce the federal income tax rate. You can, however, take actions that will have a similar effect. For example:
- Choosing the optimal form of organization for your business (such as sole proprietorship, partnership, corporation or S corporation). Although not a year-end tax planning strategy, this option deserves attention in the overall tax planning process, especially in light of the current (and temporary) 15 percent tax rate on dividends paid by incorporated businesses.
- Structuring transactions so that payments received are capital gains. Long-term capital gains earned by non-corporate taxpayers are subject to lower tax rates than other income.
- Shifting income from a high tax bracket individual (such as you, the business owner), to a lower tax bracket individual (such as your child). One fairly simple way to accomplish this is by hiring your children. Another possibility is to make one or more children partners in the business, so that net profits are shared among a larger group.
While the tax laws limit the usefulness of this strategy for shifting “unearned” income to children under the age of 14, some opportunities to lower tax rates still do exist. The time to think about those strategies is during the course of the tax year.
When to take tax deductions
There is also the question of whether a tax deduction should be taken or, if legally feasible, be ignored. Although the goal is usually to reduce taxes this year, to be really effective the tax bracket should be consistent year after year. If income is up this year but expected to be down next year, for instance, you may want to postpone asset sales or other unusual transactions until next year, when the additional profits may not be as likely to put your operation into a higher tax bracket. Or, conversely, if income and profits are down this year, disposing of unneeded equipment or business assets through a profitable sale just might generate extra income—income taxed at the current low tax rates.
Depending on the circumstances, a number of legitimate strategies that can be employed before year’s end can help you remain in the same bracket this year, next year and for many years thereafter. Those basic year-end savings strategies include:
- Delay collections. A cash-basis textile products operation can delay year-end billings or processing credit card receipts until late enough in the year so that payments will not come in until the following year.
- Accelerate payments. Wherever possible, prepay deductible business expenses, including rent, interest, taxes, insurance, and so on. Keep in mind that the tax rules limit tax deductions for some prepaid expenses.
- Accelerate large purchases. Close the purchase of depreciable personal property or real estate within the current year.
- Accelerate operating expenses. If possible, accelerate the purchase of supplies or services, or the making of repairs.
Naturally, what a business can do depends a great deal upon the accounting method used by that operation. A cash basis business, for example, deducts expenses as paid, and receipts become income when received, or made available. An accrual-basis business realizes income when billed and expenses when incurred—regardless of when income is actually received, or when payment is made.
Recovery and reinvestment
The American Recovery and Reinvestment Act (ARRA) earlier this year extended a number of expiring provisions and created a few more that will affect the year-end planning process. For example:
- First-year 50 percent bonus depreciation. ARRA extended the 50 percent bonus first-year depreciation allowance available for 2008 into 2009.
- Increased Section 179 expensing. During 2009, businesses can choose to expense and immediately deduct up to $250,000 of the cost of qualifying property and equipment. The $250,000 maximum expensing amount is reduced when the cost of all Section 179 property placed in service in 2009 exceeds $800,000.
- S corporation built-in gains holding period. For tax years beginning in either 2009 or 2010, ARRA eliminates the corporate level tax on the built-in gains of an S corporation that converted from regular ‘C’ corporation status at least seven tax years before the current tax year.
Expiring tax provisions
To make year-end planning more urgent than usual, a number of provisions in our tax law expire in 2009. Among the expiring provisions:
- The tax credit for research and experimentation expenses
- Increased alternative minimum tax (AMT) exemption amounts
- 15-year straight-line cost recovery for qualified leasehold improvements, and qualified retail improvements
- Expensing of “brownfield” environmental remediation costs
- Empowerment zone tax incentives
- Tax incentives for investment in the District of Columbia
- Renewal community tax incentives
- The Federal Unemployment Tax Act (FUTA) surtax of 0.2 percent
- Reduced estimated tax payments for small businesses
No transaction should be undertaken for tax purposes
While there is a great deal of pressure on many businesses to continue cutting costs, including taxes, the increased scrutiny tax returns face adds yet another goal: that of not running afoul of cash-strapped state and local tax authorities. Another key factor in tax planning is the often-overlooked maxim that no transaction should be undertaken only for tax purposes.
One excellent illustration of the flexibility of our tax rules is those governing bonuses. A business operating on the accrual basis has the opportunity to fix the amount of employees’ bonus payments before January 1, but to pay them early next year. Generally, the bonuses are not taxable to employees until 2010, but are deductible on the operation’s 2009 tax return, as long as they have been announced before the end of 2009, and paid before March 16, 2010.
On the other hand, while few businesses may be in a position to pay employee bonuses, a business can also benefit by delaying income until next year. Income is “constructively” received whenever it is made available to the business.
Although tax planning should be a year-round process, a number of year-end strategies can reduce not only this year’s tax bill, but future tax bills as well. Whether your operation is facing a large tax bill or severely lower taxable income, professional tax planning advice is almost a necessity. Your tax accountant should be able to help you draft a plan to make the most of your assets—and your liabilities.