YEAR END TAX PLANNING
Help Minimize Your
Company's 2006 Tax Bill
A basic principle of year-end tax saving is, accelerate deductible expenses into this year and defer income until next year. Of course, that doesn’t work in all cases. The right strategy for your company depends on several factors, including how you answer these questions:
Does your business operate on a cash or accrual basis?
Do you expect a profit or a loss for 2006?
Do you anticipate that 2007 will bring significantly higher revenue or expenses, or a tax bracket change?
Depending on the answer, you could be better off reserving some tax breaks for next year or New Court Case:
Accounting for Inventory Shrinkage
Astute inventory accounting at the end of the year can help improve the bottom line. But as one new Tax Court case illustrates, there’s no need to be greedy.
Facts of the case: The Tax Court ruled that a company could not increase reported purchases by the same amount it had properly allocated to inventory shrinkage. The result would have had the effect of counting the cost of goods twice.
The company’s dietary supplement business utilized a periodic inventory accounting method. The method required an adjustment to inventory at the end of the year to reflect the physical ending inventory count.
To compute the gross income of a business, cost of goods sold are subtracted from gross receipts. The cost of goods sold, in turn, is computed by subtracting the value of ending inventory for a year from the sum of beginning inventory and purchases during the year.
After a physical count was conducted, the company made an adjustment reflecting a $48,000 credit to inventory and an offsetting $48,000 debit to purchases.
The Tax Court agreed with the IRS that the taxpayer could not show that $48,000 in purchases replaced the lost inventory. The Court also said that including the $48,000 in purchases, as well as in its ending inventory, allowed the taxpayer to improperly increase its cost of goods. This effectively doubled the amount of actual inventory shrinkage. (Total Health Center Trust, TC Memo 2006-226)
pulling income into this year. Assuming your goal is to minimize your 2006 tax bill, here are 10 strategies to consider:
Equipment purchases. Have you taken full advantage of the Section 179 deduction? Rather than depreciate business equipment over several years, you can write off up to $108,000 for 2006. To qualify, the equipment must generally be used more than 50 percent for business (or you must keep track of personal use and reduce your deduction by that percentage) and the equipment must be put to use by December 31st.
Keep in mind, you can only use the Section 179 deduction to the extent you have taxable income. If it’s a close call, you can increase your income by limiting shareholder salaries and bonuses in order to use more of the deduction.
If your C corporation is operating at a loss in 2006 but you expect to turn a profit next year, you might want to save the expense and therefore, the deduction for 2007 (the maximum deduction will rise to $112,000 next year). Also, remember that the Section 179 deduction begins to phase out when you buy more than $430,000 in 2006 (increasing to $450,000 in 2007).
Push income into next year. If your business is cash-based, you don’t pay tax on income until it is received. If that’s the case, you can defer some income into next year by waiting to send out invoices until the end of the month, or by setting up installment plans that push most of the revenue of a sale into next year.
Bad debts. If your business is accrual-based, you can deduct bad debts in the year those debts become worthless. But to do that, you have to be able to show that the accounts are uncollectible. So act now to accelerate efforts to collect. Keep detailed records of collection calls, letters, and contacts.
Year-end bonuses. Accrual-based companies can deduct year-end bonuses for 2006, provided the amounts are paid within the first 2 and 1/2 months of the close of the tax year (by March 15, 2007). And, if the bonuses are paid after the end of the year, employees won’t pay taxes on the money until they file their 2007 returns. Lock in these deductions before January 1st by documenting your intention to pay bonuses in your corporate minutes and determining the amounts to be paid.
Caution: This special rule does not apply to all bonuses. Bonuses paid to C corporation majority shareholders or the owner-employers of an S corporation must be deducted in the year they are paid.
S corporations. If you anticipate a loss for your S corporation, keep in mind that shareholders can generally only deduct the loss to the extent of their basis in the corporation’s stock. Basis is equal to the amount of your investment in the company, with some adjustments.
While there is time, ask your tax adviser if it would be wise to increase your investment in your company to allow you to claim the full loss.
Stock up. Order supplies that you would normally buy in January and beyond. Don’t forget ink cartridges, business cards, stationery, and supplies such as paper towels and coffee. Even if you use a credit card and don’t actually pay for the items until 2007 or later, the cost will be deductible this year.
Rent or mortgage. Cash basis taxpayers should consider prepaying business rent or mortgage for January by December 31st. That provides 13 payments to write off this year.
Holiday party. With the holiday season at hand, you may be generating some fun and goodwill among the staff with a party — and you can generally write the whole thing off. Unlike entertainment expenses which are usually only 50 percent deductible, a company-wide get-together should be fully deductible.
Charitable contributions. This can be a tricky area for businesses. The IRS states that contributions which are not strictly charitable — such as those for which your company gets some tangible benefit — can be claimed as business expenses (for example, your firm purchases advertising on a program for a charity event), though not as charitable contributions. Deductions also depend on the type of entity you operate. Sole proprietors, partners, and S corporation shareholders may be able to deduct charitable contributions on their own tax return's Schedule A, while C corporations can deduct them on their business tax return, subject to limitations.
Retirement.Do yourself and your business a favor by contributing as much as possible to your retirement plan, within the deduction limits. Under most plans, you can make contributions right up to the due date of your 2006 tax return, including extensions. Even if you are the sole onwer without emplyees, you can establish a SEP (also known as a "Super IRA") on the dater your return is due (with extensions.)
If you haven’t yet established a plan, this might be a good time, but be aware that some plans, such as tradional defined contribution (profit-sharing) plans and defined benefit plans (pension) must be set up before year-end, or earlier, if you plan to make deductible contributions for 2006.
Call Ronald J. Cappuccio, J.D., LL.M.(Tax) at (856) 665-2121 for immediate help!