Year-end business tax planning is always a good idea. But this year will be remembered as a vintage year. Tax planning saves most money when you have either a new law or a change in tax rates. This year you have both.
There are three steps you must take before you can harvest a successful year-end crop:
1. Arrange for a special planning session away from the office where the tax planning team -- usually the company's top decision maker, top financial officer, and outside tax adviser -- will have enough time, without interruptions, to pinpoint financial and tax objectives and thoroughly analyze how to meet them.
2. Gather the essential financial information -- last year's financial statement and tax return, projected year-end financial statements for the current year, and a projected profit-and-loss picture for the next year.
3. Bring a checklist of possible tax moves to help achieve your objectives.
This article will provide the basics of your checklist. But first, let's talk about your objectives. The primary objective is to jockey both income and expenses into the year -- either 1981 or 1982 -- that will produce the lowest overall tax. Sometimes he strategy is simply to delay tax. But if 1981 was a loss year your best bet may be to increase the loss as much as possible.Your loss can then be carried back to prior year (when rates were higher), allowing you to recover a refund on past taxes. And the Internal Revenue Service will pay interest on the refund.
If your tax year doesn't end on December 31, save this checklist and use it when your year does end. And if you filed a return covering part of 1981 before the new law was passed, don't fail to file an amended return that takes account of the new tax changes.
For firms reporting profits on a cash basis (mainly service businesses), planning to minimize or maximize reported profits is relatively simple: The difference between the cash you take in and the cash you pay out is your profit for tax purposes. So if you want to reduce reportable income, simply pay your bills before year end, defer billing so you won't receive your customers' money until after year end, and prepay expenses coming up. If you need to increase your reportable income this year, do the reverse.
For firms reporting on the accrual basis, things are a bit more complicated. On the one hand, you can deduct many expenses you don't actually pay this year, such as bonuses, if you legally incur them within the year. On the other hand, you must count most sales as income even if you don't actually receive money for them. All the following points apply to businesses reporting on the accrual method, but many will provide useful ideas for companies using the cash method, too.
Most of these suggestions assume you want to reduce reportable income in 1981 as much as possible.If instead you want to increase 1981 reportable income -- perhaps because you expect to be in a higher tax bracket next year or you have a loss carryover that is about to expire -- you will want to consider the reverse of many of these suggestions.
BALANCE SHEET ITEMS
Many of the best opportunities for controlling profits for tax purposes occur as you review the balance sheet. Here are some important points:
* Write off all bad debts.
* Consider increasing your reserve for bad debts.
* Sell or give away obsolete inventory so you can write it off.
* If you keep damaged, old, or obsolete merchandise, make sure it is valued at its market price if that's lower than its cost.
* Make sure inventory levels and locations are designed to minimize state and local property taxes.
* Did inflation kick up the value of inventory and create phony -- but taxable -- profits? If so, switch to the last-in-first-out method of inventory accounting. (See "LIFO Saves," INC., January 1981.)
* If equipment is obsolete, abandon it so you can deduct the remaining book value, sell it, or trade it in. Tradeins are advantageous if market value exceeds book value, since you won't have to pay a capital gains tax.
* Property acquired anytime during 1981 can reap the substantial benefits of the new tax law. (See "How the Tax Cut Affects You," October.) Judge whether to acquire property either before or after year-end on the basis of which time will maximize he benefits of first-year depreciation and the investment tax credit.
* Formalize all debts (particularly to stockholders or officers). Issue notes at fair rates of interest, and pay the interest when due.
* Arrange to pay all expenses due to a holder of more than 50% of the company's shares within two and a half months of year-end so they will be deductible.
* Consider selling investments that show a loss so you can apply the loss against profits. If you have expiring loss carryovers, sell some successful investments to realize profits that can be offset by the past losses.
* Make sure that all excess cash is invested, and decide to what extent it's best to invest in taxable securities, tax-free municipal bonds, or dividend-paying stock of domestic corporations (which is 85% tax-free).
* Consider whether excess cash indicates the IRS may conclude you have accumulated too much earnings and require you to declare a dividend.
* Time dividends for the best tax advantages to the stockholders -- generally declare in 1981 and pay in 1982.
* Look at every asset and liability you haven't yet checked to determine if anything can be done to move income into the year that will be most favorable to your company.
IF YOU HAVE A CASH SHORTAGE
* Expenses due to the holder of more than half your shares can be paid with notes.
* If you have a pension or profit-sharing plan, you can delay making your contribution for 90 days if you get an automatic 90-day extension for filing your return. You can still deduct your payments in the current year, but the actual payment need not be made until five and a half months after the year ends.
* If the corporation overpaid its estimated tax, file a quickie refund claim with Form 4466.
PROFIT AND LOSS ITEMS
The following are possible ways to decrease income reportable on your profit-and-loss report:
* Delay shipping of products sold.
* Ship F.O.B. point of destination, so title doesn't pass to the buyer until after year-end.
* Make sales on consignment or approval.
The following ideas can increase deductions:
* Declare bonuses to employees, but be careful to pay the bonus to a controlling stockholder within two and a half months of year-end.
* Install a qualified pension or profit-sharing plan, declare a large contribution under your existing discretionary plan, or increase benefits under your existing defined benefit plan.
* Fix your liability for vacation pay clearly so you can deduct it.
Donate up to 5% of your profits to charity.
* Advertise benefits that will be received next year to your employees now so you can deduct them as liabilities this year.
* Obtain supplies you'll need later.
* Make needed repairs.
* Where possible, pay disputed amounts so you will be able to deduct the payments.
* Review all items on the P&L statement to see if any additional deductions can be taken.
Year-end tax planning is an "always-win" situation. But the key word is Planning.