Year-end tax planning works best when you have either a new law or a change in tax rates. This year you have both, and along with them are opportunities for huge tax savings. Although the checklist that follows will get you started, it does not attempt to cover every situation, exception, or trap. The real purpose is to get you -- and your accountant -- thinking a bit ahead of time.
Your primary objective is to jockey both income and expenses into whichever year -- 1987 or 1988 -- will produce the lowest overall tax for both years, and your strategy depends on whether you're having a profitable year or expect to lose money. If you're profitable, you'll want to accelerate deductions in 1987, when they'll be most valuable, and defer income into 1988, when it will be taxed at lower rates.
If 1987 is going to be a loss year for your company, your best bet may be to increase the loss as much as possible. Why? You can carry your loss back to 1984, when your tax rate might have been much higher, allowing you to recover a cash refund for past taxes paid. Plus, the Internal Revenue Service will pay you interest on the refund.
Here are some actions for you to consider if you want to both reduce income and increase expenses for 1987.
To reduce or defer year-end income
* Delay shipping until 1988.
* If you must ship this year, ship FOB point of destination so the title does not pass until next year. (When the title passes is key.)
* Make sales on consignment or approval (sometimes called guaranteed sales). An outright sale with right of return is income, not a deferral.
* If you sell services rather than inventory, change your procedures to defer billing into the next month or quarter. (This will have to be a permanent change since the feds frown on frequent modifications to accommodate your tax needs.)
* If you have noninventory property -- building or equipment -- that will yield a loss if sold, sell the property (the loss is deductible in full), then lease it back.
* If a noninventory property sale will give you a profit, push the profit into 1988 by doing the deal through an escrow that will close next year. Or you could give up possession in 1987, but give the buyer an option to buy in 1988 or a lease with an option to buy.
* Instead of selling equipment and having to pay a tax on the income, trade it in and pay no tax.
To increase 1987 deductible expenses
* If equipment is obsolete, sell it or abandon it so you can deduct the remaining book value.
* Place depreciable property in service before December 31, 1987. You can take a half year of depreciation even if you start to use the property as late as December. (But beware: you lose that right if the property you put into service during the final quarter is more than 40% of the total put into service during the year.)
* Deduct as an expense up to $10,000 of tangible, depreciable personal property put in service in 1987 instead of taking depreciation on that amount over a period of years. Depreciate the balance. (In this context, the phrase "personal property" excludes real estate but includes, for example, equipment.)
* If you've bought a vehicle in 1987, deduct the cost of tires and tubes immediately if you believe they will last less than a year, whether the vehicle was purchased new or used. Then depreciate the balance of the vehicle as usual.
* Contribute inventories to charities for the ill, for the needy, or for children. You can deduct up to twice the cost of the inventories contributed.
* Have your board of directors fix officers' and directors' bonuses before year-end so you can accrue the expense in '87, but pay the bonuses in '88. A warning: compensation, rents, and interest due to a more-than-50% shareholder must be paid in cash on or before December 31 to be deductible in 1987. You cannot deduct such items by accruing them.
* Contribute the maximum deductible amount allowed to your qualified pension or profit-sharing plan. If you don't have a qualified plan, install one. You can make contributions based on salaries paid all the way back to the first day of your fiscal year.
* Get an automatic six-month extension on your tax return. You can then deduct on your 1987 return 100% of the amount owed to your qualified pension or profit-sharing plan during the extension -- up to eight and a half months after the end of your fiscal year. Here's how it works: say your fiscal year ends December 31, 1987. That means your taxes are due March 15, two and a half months later. The six-month extension would take you to September 15, 1988. All contributions made during that eight-and-a-half-month period can be deducted on your 1987 return.
* Finally, look for expenses that can be paid or accrued before the end of the year. Consider, for example, using the maximum allowable charitable deduction (10% of taxable income). Or maybe you can arrange to incur advertising, sales, promotion, and production and mailing costs of catalogs this year, so that benefits will be received next year. Another possibility is to order (and obtain) all types of noninventory supplies such as printed forms and sales brochures. And be sure to think about accelerating repairs.
Year-end tax planning is always a win-win situation. This year, changes brought about by the Tax Reform Act of 1986 should be your key consideration.