With tax season looming, it pays to review some of the ways to save big bucks on your returns. As you examine the 20 tax tips that follow, you will notice two recurring themes.
First, virtually every tax decision you make will have an impact on a succeeding year. If you have an idea of what your financial situation will be like a year from now, plan accordingly. Second, today’s tax planning is focused primarily on economic investment rather than taxes alone. Business decisions must drive tax planning, not the other way around. Consider these strategies:
1. Defer or accelerate deductions
Take your deductions in the year they’ll help you the most. If you are confident you will be in a higher bracket next year, wait to make some of your charitable contributions; you will receive a larger benefit next year than you would this year. If you foresee a drop in income, accelerate deductions to get the most savings now.
2. Make charitable contributions of appreciated assets
Charitable contributions create goodwill and make good sense, so consider gifting appreciated assets. By avoiding capital gains taxes, you’ll wind up getting money back from Uncle Sam instead of adding him to your list of charities.
3. Offset capital gains with capital losses
You made $100,000 on stocks this year. Now it’s time to pay capital gains taxes. The bill: $28,000. Scrutinize your portfolio and sell off any losing stocks. Your capital losses will help offset your gains. Remember, however, that if you sell a stock at a loss, you can’t repurchase the identical security within a 61-day window (from 30 days before the sale to 30 days after).
4. Take advantage of like-kind exchanges
Thinking of selling off an old piece of equipment for which the fair market value exceeds your tax basis? Take it to your equipment dealer, apply the fair market value toward the price of a new piece of equipment, and save the cash that you would have paid in taxes on the gain.
Like-kind exchanges can also apply to real property. If you have your eye on a building and you know someone that wants one of your buildings, have that person buy the building you want and trade for yours.
5. Don’t trade in the company car, sell it
This is the same rule as No. 4 but in reverse. Say your old car has economically depreciated faster than the tax rules allow. Trading in your old car is easy but you can’t deduct the loss. Better to sell the old car, deduct the loss, and apply the cash proceeds toward a new car. (Keep in mind that you will pay more sales tax this way.)
6. “Bunch” miscellaneous itemized expenses
Professional service fees, such as those paid to consultants and attorneys, are only deductible to the extent that they exceed 2 percent of your adjusted gross income. If you don’t incur enough professional service expenses in any one year, consider “bunching” two years of expenses together so that the majority of the expenses fall in the year in which you will receive the greatest tax benefit.
7. Document charitable contributions thoroughly
Remember, 1994 is the first year of the new charitable contributions substantiation rules. For any cash contribution over $250, you must have written documentation from the charity supporting the deduction or it can be disallowed.
8. Invest in tax-free municipal bonds
In the current economic climate, you may be better off investing in tax-free municipal bonds rather than taxable investments. Tax-free bonds are currently yielding a higher after-tax rate of return than their taxable counter parts
9. Optimize accounts receivable
Each year, review your accounts receivable and consider at what level your bad debt reserve should be maintained. The bad debt reserve—which holds doubtful accounts while you wait to see if they will be paid— should be as small as possible to maximize tax deductions for bad debt expense. In addition, maintain good collection procedures throughout the year, which will improve your cash position and minimize bad debt exposure.
10. Junk inventory if it can’t be sold
Have you analyzed your inventory procedures with an eye on reducing carrying cost, getting rid of obsolete or damaged merchandise, and writing down merchandise to salable values? Also, review overhead to ensure it is being treated in accordance with the Uniform Capitalization rules. If inventory costs are increasing, consider adopting the last-in, first-out (LIFO) method. LIFO will lower your tax bills by allowing you to treat your most recent purchases as the first goods sold. Keep in mind that if you use LIFO for tax purposes, you must also use it for financial statements.
11. Leverage property, plant, and equipment
Inspect your physical plant, and sell or abandon any unused equipment so you can deduct the remaining book value. If you are buying equipment, be aware that placing more than 40 percent of your new assets in service during the last three months of the year will subject you to the “mid-quarter convention,” which can reduce your depreciation deduction for the year. Also, don’t forget to expense up to $17,500 of personal property instead of depreciating it over a period of years. (Note: The availability of this provision is phased out for taxpayers who have more than $200,000 of qualified additions).
12. Formalize shareholder loans and expenses
Make sure that interest accrues and is being paid when due, to avoid the below-market loan rules. Noninterest-bearing loans to shareholders may be declared dividends that are nondeductible to the company. Also, any compensation, rent, or interest due to a more than 50 percent shareholder of a C corp or a more than 2 percent owner of an S corp or partnership must be paid in cash before year-end in order to receive current-year deductions.
13. consider stock gifts to children
Consider income and estate tax implications of a gift or other transfer of ownership of S corporation stock. If stock is given to a child over 14 years old, income tax will be paid at the child’s lower tax bracket, easing the family’s tax burden.
14. Review qualified pension and profit-sharing plans
Are you funding your pension or profit-sharing plan to the maximum deductible amount allowed to build up your funds and get a larger tax deduction? If not, consider doing so.
It also might be time for a new plan that will better benefit your company and employees. Consider an age-weighted retirement plan for the older individuals. If you don’t have enough cash, extend your income tax return so you get an additional six months to fund the contribution.
15. Document entertainment expenses properly
Review documentation for autos or planes to make sure business use exceeds 50 percent. If your company has tickets to special events, you must document the business purpose of the expense and which members of your staff and clients’ organizations actually used the tickets. If you don’t, your deduction can be disallowed. Remember that effective in 1994, meals and entertainment are only 50 percent deductible and most club dues are nondeductible.
16. Attend educational seminars
The cost of tuition, books, supplies, transportation, meals (50 percent deductible), and lodging are deductible if education maintains or improves skills used in your business.
17. Amortize intangible assets
Have you bought a business (or a portion of one) since July 25, 1991? If so, the intangible assets, such as goodwill, customer lists, and non-compete agreements are amortizable over a 15-year life. For businesses purchased before August 1993, elections must be made to apply these provisions retroactively back to July 25, 1991. After July 1993, amortization is required by the new law.
18. File business information returns correctly and on time
Make sure you file every required information return correctly and on time (most are due to recipients by January 31). If you have 250 or more returns, you must file on magnetic media. Heavy penalties (up to $100,000) can be assessed for not filing or filing incorrectly.
19. Consider establishing an asset protection trust
For professions in which excessive liability exposure exists, an offshore asset protection trust might help, even though it is expensive. A family partnership or trust may be a less costly and drastic option. Since such options are domestic, costs are greatly reduced and the protection is still there, although it’s not as bulletproof. Partnership or trust distributions may be attached by creditors or litigants. However, creditors cannot require you to make distributions. This strategy is better than nothing and is adequate for most individuals. Warning: you can’t use this method if creditors and litigants are knocking on your door.
20. watch congress in ’95
Both Democrats and Republicans are talking about a middle-class tax cut. There is a possibility that tax rates in 1995 will be lower than 1994 for some, if not all, taxpayers. Early measures that have been discussed include:
- A $500 per child family tax credit.
- Elimination of the marriage penalty.
- Expansion of deductible IRA accounts.
- Reducing long-term capital gains tax rates.
- Liberalizing home office deduction rules.
- Increasing the annual amount of fixed-asset additions that can be expensed.
- Increasing the estate-tax unified credit.
- Modifying taxation of social security benefits.
- Modifying the Social Security earnings limit.
Stay tuned to the debate.
Alan Alport, is tax partner, Paul J. Harris tax manager, with the Chicago accounting firm of Blackman Kallick Bartelstein.