Professional Services Accounting ARTICLE -
Enjoy the View - Year End the Ideal Vista for Business Tax Planning

Target Audience: Paralegals, Law Firm Professionals, Lawyers, Law Firm Associates

Like mountain climbers reaching a great height, business owners should recognize year end as a sort of vista — the ideal place from which to reflect on the events of 2005 and look ahead to 2006. And this exercise is particularly important when it comes to income tax planning.

As the calendar winds down, review your business’s financial performance so far this year as well as your projected income and expenses for the coming year. Armed with this information, you may be able to reduce your overall tax liability by shifting income and deductions between 2005 and 2006.

Get it while you can

As a rule of thumb, you’ll most often want to defer taxable income to the next year and accelerate deductions into the current year, just because it’s better to pay taxes later rather than sooner. But, like most rules, there are exceptions. If your expected earnings in 2006 will lift your business or its owners into a higher tax bracket, for example, you may be better off shifting some income into 2005 and paying the tax at this year’s lower marginal rate.

Also, if your business is a C corporation and you don’t anticipate owing any taxes this year but expect to next year, consider shifting just enough income into 2005 to generate a small tax liability. In most cases, doing so will allow you to base your 2006 estimated tax payments on your 2005 tax liability, providing a nice cash flow boost. If you have no tax liability this year, you’ll need to base next year’s estimated taxes on your expected or annualized tax liability.

Wait ’til next year

When deferring income is your better option, you have many techniques at your disposal. If you have a cash-basis business, for example, you can delay sending out bills so that you don’t receive payments until early next year. At the same time, you can pay all your accounts payable before year end to get the deduction into this year’s return. If you haven’t gotten a bill yet, call to request one. And if you’re eligible for the installment method, you can use it to defer income on sales of noninventory property.

For an accrual-basis business, you may postpone shipping products or providing services until early next year, though don’t sacrifice customer service for tax planning. If you receive advance payments before you deliver goods or perform services, you can defer the income to next year if you meet certain requirements.

Also consider longer term strategies that allow you to defer income or gain. These include like-kind exchanges and sales of stock to an employee stock ownership plan.

Spare no expense

Income aside, there are other ways to lower your company’s 2005 tax bill. Among the most tried and true is taking advantage of depreciation rules by making planned equipment expenditures before year end. Under the “half-year convention,” you can claim six months of depreciation on most non-real-estate assets you place in service this year, even if you acquire them on Dec. 31.

But don’t overdo it. If you make more than 40% of the year’s equipment purchases during the last three months, you’ll trigger the “midquarter convention,” which may reduce your depreciation deductions for 2005.

Plan your purchases to make the most of the Section 179 expensing election as well. This year, you can write off the full cost of up to $105,000 in eligible assets. Keep in mind that the election’s benefits are phased out dollar for dollar once your total investment in Sec. 179 property for the year tops $420,000. Also, the expensing election is limited to your taxable income from the business, so you can’t use it to generate a loss.

Deduct with diligence

Of course, valuable deductions don’t begin and end with depreciation. If your business is on the accrual method, you may be able to take deductions for employee compensation accrued at year end — such as bonuses and vested vacation pay — provided you pay these amounts within the first 2 1/ 2 months of 2006.

But a company can’t accrue bonuses and other expenses owed to certain related parties, such as more-than-50% C corporation owners or any S corporation shareholders, partners in a partnership or members of a limited liability company. If you want to deduct related-party expenses for 2005, you’ll have to pay them by year end.

Last, regardless of your accounting method, remember that you can claim a deduction in 2005 for qualified retirement plan contributions. And these include amounts paid as late as the extended due date of this year’s tax return.

Weigh your options

We’ve mentioned just a few of the many strategies businesses can use to reduce taxes in 2005 and beyond. Every company is different, though, so be sure to work with your tax advisor to weigh your options and develop a year end tax plan that’s right for you.

Can you claim the home office deduction?

Just because you work from home doesn’t mean you should take year end tax planning any less seriously. In fact, you may qualify for the home office deduction. This can be a very attractive tax break because it allows you to write off a portion of your home-related expenses — such as utilities, insurance, maintenance and depreciation — that wouldn’t otherwise be deductible, but only to the extent of your net income from the business.

To qualify for the deduction, you generally must use a portion of your home “regularly and exclusively” for a trade or business. More specifically, your home office must be:

Your principal place of business,
A place where you regularly meet with patients, clients or customers, or
A separate structure used exclusively for business.
For example, your home office qualifies as your principal place of business if you conduct substantially all of your business there or you use it to conduct administrative or management activities and don’t conduct those activities from any other fixed location.

If you sell your home and otherwise qualify for the capital gains exclusion for a principal residence, beware that the depreciation deductions taken will result in a higher tax.

Find out how our expertise in professional services accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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