By Dan Fuller & David Hammond
April 8, 2010
One of my favorite tax quotes came from the prophetic Alfred E. Neuman, “today, it takes more brains and effort to make out the income tax form than it does to make the income.” In talking with a number of business clients they would tend agree. Because of this fact there is several tax benefits that businesses can take advantage of, but have a tendency to overlook.
One of them is cost segregation. When a company constructs a new building most of the cost for depreciation purposes ends up in the “building” category which is depreciated over 39 years. However, within the building there are a lot of subtleties in the application of the tax rules that can extract specific items providing an accelerated depreciation life of typically 5, 7 and/or 15 years. This benefit is further enhanced in 2009 with “bonus depreciation” which allows you to immediately expense one-half of the cost of these extracted items while being allowed to depreciate the remaining costs, too.
Another benefit which has been around for a few years is the Alternative Simplified Credit, which allows taxpayers to claim research tax credits based on their recent research expenditures, avoiding some of the complexities of the other available methodologies. The proverbial white lab coat and Bunsen burner is not a requirement for taking advantage of this credit. Many companies that are working to evolve their products and processes are conducting research that would qualify for the credit. With the state of the economy many businesses have focused on process improvements to drive down costs and increase throughput. Many of these improvements could be qualified research expenditures resulting in tax credits.
Use of the cash method of accounting instead of the accrual method is another way to save on taxes, especially for companies such as professional and personal service, construction, custom manufacturers leasing, and transportation companies. Essentially under the cash method companies do not have to record income at the time of a sale, but can wait until the cash is actually received. Likewise, expenses are only recorded when the company actually remits payment. This method is typically most beneficial to companies that have significant amounts of accounts receivable or a lapse in time between when their service is provided and when they actually get paid for the service, as it results in a substantial deferral of income. Companies with revenue greater than $10 million may be eligible to change to the cash method if their business is predominately service-based and they have no inventory.
Taxpayers that incurred income from the discharge of indebtedness from reacquisition debt in 2009 may at their election spread the resulting income pickup ratably over a five year period, thus deferring the associated tax cost of the discharge. Sound technical? How could this apply to a small business? An example of broad applicability of this occurs when a small businesses negotiates paying a vendor or other lender less than the amount due. Appling this rule the business may defer the recognition of income on the reduction in that debt for four or five years. Additionally, once they begin to recognize the income attributable to the discharge, they can pick it up ratably over a five year period. Many vendors and other lenders are open to this arrangement, as they likely have a current need for cash and are willing to get paid less than the face amount.
Another common tax misconception is that loss businesses do not have to engage in any federal tax planning as they will have no tax liability in the year of the loss. However, for many loss businesses this may not be the case given that refunds can be generated from the NOL by carrying it back to earlier tax years in which the business paid income taxes.
Generally a business can carry back an NOL to each of the two tax years preceeding the loss year and forward to each of the twenty tax years following the loss year. However, in a year that has seen the government stimulus programs such as “Cash for Clunkers,” the Federal Government has provided two “Cash for NOLs” programs that may benefit loss businesses with the correct fact pattern.
Earlier in 2009 the American Recovery and Reinvestment Act provided a tax election for small businesses (those with average annual gross receipts of $15 million or less) that could only be made for the tax year either ending in 2008 or beginning in 2008 that expanded the carry back period to three, four or five tax years for the elected tax year.
In these difficult economic times businesses of all sizes are looking to conserve cash and lower expenses. Given that taxes are a major expense tax planning has to be an important part of an overall business plan.
Dan Fuller, tax director, and Dave Hammond, tax partner, at BDO- the fifth largest accounting and consulting organization in the world -work out of BDO’s Grand Rapids, Mich. office. Dan can be reached at [email protected]and Dave at [email protected].