Year-end tax strategies for smalls - small businesses

Nation's Business, Dec, 1987 by Joan C. Szabo

Year-End Tax Strategies For Smalls

Tax experts are warning small-business owners that they should expect to deal with a host of complex changes in their next tax returns as a result of the implementation of the Tax Reform Act of 1986.

"Tax planning takes on added importance this year because of the complexity of the new law. This fact greatly increases the potential dangers for the unwary," says Richard Shapiro, national director of tasxes for the New York accounting firm of Oppenheim, Appel, Dixon & Company.

Internal Revenue Service Commissioner Lawrence B. Gibbs recently advised an audience of certified public accountants: "It's going to take more time to gather the necessary information and prepare the return. Tell your clients to start early."

Tax specialists say the most important first step in mapping your year-end tax strategy is to determine whether your company is subject to the corporate-alternative-minimum tax (AMT), which was expanded under tax reform. (The AMT does not apply to Subchapter S corporations, however.)

The aim of the AMT is to assure that companies and individuals will pay taxes, regardless of the extent of deductions or other exclusions they can claim.

"It is exceedingly important for a business to get a good handle on the alternative-minimum tax," says Shapiro. And he's referring to smaller companies as well as larger ones. "The AMT covers significant portions of U.S. businesses," Shapiro says.

Under tax reform, companies figure their taxes using the regular system at the top corporate rate of 34 percent and again under the minimum-tax method at a 20 percent rate. A company's tax liability is the higher of the two figures.

The AMT excludes many breaks available under the regular system. Depreciation is less generous, and there is a tax on half the difference between book earnings reported to shareholders and taxable income reported to the Internal Revenue Service.

If you are a small-business owner using Form 1040, the individual AMT rate is 21 percent. But here again, a number of deductions are not allowed in calculating this tax. Just as with the corporate AMT, you figure your taxes employing the regular tax system and again using the minimum-tax method, then pay the higher of the two figures.

If you are subject to the AMT, the traditional approach to year-end tax planning--deferring income and accelerating deductions--may or may not be to your advantage, says Sam Starr, tax manager in the Washington office of Coopers & Lybrand, the accounting firm.

For corporations subject to the AMT in 1987, deferring income into a 1988 regular tax year could generate permanent tax savings due to the drop in regular tax rates. This permanent tax savings might be reflected in an increased minimum-tax credit available against regular tax in future years.

The maximum corporate-income-tax rate was cut from 46 percent to 34 percent on July 1 of this eyar. For companies with income under $75,000, there are two lower rates. In addition, companies that operate on calendar years face a top rate of 40 percent this year.

The 1987 marginal-tax rate for individuals is 38.5 percent. Next year, there will be two official brackets--15 percent and 28 percent. But the marginal rate can go as high as 33 percent on joint returns reporting taxable income between $71,900 and $149,250 and single-taxpayer returns between $43,150 and $89,530. At the lower end of that range, taxpayers begin losing the benefit of the 15 percent rate applying to the first $29,750 of tasxable income for married couples filing jointly and $17,850 for single taxpayers. At the high end of the range, taxpayers begin losing the value of personal exemptions.

Here are some other year-end tax considerations:

Deferring income may still reduce your tax bill. If you are not subject to the AMT, a worthwhile tax strategy is to defer income until 1988. This strategy may be particularly helpful for a small company using the cash method of accounting.

A cash-basis taxpayer recognizes income when it is received and expenses when they are paid, while an accrual-basis taxpayer recognizes income when services and products are rendered and expenses as they are incurred.

Notes Randall Corwin, a tax partner in the New York accounting firm of Seidman & Seidman/BDO, "If you defer income until next year, you don't pay taxes on that income until you pay your 1988 income tax. In addition, you enjoy a tax savings because the rates will be lower in 1988."

What steps can be taken to defer income? If you still use cash-basis accounting, you can delay the mailing of invoices until December 31. In this way, the income due on those bills is not received until 1988, advises Richard Talkov, a tax partner with the accounting firm of Laventhol & Horwath.

Look for ways to accelerate deductions. Deductions are worth more this year because tax rates are scheduled to drop in 1988. Cash-basis companies should bunch as many business deductions as possible into 1987, say tax experts.