Accountant: minimizing liability can shrink tax burden

Real Estate Weekly, Nov 7, 2001 by Martin H. Lager

Reducing tax liability can provide a key savings in challenging economic times. When clients come to me at tax time -- either with their personal returns or for their companies -- it's my job to ensure everything has been done to protect their assets.

Here is a guideline to help corporations and high-net-worth executives minimize their 2001 tax burden and position themselves to take advantage of future economic recovery. The helpful tax tips I recommend considering include:

* Defer Year-End Bonuses: Accrual basis C-corporations can deduct a current year bonus not actually paid to an employee if: (a) the employee does not own more than 50% in value of the corporation's stock, (b) the bonus is properly accrued on its books before the end of the current tax year, and (c) the bonus is actually paid within the first 2 1/2 months of 2002. In addition, a cash basis employee who defers the income before it is earned will not be taxed until actual receipt.

* Defer Bad Debt Cancellation: Cancellation of debt generally results in taxable income to the debtor to the extent that the amount settled for exceeds the outstanding debt balance. If a taxpayer is planning to make a deal with creditors involving debt reduction, consideration should be given to postponing action until after year-end.

* Realize Capital Loss On Stock While Preserving Investment Position: In some instances, it may be beneficial to dispose of a stock position in order to recognize the capital loss. In the event the stock is an attractive long-term investment, a taxpayer may want to both preserve the position and realize the loss to the extent possible. The "wash sale" rule prohibits the recognition of loss where substantially identical securities are bought and sold within a 61-day period (30 days before or 30 days after the sale). Thus, while a taxpayer cannot simply sell the stock and buy it back that same day, the risk of loss can be limited to a 30-day period.

* Pay Contested Taxes And Other Deductible Expenses: Both accrual and cash basis taxpayers deduct contested taxes and expenses in the year paid even though the ultimate results of the contest are uncertain. Accordingly, taxpayers can pay and deduct a contested tax or expense prior to year-end, thereby requiring recognition of income in the event of a favorable future disposition resulting in a refund.

* Free Up Suspended Passive Activity Losses By Disposing Of Activity: Losses generated by passive activities may only be used to offset income from passive activities.

The losses cannot be offset against actively earned income such as salary or port folio income such a interest and dividends. Passive activities generally include any activity in which the taxpayer does not materially participate. Rental activities and limited partnership interests are normally treated as per se passive. Selling or otherwise fully disposing of a passive activity may be one way to "free-up" suspended passive activity losses. In the event of a complete disposition, any current year, as well as prior year suspended losses are fully deductible.

* Increase Withholding To Avoid The Imposition Of An Underpayment Penalty: Individuals who have underpaid an estimated tax installment are subject to a nondeductible penalty. In addition, individuals cannot avoid the penalty by simply increasing the estimated tax payment or a later period, even though such payment will reduce the period for which the penalty applies. Income tax withheld by an employer from an employee's wages or salary is deemed to have been paid equally over the four installment due dates, unless the individual establishes the dates on which the amounts were actually withheld. Therefore, if an employee increases his withholding prior to year-end, it may be possible to retroactively avoid the penalty.

* Time Insurance And Damage Claim Settlements: In general, a casualty loss is deductible in the tax year during which it occurs. That having been said, a casualty loss is not sustained to the extent that the taxpayer has a claim for reimbursement of a loss on which there is a reasonable prospect of recovery. The taxpayer is entitled to a deduction at the time when it is actually determined that he is entitled to an insurance or other payment smaller than his loss. As a result, a taxpayer who suffers a casualty loss in 2001 or earlier, and is in the process of settling a damage claim as year-end approaches, may have the chance to determine the timing of the loss. In the event the matter is close to settlement, it may be beneficial to finalize the settlement an realize the loss in 2001.

* Use Installment Sale To Defer Gain On Sales: Ordinarily, the entire profit from a sale is taxable in the year of sale. However, by making a current year sale with part or all of the proceeds payable in subsequent years, a non-dealer seller is only taxed in any year on that proportion of the profit represented by the payment received. Thus, an installment sale is an effective technique for closing transactions in 2001, while deferring substantial tax on the gain to later years. Since the election out of recognizing gain under the installment method (i.e., recognizing the entire gain currently) is made in conjunction with a timely filed return (including extensions), a taxpayer making a qualifying sale in 2001 has until 2002 in which to decide how best to structure the sale from a tax perspective.