Last Call for Tax Planning

There are few things retailers can do after December 31 that will significantly reduce their tax bill for the previous year. However, proper year-end tax planning can have a significant impact on the April 15 bill — and on many tax bills down the road.

Tax planning involves the timing and method by which income is reported and deductions and credits are claimed. Retailers want to time income to fall in years when it will be subject to the lowest tax bite, and time deductible expenses to fall in years when they will offset income subject to a higher tax rate.

The first step in tax planning is to maintain accurate and up-to-date business records that separate different types of income. By separating different types of income, the taxpayer can lower the amount of tax owed. For example, gains from the sale of assets, as opposed to general revenues, are taxed at the lower capital gains tax rate. Retailers must also break business expenses into deductible expenses, personal expenses, and capital purchases.

The year's end offers a chance to balance the timing of income and deductions between the current and upcoming year, for maximum tax advantage. Deferring income to next year may provide tax benefits, especially if the business is expected to be in a lower tax bracket. Many businesses (especially those using the cash method of accounting) can prepay some business expenses, as expenses are deductible in the year they're incurred.

On the income side, delayed billing, foregoing advance payments, or sluggish collection efforts are legitimate methods of delaying income until the following year. However, leaving uncashed checks in a drawer until January won't work. All income actually received during the tax year is taxable.

Tax planning is not only effective in a high-income year, it's equally important for your not-so-prosperous years. Planning benefits businesses hard hit by acts of nature, thefts, or other casualties. For example, a loss from theft or embezzlement is generally deductible for the tax year it is discovered. In the case of a loss from a disaster that warrants federal assistance, a special timing rule exists to help cushion the loss. However, the election to deduct a 2004 disaster loss in 2003 must be made before the due date of the 2004 tax return.

Owners of incorporated businesses have an option when taking profits from their operation. Compensation expenses are deductible at the corporate-level, while dividends are not. Compensation, however, continues to be taxed at rates as high as 35 percent at the individual level, while dividends are taxed at only 15 percent.

One planning strategy might involve methods other than compensation to reduce the incorporated gift business's tax bill — retirement plan contributions and interest deductions are two options. This simple strategy, combined with a return to paying dividends to shareholders, might offer the best of both worlds.

A tax credit is a dollar-for-dollar reduction in the amount of tax that a specialty retailer owes. Unlike deductions, which merely reduce the amount of income subject to taxes, a credit reduces the actual amount of tax owed. And yes, there are still tax credits in our tax rules. Two of them are:

• Disabled Access Credit. In accordance with the Americans With Disabilities Act, any eligible small business is entitled to a nonrefundable, disabled access income tax credit for expenditures incurred in making a business accessible to disabled individuals. The credit is equal to 50 percent of the amount of eligible yearly expenditures between $250 and $10,250.
• Pension Start-Up Credit. For tax years after 2001, if a retailer begins a new qualified defined benefit or defined contribution plan (including a 401(k) plan, SIMPLE plan or simplified employee pension plan) he or she can receive a tax credit of 50 percent of the first $1,000 in startup costs.

Year-end tax planning should include a review of your operation's current business structure. But remember, taxes are just one consideration when it comes to the structure of a business entity.

With certain exceptions, an S corporation does not pay federal corporate income taxes. Instead, S corporate income, losses, deductions, and credits "pass through" to the owners to be reported on their individual tax returns. Thus, S corporation income is taxed only once — to the shareholders — unlike regular 'C' corporation income, which is taxed twice — once to the corporation and again to the shareholder as dividend income

Like a corporation, a limited liability company (LLC) provides its owners with protection from personal liability for business debts and obligations. But most LLC owners can choose to have their businesses treated as partnerships for income-tax purposes. Partnership treatment means that income, losses, deductions, and credits pass through to the owners to be reported on their individual income tax returns; LLC income is not subject to double taxation, and an LLC can allocate income and expenses among its owners to the same extent that a partnership can.

Although the Internal Revenue Service occasionally disagrees, the courts strongly back taxpayers' right to choose the course of action that will result in the lowest tax liability. Tax planning, therefore, is a process of looking at various options to determine whether, when, and how retailers should handle transactions so that taxes are reduced or even eliminated. Remember, however, that tax law requires the transaction to be completed before the end of the tax year.