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Year End Tax Planning

Help Minimize Your
   Company's 2006 Tax Bill

A basic principle of year-end tax saving is, accelerate deductible expenses into this year and defer income until next year. Of course, that doesn’t work in all cases. The right strategy for your company depends on several factors, including how you answer these questions:
  • Does your business operate on a cash or accrual basis?
  • Do you expect a profit or a loss for 2006?
  • Do you anticipate that 2007 will bring significantly higher revenue or expenses, or a tax bracket change?
  • Depending on the answer, you could be better off reserving some tax breaks for next year or

    New Court Case:
    Accounting for Inventory Shrinkage

        Astute inventory accounting at the end of the year can help improve the bottom line. But as one new Tax Court case illustrates, there’s no need to be greedy.
    Facts of the case: The Tax Court ruled that a company could not increase reported purchases by the same amount it had properly allocated to inventory shrinkage. The result would have had the effect of counting the cost of goods twice.
    The company’s dietary supplement business utilized a periodic inventory accounting method. The method required an adjustment to inventory at the end of the year to reflect the physical ending inventory count.
    To compute the gross income of a business, cost of goods sold are subtracted from gross receipts. The cost of goods sold, in turn, is computed by subtracting the value of ending inventory for a year from the sum of beginning inventory and purchases during the year.
    After a physical count was conducted, the company made an adjustment reflecting a $48,000 credit to inventory and an offsetting $48,000 debit to purchases. 
        The Tax Court agreed with the IRS that the taxpayer could not show that $48,000 in purchases replaced the lost inventory. The Court also said that including the $48,000 in purchases, as well as in its ending inventory, allowed the taxpayer to improperly increase its cost of goods. This effectively doubled the amount of actual inventory shrinkage. (Total Health Center Trust, TC Memo 2006-226)

    pulling income into this year. Assuming your goal is to minimize your 2006 tax bill, here are 10 strategies to consider:

    Equipment purchases.
    Have you taken full advantage of the Section 179 deduction? Rather than depreciate business equipment over several years, you can write off up to $108,000 for 2006. To qualify, the equipment must generally be used more than 50 percent for business (or you must keep track of personal use and reduce your deduction by that percentage) and the equipment must be put to use by December 31st.

    Keep in mind, you can only use the Section 179 deduction to the extent you have taxable income. If it’s a close call, you can increase your income by limiting shareholder salaries and bonuses in order to use more of the deduction.

    If your C corporation is operating at a loss in 2006 but you expect to turn a profit next year, you might want to save the expense and therefore, the deduction for 2007 (the maximum deduction will rise to $112,000 next year). Also, remember that the Section 179 deduction begins to phase out when you buy more than $430,000 in 2006 (increasing to $450,000 in 2007).

    Push income into next year.
    If your business is cash-based, you don’t pay tax on income until it is received. If that’s the case, you can defer some income into next year by waiting to send out invoices until the end of the month, or by setting up installment plans that push most of the revenue of a sale into next year.

    Bad debts.
    If your business is accrual-based, you can deduct bad debts in the year those debts become worthless. But to do that, you have to be able to show that the accounts are uncollectible. So act now to accelerate efforts to collect. Keep detailed records of collection calls, letters, and contacts.

    Year-end bonuses.
    Accrual-based companies can deduct year-end bonuses for 2006, provided the amounts are paid within the first 2 and 1/2 months of the close of the tax year (by March 15, 2007). And, if the bonuses are paid after the end of the year, employees won’t pay taxes on the money until they file their 2007 returns. Lock in these deductions before January 1st by documenting your intention to pay bonuses in your corporate minutes and determining the amounts to be paid.

    Caution: This special rule does not apply to all bonuses. Bonuses paid to C corporation majority shareholders or the owner-employers of an S corporation must be deducted in the year they are paid.

    S corporations.
    If you anticipate a loss for your S corporation, keep in mind that shareholders can generally only deduct the loss to the extent of their basis in the corporation’s stock. Basis is equal to the amount of your investment in the company, with some adjustments.

    While there is time, ask your tax adviser if it would be wise to increase your investment in your company to allow you to claim the full loss.

    Stock up. Order supplies that you would normally buy in January and beyond. Don’t forget ink cartridges, business cards, stationery, and supplies such as paper towels and coffee. Even if you use a credit card and don’t actually pay for the items until 2007 or later, the cost will be deductible this year.

    Rent or mortgage.
    Cash basis taxpayers should consider prepaying business rent or mortgage for January by December 31st. That provides 13 payments to write off this year.

    Holiday party.
    With the holiday season at hand, you may be generating some fun and goodwill among the staff with a party — and you can generally write the whole thing off. Unlike entertainment expenses which are usually only 50 percent deductible, a company-wide get-together should be fully deductible.

    Charitable contributions.
    This can be a tricky area for businesses. The IRS states that contributions which are not strictly charitable — such as those for which your company gets some tangible benefit — can be claimed as business expenses (for example, your firm purchases advertising on a program for a charity event), though not as charitable contributions. Deductions also depend on the type of entity you operate. Sole proprietors, partners, and S corporation shareholders may be able to deduct charitable contributions on their own tax return's Schedule A, while C corporations can deduct them on their business tax return, subject to limitations.

    Do yourself and your business a favor by contributing as much as possible to your retirement plan, within the deduction limits. Under most plans, you can make contributions right up to the due date of your 2006 tax return, including extensions. Even if you are the sole onwer without emplyees, you can establish a SEP (also known as a "Super IRA") on the dater your return is due (with extensions.)

    If you haven’t yet established a plan, this might be a good time, but be aware that some plans, such as tradional defined contribution (profit-sharing) plans and defined  benefit plans (pension) must be set up before year-end, or earlier, if you plan to make deductible contributions for 2006. 

    Call Ronald J. Cappuccio, J.D., LL.M.(Tax) at (856) 665-2121 for immediate help!


     Opportunities are Knocking
     — Until December 31st

    With just a couple weeks left in the year, now is the optimal time to put tax planning ideas into action. Consider these 10 popular year-end strategies for individuals.


    Maximize charitable giving. As a general rule, you can

    Section 529 Plans Can Provide Tax-Smart Learning for Kids and Adults

        Contributing to a Section 529 Plan before year end on behalf of children or grandchildren can be a wise idea. But have you ever thought about
    one of these tax-favored accounts for yourself — to pay for post-secondary courses you might want to take in the future?
        Adults can open up Section 529 plans (also called Qualified Tuition Programs) and make themselves the beneficiaries. The plans allow you to put money in a state plan for tuition, fees, books, supplies, and equipment that are required to attend an eligible educational institution.
        What's an eligible school? "It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions," according to the IRS.
        That means you can generally use withdrawals to study for a second career, go to graduate school, or do coursework in retirement.
        Section 529 advantages include:
         Your account grows tax-free and withdrawals are not federally taxed when used for eligible education expenses.
    Many states allow income-tax deductions (up to different annual maximums) for contributions to the state’s plan — and some don’t tax withdrawals.
    There are no income limitations and you can put a substantial amount into a plan at one time.
    What if you don't use the money? You can change the beneficiary to a family member or leave the account alone and let it become part of your estate. Another option is to withdraw the money. However, the earnings will be subject to federal (and any state) taxes, as well as a 10 percent penalty. (The penalty doesn't apply to the principal.)

    Make a Last-Minute Swap of Munis

        You might want to arrange a municipal bond “swap” to reduce your 2006 tax liability.
    In reality, a bond swap is the simultaneous sale of one bond and purchase of another issue. Typically, you may sell a bond that's showing a loss and acquire a bond with similar investment characteristics. When the swap is complete, you're essentially in the same investment position as you were before the exchange took place.
    ax difference: Now you have a current loss that you can deduct on your 2006 tax return. And if the bond you acquire in the swap has higher interest, so much the better.
    More muni bonds are usually available for exchange at year-end than corporate bonds. But the marketplace can be thin, so move quickly.
    Example: Suppose you own an Apple City muni purchased years ago for $10,000. The bond's current value is $8,000. It will mature in 18 years and has a 4.5 percent interest rate. Currently, you're showing a net $2,000 gain in capital gain transactions. So you swap your Apple City bond for an Orange City muni.
    The Orange City bond also has a face value of $10,000 and a current value of $8,000. However, as opposed to the Apple City bond, it matures in 20 years and has a coupon rate of 5 percent.
    Benefits: The $2,000 loss from the sale part of the swap eliminates your capital gains tax for the year. Next, you get a small increase in annual income. Instead of earning $450 of tax‑free interest each year, you are entitled to receive $500 tax‑free.
    Caution: Under the “wash sale” rule, you cannot realize a tax loss from a security sale if you reacquire a substantially identical security within 30 days. To avoid this, consider swapping bonds of different issuers. Or if the bonds come from the same issuer, make sure there's a significant difference in the maturity dates and interest rates.
    deduct the amounts donated to qualified charitable organizations in 2006. This includes charges to your credit card made before year-end. But before giving too generously, make sure you meet the limitation and substantiation rules that can be involved with large gifts.

    It may be better from a tax standpoint to contribute certain appreciated assets to charity that have been held more than 12 months. That way, you avoid paying capital gains tax but can still deduct the full fair market value as a charitable deduction.

    And If you've reached age 70 1/2, there's a new tax saving opportunity you might want to consider: The Pension Protection Act of 2006 now permits you to make cash donations to many tax-exempt charities directly out of your traditional or Roth IRA. Click here for the details.
    Caution: Household goods and clothing donated to charity after August 17, 2006 are generally deductible only if they are in good or better condition.


    Watch out for the alternative minimum tax (AMT), which can blindside unsuspecting taxpayers. Ask your tax adviser to estimate your AMT liability for 2006. You might be able to avoid the AMT by postponing certain “tax preference items” to 2007.


    Take required IRA distributions. If you're due to take a mandatory withdrawal from a retirement account for 2006, don't forget to complete the transaction by December 31. Neglecting to do so could result in a 50 percent penalty on the withdrawal you should have taken.


    Balance investment holdings. If you’re showing a net capital gain for the year — for example, you had more stock money makers than losers — you might realize some losses before the end of the year. Losses can be used to offset capital gains, plus up to $3,000 of highly taxed ordinary income. Any excess loss is carried over to next year.

    Conversely, if you have more stock losers than winners thus far, you could realize some capital gains before the end of the year. Since the gains are offset by the prior losses, they are effectively tax-free up to the amount of the losses.


    Secure college tax breaks. Do you have a college tuition bill that's due in early 2007? If you pay it this year, you can take advantage of the Hope and Lifetime Learning credits on your 2006 tax return, if you qualify. You're allowed to prepay for academic periods beginning in the first three months of 2007.


    You can deduct unreimbursed medical and dental expenses but only to the extent the annual total exceeds 7.5 percent of your AGI. That is a tough hurdle for many taxpayers. Try to “bunch” non-emergency medical expenses — such as eye exams, ongoing prescriptions and dental cleanings — this year if you expect to clear the 7.5 percent threshold.


    Provide more support. If you have a child in college or grad school under age 24, you can still claim a dependency exemption for the child by providing more than half of his or her support. You might decide to add a few extra dollars of support at year-end to ensure the exemption for another year.


    Bulk up your qualified retirement plan. Extra contributions made to the plan can help build up your nest egg on a tax-deferred basis. Plus, if you qualify, you can reduce your taxable income for the year, within limits.


    Consider a Roth conversion. December 31 is the deadline to convert a traditional IRA into a Roth IRA. You have to pay income tax on the amount placed in the Roth account but you escape taxes on future appreciation and earnings that accumulate. To qualify for a conversion, your adjusted gross income for the year must be under $100,000. This can be a good strategy if you are involved in a start-up business and your income is down.

    Bonus: If the value of your IRA is currently down, the tax cost of converting a traditional IRA to a Roth will be lower too. What if you converted to a Roth earlier this year when your IRA was worth much more? You can change your mind by "recharacterizing" the conversion by the end of the year. Then, you'll have a regular IRA again.

    Once you recharacterize to a regular IRA, you can switch back or "reconvert" to a Roth IRA and owe a lower tax bill. But you have to wait 30 days after the recharacterization, or until the next calendar year, whichever is later.

    Remember: Converting an IRA increases your adjusted gross income, which can make you ineligible for certain tax breaks. A boost in your income can also make some or more Social Security benefits taxable. The rules are tricky so consult with your tax adviser.


    Be energy efficient. During 2006 and 2007, individuals can make energy-conscious purchases that provide tax benefits. Two limited tax credits are available for expenditures to improve the energy efficiency of existing homes and include outlays for items such as storm windows, insulation, electric heat pumps and solar panels.

    This is just a brief overview of ten year-end techniques. Here are a couple more tax-saving considerations for 2007. Your tax adviser can provide more information for your situation.


    Shift a child’s investments into tax-free or tax-deferred vehicles to minimize “kiddie tax” complications. A new rule: For 2006, investment income above $1,700 received by a child under age 18 is taxed at the top tax rate of the child’s parents. Before 2006, the tax only applied to children under age 14.


    Think about consolidating personal debts into home equity debt. Although interest on personal debt can’t be deducted, you can write off the mortgage interest paid on the first $100,000 of home equity debt, even if the proceeds are used personally. But be careful: A home equity loan must be secured by your residence.

    Virtualex.com Ronald J. Cappuccio, J.D., LL.M.(Tax) 1800 Chapel Avenue West Suite 128 Cherry Hill, NJ 08002 Phone:(856) 665-2121      Fax: (856) 665-9005 Email: ron@taxesq.com

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