Year End Tax
Company's 2006 Tax
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?Depending on the answer, you could be better
off reserving some tax breaks for next year or
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?
into this year. Assuming your goal is to minimize your 2006
tax bill, here are 10 strategies to consider:
Accounting for Inventory
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.
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
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
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
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.
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
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.
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
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.
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.
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.
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.
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.
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.
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
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
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
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
— Until December
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.
charitable giving. As a general rule, you can
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.
Section 529 Plans Can Provide
Tax-Smart Learning for Kids and
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
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
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
account grows tax-free and withdrawals are not
federally taxed when used for eligible education
states allow income-tax deductions (up to different
annual maximums) for contributions to the state’s plan
— and some don’t tax
no income limitations and you can put a substantial
amount into a plan at one time.
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.)
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
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
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
$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
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
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
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
Caution: Household goods and
clothing donated to charity after August 17, 2006 are
generally deductible only if they are in good or better
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.
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.
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.
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.
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
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
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.
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.
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.
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
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.
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
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.
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