You can dramatically increase your chances of successfully planning your year-end taxes if you develop a systematic plan for matching value-added ideas with specific situations. By using the tax provision and the M-3 to identify tax planning opportunities, you will quickly zero in on precisely what does and does not matter.
If your business operates as a regular C-corporation and prepares GAAP based financial statements, you should focus your attention first on the tax provision. ASC 740 (SFAS 109 prior to codification) provides that a current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year and a deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards. By analyzing these deferred balances, you will identify those ideas that are relevant to your situation.
Deferred tax assets are composed of future tax deduction; thus you need to consider whether it is possible to take affirmative action that will accelerate these future deductions to the current or a prior year. For example, if you have a large deferred tax asset attributable to net operating loss carryforward, you should consider ways to accelerate income to the current year to utilize those losses. With business asset valuations at historic lows, you may wish to evaluate the benefits of removing real estate from C-corporations or converting C-corporations (and certain S corporations) to LLCs using your state’s (or Delaware’s) statutory conversion provisions.
Deferred tax liabilities are composed of future tax obligations generally resulting from deductions that are accelerated for tax purposes, but not for book. You need to analyze those items giving rise to the deferred tax liabilities and look for ways to increase them. For example, claiming so-called “bonus depreciation” or assigning shorter class lives to depreciable assets generally results in an increase in deferred tax liabilities.
If you operate your business as a passthrough entity, you generally will not have a tax provision (with limited exceptions for built-in gains or the passive income penalty tax). Nevertheless, a comprehensive book to tax reconciliation is required to complete the Schedule M-3 (or M-1 if total assets at the end of the tax year are $10 million or less). In this case, you should start your search by systematically going through each book/tax difference and considering whether it is possible to suggest actions that will increase or decrease those adjustments.
For example, prior to year end, you should look for way to increase your subtraction adjustment for certain prepaid expenses by changing your payment behavior by only a few weeks with respect to one or more qualifying expenses. If you simply add back your reserve for bad debts (i.e., treat it as 100% nondeductible in the current year), you should carefully analyze the book reserve before year end (rather than simply making an adjustment to the reserve based on macro-data) to identify those accounts that qualify for partial or full deduction. Remember, you conserve cash if you systematically find ways to increase the subtractions and reduce the add-backs.
If you want to increase your chances of success, start by increasing the number of times at bat. You can do that efficiently by focusing on taking proactive actions that directly impact client tax provisions and Schedule M-3 (or M-1) reconciliations. To get you started, here is a partial list of items we routinely consider in our review of client tax provisions and Schedule M-3s:
- Verify you properly claimed bonus depreciation and assigned class lives in the current and prior years
- Verify you properly claimed section 179 deduction on qualifying new and used assets and take advantage of the new provision allowing immediate write-off for certain real property assets
- Avoid the application of the mid-quarter convention by carefully selecting assets expensed under section 179
- Be proactive in accelerating qualifying prepaids
- Identify favorable accounting method changes qualifying under the automatic change provisions of Rev. Proc. 2008-52, 2008-36 IRB 587 and Rev. Proc. 2009-39, 2009-38 IRB 371
- Restructure affiliate business in manner to claim the worthless stock deduction for failing affiliates (see Rev. Rul. 2003-125, 2003-2 CB 1243)
- Scrutinize slow and no pay accounts receivable to find those qualifying for partial or full deduction
- Carefully handle obsolete inventory to ensure year-end write downs are deductible for tax purposes
- Determine whether IBNR is being properly reported (qualifies for automatic change)
- Identify disputed sales
- Exclude shipping supplies and costs from inventory; and
- Determine whether you are an eligible small business with excess credits generated in 2010 that can be carried back five years and fully offset alternative minimum tax