Effective Tax Planning is a Year-Round Endeavor
Every tennis-related business owner and manager should recognize the need for — and the benefits that can be derived from — tax planning. The objective of tax planning is to defer or reduce taxes whenever possible. Unfortunately, tax planning is often complicated when state and local business taxes are brought into the equation.
One of the most difficult — and often overlooked — aspects of tax planning involves your business’s liability for state and local taxes. All too often, planning to take advantage of a legitimate “loophole” in the federal tax laws will reduce or even eliminate the benefits that transaction generates on the state tax return.
We may be in the midst of tax season right now, but at its most basic, tax planning is an ongoing event. Every retailer should be on the lookout for ways to reduce their operation’s federal and state tax liability. Many businesses have a lot of ups and downs from one year to the next. Sizable profits in one year reduced by a big tax bill often leaves the operation without the reserves necessary to tide it over when business might not be so good.
Effective tax planning for any business involves a number of steps, including:
- Assessing the personal tax situation of the owners, shareholders or partners;
- Developing and implementing tax-reducing strategies on an ongoing basis;
- Reviewing the form of doing business, such as sole proprietorship, partnership, limited liability company, S corporation, regular ‘C’ corporation or even multiple entities;
- Reviewing your business’s accounting period and accounting method;
- Coordinating the business’s tax strategy with that of the owners;
- Minimizing state and local taxes; and
- Factoring tax law changes into the ongoing tax planning process.
It is obvious that recent tax law changes have significantly increased both the complexity and the rewards for tax planning. Remember, however, law changes do not impact only the federal tax bill.
The federal Job Creation and Worker Assistance Act of 2002, for example, made a number of significant changes to our basic tax law. Designed to stimulate the economy, many retailers have already benefited from those changes, several of which were retroactive to the 2001 tax year. Unfortunately, the tax authorities in many states have been somewhat cool to the federal stimulus efforts.
Because most states use the Internal Revenue Code, the federal tax law, as the base for their state income taxes, the federal cuts threatened to reduce state revenues. Many state legislatures have forestalled that possibility — and reduced the amount of savings that many retailers might otherwise enjoy as a result of the economic stimulus package — with other tax legislation passed in 2002.
With states limiting, or taking away completely, the benefits of JCWA, how can any owner hope to fully stimulate the economy of their tennis business? The answer lies in the systems — both federal and state.
Giving ‘em a tax break?
The JCWA included a provision that allows businesses a “bonus” 30 percent depreciation deduction on capital equipment purchased between Sept. 11, 2001, and Sept. 11, 2004, and a second one that extended the time period for using net operating losses to offset taxes. In essence, it creates refunds of previously paid taxes for many troubled retail operations.
But the implications of the federal stimulus package for state budgets were reportedly too large for many state legislatures to go along with. A majority of states have declined to fully adopt both the depreciation “bonus” and the net-operating-loss provisions. The result will be more tax dollars flowing into straitened state treasuries while many businesses will face increased complexity as they account for their income and assets differently for state and federal purposes.
On your business’s federal tax returns, the 30 percent bonus depreciation is allowed for both regular and alternative minimum tax (AMT) purposes for the tax year in which the property is placed in service. Naturally, the basis of the property and the depreciation allowance in the year of purchase as well as in later years must be adjusted to reflect the additional first-year depreciation deduction. In other words, any bonus deprecation claimed on the tax return will reduce the book value of the underlying asset and the amount of depreciation deductions that can be claimed in later years.
But because only 13 states have laws that conform to the new federal provisions on bonus depreciation, businesses operating in states that choose not to conform will find themselves compelled to keep multiple sets of books on the current book value (basis) for each asset that qualifies for the federal provision.
Under our federal tax rules, net operating losses (NOLs) can be carried back two years. The new law temporarily extends that carryback period from two to five years. In addition, certain NOLs usually carried back for three years, such as casualty losses, can also be carried back five years under the JCWA.
This enhanced federal carryback applies only to losses that arise in tax years ending in 2001 and 2002. Businesses are given one opportunity to “elect out of” or reject this treatment, and the choice is final.
The new law also allows a taxpayer’s NOL deduction to reduce its alternative minimum taxable income up to 100 percent.
Unfortunately, only seven states have adopted the NOL provision and only four of those — Alaska, North Dakota, Oklahoma and Vermont — have adopted the provision as written in the federal law. Delaware, New York and Wisconsin have adopted the basic NOL provision but limited the amounts that can be carried back. Factoring into planning Faced with budget shortfalls, many states are balking at adopting tax breaks included in the federal economic stimulus package and other federal tax-related legislation. The quandary for the states is this: Should they go along with the tax breaks and suffer another revenue hit, or refuse, thereby denying business taxpayers some benefit and complicating an already complex tax code?
Regardless of whether the states decide to accept or reject tax benefits created on the federal level, businesses can claim a legitimate federal tax deduction for all state, local and foreign taxes paid or accrued within the tax year — at least to the extent that they are directly attributable to the business (or to the production of income). In fact, even advance payments of estimated state income taxes made by a cash-basis tennis business under state law are tax deductible in the year paid.
The fact that a state is out of conformity with the JCWA and other federal tax breaks now doesn’t mean that it will necessarily remain so in the future. A number of states normally synchronize their law to the federal provisions as of Jan. 1 of each year.
Remember, however, tax law changes whether on the federal or state levels are not the only reasons for business tax planning. The changing economic climate, competition, the personal circumstances of the owners and, of course, the goal of both the business and its owners are constantly changing. Tax planning should reflect those changes.
Tax planning is — or should be — a year-round endeavor. You should know what deductions are available to your operation and you need to keep the records necessary to support and document every transaction.
In this manner, the resulting tax savings can be used to successfully operate and grow the business.
See all articles by Mark E. Battersby
About the Author
Mark E. Battersby is a tax advisor and author in Ardmore, Pa.