Editor’s Note: Deborah B. Andrews is a member of the Business Section of Ward and Smith, P.A.

RALEIGH – Although it is late in the year, businesses still can take action to minimize tax liability. The most common method for the creation of year-end tax savings is to accelerate deductible expenses into the current year and to defer taxable income into the following year. However, tax planning is not that simple because it is impacted by several factors, including profits and losses. For example, if your business is going to have a loss for the year, accelerating expenses may be useless.

In considering what actions may be useful in reducing taxes, the accounting method used by the business is important. Businesses using the cash method of accounting recognize income when payments are received and deduct expenses when payments are made. Thus, in most cases, any payment not actually received in 2007 is not taxable income in 2007, and any expense not actually paid in 2007 is not deductible, regardless of when the payment was earned or the debt incurred. On the other hand, businesses using the accrual method of accounting recognize income at the time the income is earned and recognize expenses at the time the debt is incurred. As a result, there are more planning opportunities for accrual-based businesses.

Another factor to consider is the structure of the business because it determines how profits will be taxed. Businesses operating as S corporations, partnerships, and limited liability companies are “pass-through” entities, meaning that the profits and losses of the business are passed on to the owners of the business as though the business entity did not exist. As a result, these businesses usually do not pay taxes (at least not North Carolina or federal taxes), and planning needs to be undertaken in the context of the implications of the pass-through to the business owners.

Keeping these factors in mind, and, depending on your particular situation, the following tips may help reduce your tax bill.

Purchase Equipment

Businesses are permitted to deduct the cost of certain types of equipment used to conduct a trade or business, such as machinery, computers, and office furniture. Usually, the deduction is based on an allocation of the cost over what the IRS determines is the useful life of the item, allowing an equal percentage of cost to be deducted for each year of the equipment’s useful life. There is, however, a special deduction, referred to as the "Section 179 deduction," which allows businesses to immediately expense an annual dollar amount for equipment purchased and placed in service during the year. For tax years 2007 through 2010, the aggregate Section 179 deduction is $125,000 per year, adjusted for inflation. The deduction is normally used for several smaller items added together.

An unused Section 179 deduction cannot be rolled over. Furthermore, if you purchase too much equipment, your deduction could be reduced. For any given year, the amount of the Section 179 deduction is reduced by the amount that the total cost of all Section 179 property placed in service exceeds a threshold set by the IRS. For example, the 2007 threshold is $500,000. If the total cost of your Section 179 property for 2007 is $515,000, the total cost exceeds the threshold by $15,000. Therefore, the maximum amount that you can deduct under Section 179 will be $110,000 ($125,000-$15,000.)

The Section 179 deduction is allowed for the year in which the equipment is placed in service even if you pay for the equipment over a period of time. Thus, if you purchase and place in service equipment costing $125,000 on December 31, 2007, you may be able to deduct the entire $125,000 in 2007 even if you only make a small down payment for the purchase. However, there is an important factor you must consider when purchasing equipment at this time of year. If the cost of all equipment placed in service by you during the last three months of the year exceeds 40% of the total cost of all equipment you placed in service during the entire year, your depreciation deduction may be reduced.

Make a Charitable Contribution

Just like individual taxpayers, businesses are allowed a deduction for charitable contributions. If your business operates on an accrual basis, contributions pledged by year end are deductible in 2007, even if the contribution is not paid until later. Businesses operating on a cash basis, however, must actually make the contribution before year end.

Pay Bonuses

Reasonable compensation paid to employees is deductible. So, one easy way to reduce year-end profits is to pay employee bonuses. If your business operates on an accrual basis, bonuses declared by December 31 and paid by March 15 (assuming a calendar tax year) are deductible for the 2007 tax year.

Write-Off Uncollectible Receivables

If your business reports on an accrual basis and has customers that are delinquent in their payments, you may be able to write-off the delinquent amounts. The key is determining if, and when, the unpaid amounts are uncollectible. If you have made repeated attempts to collect the debt in 2007 and have adequate documentation of your collection efforts, you may be able to reduce your 2007 income by the amount that is considered uncollectible, because the accrual method would have required you to include it in income for a prior period.

Make Contributions to a Retirement Plan

There are many forms of retirement plans. Regardless of the type of plan, a primary objective of all such plans is to allow an employer to take a current deduction for its contributions to the plan while employees defer paying tax on the contributions until future years.

If your business does not have a retirement plan, it’s not too late to establish one for 2007. In most cases, as long as the plan is in place before the end of 2007, contributions may be made in 2008 and still result in a deduction for 2007. A simplified employee pension ("SEP") plan can even be established in 2008, and contributions can be made as late as the extended due date of the employer’s 2007 tax return in order to claim a 2007 deduction. Each type of plan is subject to a variety of requirements and restrictions, necessitating a careful determination of the type of plan that is most suitable for your business.

Use Expiring Loss Carryforwards

If you have loss carryforwards that are about to expire, consider the following options to bring income forward into this year in order to offset the losses before they expire:

• Accelerate income by having customers prepay for goods or services.

• Sell the right to future income to which your business is entitled for a current payment.

• Sell appreciated property and use the funds to purchase replacement property. The gain is offset by the loss carryforward, and you receive an increased basis in the property.

Conclusion

Year-end tax planning is extremely important but can be complicated. The tax laws and regulations are constantly changing, which can make it difficult to determine which course of action to take. Taking no action, however, is likely to cause your business to pay more in taxes than it would be required to pay with careful planning.

© 2007, Ward and Smith, P.A.

Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Deborah Andrews practices in the Business Section. She advises a wide range of businesses, individuals, and tax-exempt organizations on complex tax matters and compliance. Comments or questions may be sent to dba@wardandsmith.com.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.