Divider
Divider

Blake Christian
Blake Christian

Post-Busy Season Tax Review

Maintaining momentum in the off season.

April 28, 2011
by Blake Christian, CPA, MBT

Now that you have completed the first phase of the 2011 filing season, it is a good time to catch your breath, take a step back and evaluate your compliance and consulting projects for the remainder of the year.

This spring respite offers an excellent opportunity to review your “busy season” successes and failures and how to best plan for the remainder of the tax-filing season.

Some issues to keep in mind during this time of year include the evaluation of:

  • Net operating loss (NOL) carry-back potential. The loss and credit carryback rules are complex and have changed over the past few years so a thorough review of the rules and your various options are critical before returns and carryback claims are filed. Opportunities for prior year corporate and personal refunds should be fully examined for any clients with 2010 or prior year losses.
  • Evaluate whether your entity structure is the most tax efficient for the short term and the long term.
  • Analyze the accounting periods and methods of your clients and your own business entities to ensure that your clients are fully compliant and also well positioned for tax minimization into the future.
  • Update clients’ estate tax plans in light of the December 2010 income, estate and gift-tax changes.
  • Review technology and personnel needs.

Following are more details regarding these planning strategies:

Net Operating Losses

In this challenging economy, taxpayers have the possibility of generating business and personal-tax deductions that exceed reportable taxable income. In such cases, taxpayers may have reportable “regular” and/or alternative minimum tax (AMT) NOLs. Taxpayers generally can carry back these NOLs two years and then apply them forward 20 years to offset any taxable income in those years. This can be especially advantageous to taxpayers that experience widely fluctuating income and losses, applying NOLs to those years that the taxpayer experiences reportable profits. Forms 1045 (PDF) and 1139 (PDF) are used to accelerate the payment of a refund of an NOL for individuals and corporations, respectively.

To the extent business returns have been extended, tax preparers should be evaluating the carryback potential BEFORE filing the 2010 tax return in order to maximize refunds from prior years. For example, accelerating deductions and deferring income may not be top of mind to someone preparing a return with a large loss; however, the preparer will be more inclined to maximize the 2010 loss if this will result in larger refunds from prior years. Special care is also required in evaluating the interplay of both the “regular” and AMT NOLs on prior year refunds.

Business Legal Structure

There are a wide variety of legal structures used to organize a business and the short-term and long-term tax aspects of the entity structure should not be overlooked. There are benefits and downside issues that should be taken into account when starting a business or determining a change in business structure is needed.

Numerous issues must be evaluated in choosing the initial form of operation. Factors include: projected income or losses, debt-to-equity structure, equity owner profiles, nature of income, likelihood of future new owners being added and the method of the shifting ownership, e.g. capital infusions, purchase from existing owner(s), issuance of options, among others.

The basic legal structures are: sole proprietorships, limited liability corporations (LLCs)/ partnership, S Corporations and C Corporations. Trusts, co-ops, interest-charge domestic international sales corporations (DISCS) and disregarded entities (generally treated as a division of the owner(s)) are less common, but entities you will generally see within your client base or corporate structure.

Operations and owner objectives change over time, so a periodic review of the appropriateness of various legal structures is recommended.

Accounting Periods and Methods

It is common to find new clients using inappropriate accounting methods (and in some cases accounting periods). The accounting methods used should clearly reflect the income and expenses of your business. The selection of an overall accounting method, as well as methods for specific tax items, is critically important because it can dramatically affect the current and future tax obligations and cash flow. The two basic overall tax-accounting methods for reporting taxable activities are the accrual and the cash method. However, some entities may be required and/or allowed to use a hybrid method.

After an accounting method is chosen, the business usually keeps that method until a formal request to the Internal Revenue Service (IRS) is approved or when the IRS requires a change to be made during the course of an audit. A taxpayer-initiated voluntary change is generally preferable since positive (taxable) adjustments resulting from the accounting change can be spread over a number of future years whereas an IRS-initiated change will generally impact a past year in full — and interest and penalties will also apply. The election to change the method of accounting is made on Form 3115 and must generally be filed on or before the extended due date for filing the return containing the method change. Some accounting methods changes are “automatic” with the timely filing of the Form 3115, while other elections require affirmative approval from the IRS.

Similar issues may arise with respect to clients’ or business entity tax reporting periods. Flow-through entities such as S Corps, LLCs and partnerships, must generally report on a calendar-year basis, or choose a year-end that ends in October or November. To the extent a business has chosen an erroneous year-end, or if the taxpayer wants to change to another allowable year-end, such an election can generally be made on IRS Form 1128 (PDF) by the extended due date of the first effective year (i.e., the first year with the new desired year-end). However, certain S Corp elections of allowable fiscal years (e.g. October or November) are generally due by the 15th day of the fifth month following the end of the prior fiscal year.

The vast majority of these changes in method require a significant “fee” (generally $650 to $3,200) payable to the IRS for processing the request.

Estate and Gift Tax

During 2010 we had a temporary break from the estate taxes for those “lucky” (or more correctly the lucky beneficiaries of) taxpayers dying in calendar 2010. However, for 2011 the estate tax is back and it will impose federal taxes on taxable estates worth over $5 million at a rate of 35 percent. As a result, practitioners with clients in this net-worth range should be assisting their clients and their attorneys with updating their wills and estate planning documents.

Technology and Personnel

Finally, spring and summer represents an excellent period of time to review your hardware and software needs. You may have discovered some gaps between your tax-compliance and
research-software capabilities and client-project needs. What percentage of your business and personal returns did you e-file? Are your software licenses current? Do you have research tools that match your practice areas? Are your mobile applications fully compatible with your firm/company network? Is your website in need of a facelift or full overhaul?

Conclusion

With the advances in technology, your firm can achieve huge technology efficiencies and quality control improvements at relatively low costs. Therefore, this is an area that your firm’s internal IT group should fully analyze or outsource the analysis if internal resources are limited.

Spending time in the aforementioned areas should pay dividends for the remainder of the year as well as into future years. Procrastination will likely cost you more than just profits.

 Rate this article 5 (excellent) to 1 (poor). Send your responses here.

Blake Christian, CPA, MBT is a tax partner in the Long Beach office of Holthouse Carlin & Van Trigt LLP and is co-founder of National Tax Credit Group, LLC. He can be reached at (562) 216-1800.