* Cash basis of accounting. If your business is on the cash basis, try to bill your customers at the very end of December, which will defer the income until 2005 when collected. If cash flow permits, pay as many outstanding bills as possible by Dec. 31, so you can write off the expenses in 2004.
* Accrual basis of accounting. For accrual basis entities, expenses are generally deductible in the year incurred, even if not paid until the following year. So take care to include all such expenses and liabilities in the final year-end accounting.
Exceptions include expenses payable to the majority owner (ownership of more than 50 percent) for items such as bonuses, rent and interest, which aren't deductible until paid. Also, reserves are often established to cover potentially uncollectible accounts receivable or obsolete inventory. For tax purposes, these reserves are not deductible.
The accounts receivable and inventory items must be written off in order to claim a tax deduction. Review your accounts receivable aging and inventory listings before year-end and write off items that no longer have value.
Here are two other items worth looking at.
* Section 179 deduction and 50 percent bonus depreciation. If you plan to purchase tangible business property, such as machinery and equipment, computers or office furniture early in 2005, consider making the purchases before the end of 2004. These purchases may be eligible for Section 179 depreciation, which provides for an immediate tax deduction, instead of depreciating purchase costs over the life of the assets.
If eligible for the Section 179 deduction, your business can deduct up to $102,000 of tangible property, subject to a phase-out rule, when qualified property purchases for the year exceed $410,000.
A special 50 percent bonus depreciation deduction may also apply, even if your business doesn't qualify for the Section 179 deduction, which provides for accelerated first-year depreciation for purchases of eligible new property. You get an immediate deduction of 50 percent of the property's cost, in addition to regular depreciation deductions. New property must be purchased by Dec. 31, 2004.
* Alternative Minimum Tax (AMT). AMT is a separate method of calculating income tax, designed to reduce the tax benefits of certain deductions for high-income corporate and noncorporate taxpayers. You are required to pay the higher of the regular tax or AMT.
Each year, the number of people paying more taxes due to AMT is increasing. AMT often comes into play if you have large capital gains, claim a high number of personal exemptions, exercise incentive stock options or have large state and local tax deductions.
If your business is a pass-through entity, such as an S corporation, a limited liability company or a partnership, AMT adjustments such as depreciation pass through to your individual tax return.
Understanding the AMT exposure will facilitate proper planning at the end of 2004, which may reduce or eliminate AMT completely.
Looking ahead to 2005
Depending upon your expected tax situation in 2005 versus 2004, it may be advantageous to postpone a deduction until 2005 or increase your income in 2004. Accordingly, it is important to estimate your AGI and taxable income for 2004 and 2005 before year-end to determine the best path.
Where is your business headed in 2005 and beyond?
Growth in sales, employees, locations and capital equipment can provide opportunities to reduce your taxable income by taking advantage of numerous tax and economic incentives. For many of these incentives, applications must be completed before finalizing growth plans. Do you have a written financial plan for your personal finances in 2005 and beyond? Do you have a wealth transfer plan?
Sound financial planning will minimize your current and future tax burdens.
Terry L. Silver, CPA, JD, (email@example.com) is a partner in Skoda, Minotti & Co.'s tax planning and preparation department. Joseph P. Regalbuto, CPA, (firstname.lastname@example.org) is senior manager. Reach them at (440) 449-6800.