US Business Review

Improve your aim

Are taxes blowing your profits away? If so, it’s time for a new approach. By Stewart L. Cloer, esq.

When the weather forecast predicts a heat wave, most people don’t rush to don fur-lined parkas. And a prediction of snow flurries doesn’t usually bring out the bikini crowd.

In other words, then, it can be very useful to have a good idea of what is to come, and then to plan accordingly.

Rear-View Mentality
Using the same analogy, strategic financial planning is a proven top-down management tool adopted by many successful companies to forecast conditions and position resources in order to maximize efficiencies and greatly improve the bottom line. Yet tax preparation is still viewed, for the most part, in a reactive context, guided only by past returns in effect, planning ahead by looking in the rear-view mirror.

For better results, it is time to apply strategic principles to tax planning, as well. It is easier to decrease tax liability and exposure of a company when this is done on an ongoing basis and embedded in the corporate culture.

Weather forecasting is an inexact process because it depends on many variables. However, strategic financial forecasting for a company has a much greater degree of accuracy because it is based around only one main variable: sales.

Using existing contracts, ongoing accounts, changes in the general business environment and the specific business plan a company has for the upcoming period, an estimate of sales is projected for that period. Based on this projection, related projections are made on expenses.

Taken with the estimate of current levels of investment and fixed assets, the company’s financial needs for the period can be calculated. With this projection, the elements contributing to an overall tax strategy can be addressed.

Feeding the 800-Pound Gorilla
There are many taxing agencies – including federal, state and local with which a company can be required to comply. There are taxes levied on income, sales, property and, if a company operates internationally, the tax laws of those jurisdictions must be applied, as well.

However, the single-largest tax liability by far for any U.S. corporation is most likely found on Form 1120 – the federal corporate income tax. In order to make sound financial decisions, it is necessary to have a basic understanding of the concepts underlying this tax structure.

Most of the Fortune 500 companies, and certainly the top-300 corporations, employ full-time in-house tax departments devoted to continual tax planning. Specialists in these departments keep current with every change in the tax codes and can quickly zero in on its implications to minimize exposure for the company.

Yet, most small and medium-sized businesses that rely on a single accountant or accounting firm are usually compliance-oriented, bending over backwards to avoid anything that might draw the attention of the IRS.

In the process, these firms leave quite a bit that is legitimately theirs on the government table.

Audit-Phobia
A good rule of thumb is: when in doubt, deduct. Although all returns are subject to scrutiny by the IRS, the truth is that only a small percentage of these actually undergo audits.

The individual or company that shies away from legitimate deductions and takes an overly conservative approach to classifying expenditures could be losing a great deal to an emotional and unnecessary fear.

Put another way, a boat owner in Florida may take care to heed all hurricane warnings, but would be foolish to never take the boat out at all because of that one danger.

In large measure, most deductions do not invite an audit. There are some, however, that are more likely than others to bounce a return out of a computer and invite an audit. They are:

• Large travel and entertainment deductions. This is the area that is probably most likely to generate suspicion.
• Deductions for expenses not typically associated with this type of business.
• Deductions for items of a personal or recreational nature.
• Large deductions that are out of line with the income that is being reported.

And what if a deduction does, by mistake, trigger an audit and is ultimately not allowed? The company simply pays the back-tax, plus interest accrued.

Proactive vs. Reactive
The reactive approach to tax planning is the way most people approach filing their individual returns – ship the shoebox full of receipts to the accountant, and hope for the best. In business, a proactive approach is best, where upper management strives to make sure that every expense of the business becomes a tax deduction, either currently or in future years.

Transactions are reviewed on an ongoing basis with regard to both structuring and timing to achieve the best tax advantages.

Often, the wording in a particular contract, or how an expense is described, can mean the difference between something that is deductible and something that isn’t. On the timing side, as a company nears the end of its taxable year, business transactions can be structured to increase or decrease the profits, and therefore, increase or decrease the amount of taxes it pays. Within these limits, businesses can postpone or accelerate purchases and other business expenses.

Top Management Involvement
In any strategic decision concerning operations, including tax planning, upper management must be involved. And yet, most companies rely on either part-time or outside tax accounting or consulting services.

Although experienced tax accountants will know about most of the deductions, they cannot possibly take the time to ask clients about each particular transaction and decide whether to record it as a deduction or not.

Only upper management knows the particular ins and outs of the business intimately enough to make informed decisions. One hundred percent reliance on bookkeepers, accountants, attorneys and software programmers – or the IRS itself – is unwise.

To maximize the value and expertise available, management may choose to work with professional tax consultants to maintain an ongoing dialogue, continually updating the company’s tax landscape. As Julian Block, the well-known author of many books on tax strategies, notes, "The best-informed client gets the best advice."

The Importance of Being Current
Tax laws are under constant revision and can, like a change in the weather, leave the uninformed and unprepared open to the possibility of getting soaked. In most organizations, it is up to the CFO to oversee all financial planning, including tax liabilities.

With more than 422 current deductions in the IRS code, and a constantly changing constellation of tax credits available, small and medium-sized companies do not have these resources to track and take advantage of every opportunity. Accordingly, many CFOs choose to align with a firm or group that uses professional tax consulting to keep track of all tax law changes, and gauge the potential benefits and drawbacks specific to their individual industry and business.

In an old Bob Dylan song, we’re told that it "doesn't take a weatherman to know which way the wind blows." In tax planning, it does take competent, professional advice to strategically plan your company’s future.

Without it, it’s too easy to watch hard-earned profits simply blow away.

Stewart L. Cloer, JD, LLM, MFP is a senior manager for ITA, a tax consulting firm and a related company of IPA IPA and its combined family of consulting firms provide comprehensive business consulting, tax planning and business valuation services to companies in the United States and Canada. For further information, call 800-531-7100 or visit www.ipa-iba.com