March 2002

Tax Strategies for Today's Economic Times

By JAMES S. ANCHIN CPA

With tough economic times at hand, utilizing the right tax strategy is more important than ever. With smart, strategic planning, construction companies can make the most of their financial positions, set their company up for future tax advantages and even recoup past taxes in some situations. Additionally, the right tax strategy can help ease the pain of a bad year, map out a solid course to weather an economic downturn and put the company in a favorable position when the economy reheats.

Contractors that have found their income dip this year, may want to consider some of the following scenarios to boost their cash flow. A "C" corporation that made quarterly federal estimated tax payments based on prior year's income, but whose income is projected to fall short of last year, may be able to file to get a "quick" refund (generally within 45 days) of overpaid taxes. If you're a contractor that will have a net operating loss this year, there are options. One option is to carry back the loss to the two previous years and then carry forward the loss up to 20 years. This will offset the taxable income. If the carry-back results in only a small refund, it might make more sense to forego the carry-back and instead carry-forward the loss. This will offset future taxable income that may be subject to higher tax rates. On the other hand, if your company had taxable income last year, and expects to incur a net operating loss this year, you can postpone payments due for last year's tax. Be advised though that the IRS will charge interest on the deferred tax.

What About Debts?

Generally, if a company shows debt on its books that is forgiven, it will realize income (to the extent that it is forgiven). However, if said company is insolvent, it may exclude that income to the extent of its insolvency. For instance, if Contractor XYZ has $10,000 in bank debt which is settled for $9,000, it realizes $1,000 in income. If the realization of the extra $1,000 doesn't put the company into the black, it isn't acknowledged for tax purposes. If XYZ did meet the debt forgiveness criteria to be considered for tax relief, there would be a price to pay. XYZ would have to forego certain tax advantages such as a reduction of loss or credit carryovers or a reduction in the basis of the company's assets.

If a company is faced with transferring property back to its creditor in settlement of a loan, subtle differences in the structure of the transaction may produce tax savings. Tax wise, it matters whether the debt is non-recourse or recourse. With non-recourse debt, under which the creditor can only collect the collateral upon default, the transfer would be treated as a sale of property. If the debt exceeds the market value of the property, the borrower is left with a gain equal to the difference between the balance of the debt and the basis of the property. With recourse debt, in which the creditor has recourse to a third party or additional property in the event of default, the same transfer is treated as two transactionsÑa sale to the extent the market value of the property exceeds its basis and a forgiveness of debt to the extent the loan balance exceeds the market value. As previously discussed, the forgiveness of debt may not be taxable if a company is insolvent.

For contractors with a temporary economic slump but a bright future, acting now to defer deductions for a sunnier day is a sound strategy, (even though this may run contrary to the usual tax strategies of deferring income and accelerating deductions). Slower depreciation methods on current fixed asset additions will help conserve those deductions for futureÑand presumably more lucrative years. Likewise, not expensing recently acquired fixed assets and saving the deductions to offset future years increased income will help to save taxes down the road. Delaying payment of employee bonuses may also allow you to defer the deduction until next year, when it may be more advantageous.

Rather than just letting the chips fall where they may, contractors can maximize their tax opportunities. By reviewing these opportunities carefully, and the subtle differences between seemingly similar strategies, a huge difference in the amount of tax savings can be realized.

About the author: Mr. Anchin is managing partner of Anchin, Block & Anchin, LLP, a New York City certified public accounting firm that specializes in meeting the needs of contractors in the tri-state area.