Year-End Tax Planning: 6 Quick (and Legal) Finance Fixes

David Worrell
Mon, 22 Dec 2014 00:00:00 +0000

When the sun finally sets on 2014, will your company be able to report the kinds of profits you expected? Or will your year-end financial statements look a bit gloomy? Maybe you are showing a bad loss, and your banker wants to see a profit. Or maybe you've got a bit too much profit and are looking for some year-end tax planning? Either way, you need to make your financial results serve your business purposes, while at the same time staying out of hot water.

How? Fortunately, accounting rules are flexible enough to let you (legally) make paper adjustments that can radically change your business's financial results. In fact, there are plenty of ways you can alter your financial reporting to produce "better looking" –- and truly more meaningful –- financial statements without ever courting legal, ethical, or tax problems.

Let’s take a look at six year-end tax planning situations where we have legitimate choices that significantly change our financial statements:

1. Expense or Investment?

The fastest way to increase your book profits is to "capitalize expenses," which means to move expenses off of the P&L and onto the balance sheet. Almost any large purchase can be “capitalized,” which creates an asset and removes the expense. Capitalizing an asset spreads the cost across many periods (as depreciation) and increases short-term profits.

Sometimes capitalization is required -- like building new walls in a rented office, for example. These leasehold improvements should be classified as an asset. Other times, the rules are not so clear. A new phone system is clearly an asset, but how about the cost to install it and to train the staff? If the training is listed as "free" on the contract, should you expense the value of training anyway?

You can make the decision to capitalize expenses or not: increasing or decreasing expenses in one period, and increasing or decreasing assets and depreciation costs over the long term. How you decide will impact profits and perhaps taxes, too.

2. Time Shifting Income and Expenses

The calendar year will soon be “closed” but business spending continues past the end of any month or year. Loading expenses into an earlier period, or delaying deposits into a later one, is one way to "shift" profits around on the calendar. That sounds nefarious, but there are some good, legitimate reasons to do this, including simply correcting quirks in the calendar. A power bill, for example, is a monthly expense. If we do not receive the December power bill until January 10, that’s no reason to skip the expense in December. Clearly, the December P&L should contain an expense for power, so adjusting the date on the bill is a reasonable and legitimate use of this technique. Better yet, if you can anticipate the power bill in December and write the check (whether you have the bill or not), then the expense decreases taxable (cash) profits for the year.

NOTE: When financial statements are prepared for management (not for taxes or other legal purposes) this kind of time shifting is an important way to smooth out revenue and expenses. It is difficult to manage a business when several large invoices land arbitrarily in one month, so assigning part or all of the expense to another month may help make sense of what is actually going on in the business.

3. Changing Reporting Periods

One month or year can show a loss, while the next shows an extreme profit; that’s the nature of business. When you're reporting for tax purposes, you don't have much choice about which months to report. But if you're printing financial statements for a bank or investor, forget about reporting on a strict calendar year. Instead look at a more representative period, such as the last 12 months, sometimes called TTM ("trailing twelve months"), or a period ending with an upswing in your natural business cycle. (e.g., If most of your sales occur in August, put August at the end of your reporting period.) This is a respected way to characterize financial results, for example, in a fast-growing company, or toward the end of one period when the last period’s data would be out of date. And, with some help from a CPA, you may even be able to change the reporting period for tax purposes.

4. Revenue Recognition

Businesses with multi-month delivery cycles and big invoice values are expected -- even required -- to spread income out as it is earned rather than showing it all in the month when an invoice was paid. (This is part of "accrual accounting.") At year end, that means you might not have to pay tax on a large customer payment if you have not finished the work. Prepayments from customers can be treated as "liabilities" and not income as long as the work remains incomplete. GAAP (Generally Accepted Accounting Princicples) has some rules about this based on measuring the work actually completed during a period. Consult with a CFO or CPA about how to measure this, and to decide whether your year-end tax planning should include a switch to paying taxes on an accrual basis.

5. Inventory Valuation

Inventory is one area where small changes in record keeping can have large impacts on the financial statements (and year-end tax planning!). Old inventory can be “written down” (meaning it is devalued or discounted) simply because it is old. The thought is that last year’s models left in inventory are not worth as much as this year’s. Writing down inventory is an accepted way to take an expense in the current period and adjust the cost of goods for future sales.

6. Inventory Expense Recognition

When a company sells a product from inventory, profit depends on how we calculate and recognize the cost of goods sold (COGS). Should we value it at the average price we paid for what we've got on hand? Or at the price we will pay to replace it next week? There are generally accepted rules for guiding this decision, and it is important to remain consistent. Which method you choose -- and if you choose to change the method -- can have a substantial impact on profitability since it will shift the cost of goods.

Make the Data Useful

There are plenty of legitimate reasons for changing the way we record things on our books. The rules of GAAP provide enough flexibility to push and mold our financial statements into useful reports.

Note that I said "useful reports." I did not say tax or regulatory filings. If your business is submitting formal financial statements for legal or tax purposes, a thorough review from a knowledgeable CPA or tax attorney is always the right move. Just be sure to discuss the six issues above with your CPA in order to maximize your tax benefit.

In the meantime, remember that financial reports are meant to help you make better business decisions. Financial statements that are knowingly false, twist reality beyond recognition, or are based on wants instead of facts will not give you meaningful information.

Dedicated to your (Year-End) profits, David Worrell