Business Down?
Your Taxes May Be Up!
2008 is not shaping up to be a good year for
most design firms. THE INTERNAL REVENUE SERVICE MAY DISAGREE!!!
Cash strapped developers and tightening credit markets have
resulted in the cancellation or delay of many projects. The
credit markets have even slowed governmental infrastructure
projects. Undoubtedly your business is down.
Most A&E firms maintain their accounting records and manage
their business on the accrual basis of accounting. However, when
computing their income taxes, most firms use the cash method of
accounting. Over time, the net income is the same, but the
income tax is delayed. Frequently, in a growing firm, the ever
expanding accounts receivable balances will defer taxes almost
indefinitely with cash basis taxable income being less than
accrual basis book income. When business is declining the taxes
previously deferred will come due at the worst possible time.
Tax Trap #1
If your 2008 accounts receivable balance is less than it
was on January 1st, watch out!
The first potential tax trap for the unwary is created by
collecting 2007 accounts receivable in 2008. Taxable revenue
will be greater than accrual revenue when cash collections
exceed new billings for the year. It looks and feels like
revenue is down for the year, but for tax purposes it may be up.
Tax Trap #2
Does conserving cash seem prudent in these times? Think
twice! The loss of a 2008 tax deduction must be considered.
Tax trap two is delaying payments to vendors to conserve cash
in 2008. Under the cash method of accounting, a tax deduction is
only allowed when it is actually paid. The only significant
exception is the delay of the payment of the company’s
retirement plan contribution until the extended due date of the
tax return. If your accounts payable balances have increased
since January 1st and your business has not, tax trap two may
have you.
Tax Trap #3
Does immediately expensing furniture and equipment
purchases for tax purposes ring familiar?
That is tax trap three. Making the election (frequently
called a Section 179 deduction) to deduct the cost of the
acquired assets was a good idea; it saved tax in the year of
purchase. The risk is that your 2008 books show a depreciation
expense for an item that was already deducted for income tax
purposes. Your taxable income will be greater in 2008. Watch
out!
Tax Trap #4
Are you paying down debt?
A fourth tax trap! Even though the interest portion of debt
payments is deductible, the principal payments are not. Cash
payments used for principal reduction are not deductible, even
for cash basis tax purposes.
The combination of declining accounts receivable balances and
increased accounts payable balances will almost certainly result
in greater taxable income than economic or accrual basis income
you are showing on your financial statements.
Recommendations
Our recommendations for managing these issues are:
-
Know where you stand on the cash
basis before Thanksgiving. This deadline will give you time
to develop a plan.
-
In safer times, we might have
recommended delaying cash collections until 2009. In the
current economic climate, follow this strategy only if
you are confident in the client’s ability to pay.
-
Pay vendors and other expenses by
year end unless the due date is greatly delayed.
-
Manage state income tax estimates
to determine if they should be paid in 2008.
-
Consider keeping more cash in the
firm for 2008, because 2009 could even be worse.
The Authors: Arthur B. Dana, CPA, CVA, is a partner
with Deemer Dana & Froehle LLP. He is also the chairman of the
board of TSG Water Resources, Inc., a multinational engineering
and construction firm.
Mindy L. Wall is the A/E tax senior for the firm. She
maintains her memberships with the American Institute of
Certified Public Accountants and the Georgia Society of
Certified Public Accountants.
About Deemer Dana & Froehle: Deemer Dana & Froehle has
provided accounting and financial services in the Southeast for
over forty years. Their well-rounded professional team draws
from a deep reservoir of expertise and brings a
relationship-centered approach to each client engagement. Deemer
Dana & Froehle serves as business advisor, sounding board and
advocate for clients in a number of industries, with a strong
focus on Architecture & Engineering firms. Offices located in
Atlanta and Savannah, GA.
If you want to contact Deemer Dana & Froehle, click
here.
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