As year-end approaches, most clients ask what is on the tax horizon for 2014. Tax discussions in Washington continue and some are predicting the possibility of higher taxes. But honestly, no one really knows. So for now, effective tax planning strategies focus on the mantra“if you can’t eliminate or reduce the tax, the next best thing is to defer it.” This includes C Corporations, which, like individuals, should decide when and how to structure transactions of income and deductions between 2013 and 2014 based on current tax laws.
Accelerating Income – Avoiding High-Rate Bubbles
Acceleration of income may be advisable in some cases. For example, if a corporation thinks it will be subject to the 39% "bubble" in 2014, they may want to consider accelerating income before the end of 2013.
Assume a C Corporation expects taxable income of about $90,000 for 2013, but expects its income to go well over $100,000 in 2014. Accelerating $10,000 in income from 2014 to 2013 will save about $500 in taxes; since the $10,000 will be taxed at only 34% instead of 39% ($10,000 x 5% = $500). This represents a return of 14.7% on the $3,400 used to make the early tax payment ($500 / $3,400 = 14.7%). Similar considerations apply to situations where the acceleration of income from 2014 into 2013 will prevent the corporation from moving into other higher tax brackets next year, say from the 15% bracket into the 25% bracket, or from the 35% bracket into the 38% "bubble" that applies to corporate taxable income between $15 million and $18,333,333.
Why this works: Corporate taxable income between $100,000 and $335,000 is taxed at the rate of 39% to phase out the benefits of the 15% and 25% brackets that apply to a corporation's first $75,000 of taxable income. Taxable income between $75,000 and $100,000, and between $335,000 and $10 million, is taxed at 34%. Taxable income over $10 million is taxed at 35%, except that there is also a 38% "bubble" that applies to corporate taxable income between $15 million and $18,333,333 to eliminate the benefit of the 34% rate.
Small Corporation AMT Exception
Another strategy to consider is qualifying for the small corporation alternative minimum tax (AMT) exception. The tentative minimum tax of a corporation is zero for any tax year if the corporation's average annual gross receipts for all three-tax-year periods ending before that tax year do not exceed $7,500,000. The gross receipts test is applied by substituting $5,000,000 for $7,500,000 for the first three-tax-year period of the corporation taken into account under the test. In other words, the $7,500,000 amount is reduced to $5,000,000 for the corporation's first three-tax-year period.
An illustration may help clarify: A calendar-year corporation was created on January 1, 2006. To qualify as a small corporation for 2013:
- The corporation's average gross receipts for the three-tax-year period 2006 through 2008 must be $5,000,000 or less, and
- The corporation's average gross receipts for the 2007 through 2009 period, the 2008 through 2010 period, the 2009 through 2011 period, and the 2010 through 2012 period must be $7,500,000 or less.
If the corporation qualifies for 2013, the corporation will qualify for 2014 if its average gross receipts for the three-tax-year period 2011 through 2013 also are $7,500,000 or less. Note: If the corporation does not qualify for 2013, it can't qualify for 2014 or any later year.
Thus, a corporation such as the one in the illustration should consider deferring income to 2014 if necessary to keep average annual gross receipts for the three-tax-year period 2011 through 2013 at $7,500,000 or less. This will preserve the AMT exemption for 2014.
Estimated Tax Payments
Another common strategy is planning for estimated tax payments. Corporations, other than certain "large" corporations (see below), can avoid being penalized for underpaying estimated taxes if they pay installments based on 100% of the tax shown on the return for the preceding year. Otherwise, they must pay estimated taxes based on 100% of the current year's tax. However, the 100% of last year's tax safe harbor isn't available unless the corporation filed a return for the preceding year that showed a liability for tax. As ridiculous as it seems, a return showing a zero tax liability doesn't satisfy this requirement. Only a return that shows a positive tax liability for the preceding year makes this “safe harbor” exception available.
To apply this strategy, a corporation (other than a "large" corporation) that anticipates a small net operating loss for 2013 (and substantial net income in 2014) may find it worthwhile to accelerate just enough of its 2014 income (or to defer just enough of its 2013 deductions) to create a small amount of net income for 2013. This will permit the corporation to base its 2014 estimated tax installments on the relatively small amount of income shown on its 2013 return, rather than having to pay estimated taxes based on 100% of its much larger 2014 taxable income. Also, by accelerating income from 2014 to 2013, the income may be taxed at a lower rate in 2013 instead of higher rates in 2014 (see “bubble” discussion above).
Tax Warrior Perspective
With regard to the estimated tax planning strategy, it should be noted that where a 2013 net operating loss would result in a carry back that would eliminate tax in an earlier year, the value of the carry back should be compared to the cost of having to pay only a small amount of estimated tax for 2014.
Generally speaking, a taxpayer will be treated as a "large" corporation only if it had taxable income of $1 million or more in any one of the three preceding tax years. As a result, a corporation that didn't reach that threshold in 2011 or 2012, but expects net income of $1 million or more in 2014 and later tax years, will have an additional incentive for deferring income into (or accelerating deductions from) 2014. If structuring transactions allows a corporation to avoid reaching the $1 million threshold in 2013, it will be able to use the 100% of last year's tax estimated tax payment safe harbor in 2014 as discussed above.
Many tax planning strategies individually are small but collectively can chip away at what is often the single largest expenditure of any business--income taxes.
The Tax Warriors® at Drucker & Scaccetti have deep expertise in devising these strategies for your business. Tax can be used as a competitive advantage in business, if you know how to apply certain parts of the Code to your business’s situation. That is the foundation of our tag line “Tax As A Business Strategy®.”
Contact us if you have questions about how deferring or accelerating income can help your business gain an competitive edge. Click “Ask a Tax Warrior” below and one of our tax consultants will contact you promptly to discuss your particular situation.