Year-End Tax Planning: How to Manage Taxes for Closely Held Private Companies

This article originally appeared in the October 2013 issue of Smart Business Philadelphia magazine.

Many closely held private companies are organized as partnerships or S corporations — pass-through entities with no material tax implications at the organization level. For owners of such businesses, tax planning predominantly focuses on the individual. To properly plan for those taxes, you need to start well before the end of the year, says Michael R. Viens, a director in the Tax Strategies group at Kreischer Miller.

"Although it can be difficult to precisely forecast results for the entire year, a reasonable estimate, along with identification of the material differences that will exist between financial and tax reporting, should be developed," says Viens.

Smart Business spoke with Viens about key considerations in developing an effective tax planning process.

What is involved in year-end tax planning?

It starts with a solid foundation — just like an unstable foundation can be problematic with a house, tax planning based on inadequate information can lead to a bad outcome.

Some things to consider when developing your forecast are year-end activities that can affect tax reporting, items such as fixed asset additions, the cash basis tax reporting impact of the collection of receivables and seasonal swings in profitability.

It’s also important to take into account tax considerations unrelated to the business. Key components of a business owner’s personal tax obligations are W-2 wages and share of business income listed in a Schedule K-1. But you also need to consider other aspects of the personal tax puzzle. Acceleration of tax deductions is frequently part of tax planning; however, you have to consider what the ultimate tax benefit will be. Too much acceleration of deductions in a particular tax period may result in limiting the related tax benefit to a lower tax bracket than if taken at another time.

So it’s sometimes better to pay taxes earlier rather than defer payment?

Much of tax planning involves a question as to timing when to pay. If there is no material direct or indirect interest charge for deferring payment, that is normally the recommended course. However, a ‘pay as you go’ approach can lead to a better outcome when economic circumstances are not ideal for the accumulation of a significant tax payment deferral.

Another concern with a deferral of tax liabilities is that it can be difficult to monitor future tax payment obligations. Because pass-through entities are not required to identify those liabilities in finance reports, those reports will not help you keep track of when tax obligations may come due.

How does wealth transfer impact tax planning?

Effective estate tax planning may run counter to income tax strategy. You may be able to defer payment of tax due on business profits, but you might not want to do that from an estate tax standpoint. When it’s time to transfer ownership to children, they might not be aware of the need to handle payment of deferred tax obligations. An owner may want to pay the tax, thereby reducing his or her taxable estate and leading to a higher amount of wealth passing along to his or her children.

Should your tax strategy change every year?

An effective tax planning process generally includes some constant elements, such as deferral of revenue recognition and acceleration of deductions. But you need to be flexible to address new challenges.

For example, the new Medicare tax on net investment income will adversely affect owners who do not materially participate in a business, as well as rental arrangements in which commercial property is owned under separate entities. An effective tax plan will consider such changes and adapt to the extent possible.