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Looking for year-end cash? Make all the right tax moves — from changing your accounting to buying capital equipment now, rather than later — and you may strike a hidden cash vein.
Marie Leone, CFO.com | US
December 11, 2008
Finance executives are leaving no stone unturned in their effort to find hidden cash before the end of the year. Caught in a credit crunch with limited power to borrow at reasonable interest rates, many CFOs, treasurers and controllers are diligently working to squeeze cash out of their organizations in a year-end effort to boost liquidity.
Now more than ever, "cash is king, and a lot of companies are receptive to focusing on opportunities in the tax area that they may not have been eager to focus on in the past," says David Auclair, managing principal in Grant Thornton's national tax office. "There is nothing like the current economic situation to spur companies to generate cash," echoes Mel Schwarz, Grant Thornton's director of tax legislative affairs. "There is more at stake now, and the level of interest, concern and effort [regarding cash generation] is more intense," he adds.
Companies can turn tax benefits into cash in several key areas, say experts. But some opportunities have a tight deadline. For example, C corporations (companies with more than 100 shareholders that are not sole proprietorships or partnerships) that pay quarterly estimated taxes will make their last payment of 2008 on Dec.15. This is a chance for those businesses to calculate if they have overpaid for the year, and if that's the case, they can hang on to the extra cash.
Overpayment is more likely this year as estimated taxes computed at the beginning of 2008 may not have taken into account unexpected losses stemming from the credit crisis. But if staffers are too busy with year-end closings to calculate the potential overpayment by the Dec. 15, companies can file an Internal Revenue Service form 4466 "quickie" refund, says Schwarz. The quickie refund allows C corporations to file a refund request before filing a tax return, and the IRS promises action on the request within 45 days.
Companies can also mine for cash in capital spending, if they spend quickly. The Economic Stimulus Act of 2008 — which is set to expire on Dec. 31 — allows companies to use the Section 179 provision to purchase up to $800,000 of qualifying equipment for a total deduction of $250,000, explains John Salza, a BDO Seidman tax partner and leader of the firm's national tax accounting methods group.
The law, which may be extended into 2009 if Congress acts soon, also includes a special 50 percent bonus depreciation allowance. The bonus is available on top of the regular first-year allowance tied to the purchase of most types of tangible property, as well as computer software, acquired and placed into service in 2008. The Section 179 deduction is a complete write-off in the year the equipment goes into service, while the bonus depreciation provision accelerates the recovery period.
So, if a taxpayer has cash on hand and is looking to make a purchase early in the first quarter of 2009, it may be worth making the purchase sooner than later to generate extra cash flow from the deductions. In addition, Auclair points out that new cogs and parts of a refurbished or retrofit piece of used equipment may also qualify for one of the stimulus act tax breaks.
Timing is also a big tax planning issue this year, especially to companies that seek more cash flow. Historically, public companies that are pumping out substantial profits don't worry about accounting issues related to timing, such as accelerating expenses and deferring taxable income. Indeed, those companies are traditionally worried about earnings-per-share and permanent tax benefits. But with the economy sagging, and cash becoming more valuable, "even publicly-traded companies are looking at what we call timing items, cash benefits . . . even though it doesn't affect their effective tax rate," posits Salza.
Timing changes "probably provide companies with the biggest bang for their buck, the biggest cash benefit," says Auclair. By his lights, companies weathering the current economic crisis are more receptive to timing opportunities than they were in the past.
Such accounting changes affect taxable income, and are therefore subject to IRS approval. But prodded by the credit crisis, the IRS gave companies a bit of a break by increasing the number of changes that garner "automatic" consent, which total about 18 now. In a bulletin put out in September (Revenue Procedure 2008-52), the IRS provides a list of permissible accounting changes that apply to 2008, but can be filed along with corporate tax returns prepared in 2009. Changes made in 2008 not deemed to be automatic must be filed with the IRS by Dec. 31, for calendar year companies.
Timing changes named in the IRS automatic list include receipt of advanced payment for goods and services on the income side, and prepaid expenses — such as insurance outlays — on the expenditure side. Another common issue on the automatic list that may help companies uncover cash involves the amortization life of tangible and intangible property. For example, a company may be using a 39-year amortization life for an industrial machine, when a 5-year life is more appropriate.
Distressed companies will also find opportunities to spin tax breaks into cash. For example, loss companies should take stock of potential net operating losses and the associated tax benefit before consolidating the debt, asserts Salza. If a loss company successfully writes off debt, its NOL may be wiped out. While that may be prudent in some cases, eliminating NOLs could cost a company all of its 2008 tax deductions linked to the loss, plus any carryforward losses from past years that could offset current income.
Another way for troubled companies to fish for cash is to take now deductions that would normally be held until 2009, especially if executives expect their companies to lose money next year. In that case, a company can grab a deduction for accelerating contributions to pension and 401(k) matching plans, says Salza, or paying out bonuses within two-and-one-half months of the year's end. If a company is legally obligated to pay out a bonus, a 2008 deduction can be taken as long as the incentive is paid out within the prescribed period.
In the category of "most overlooked" deductions, Salza points to bad debt — particularly accounts receivables that companies deem uncollectible. "This is one of the largest liquid assets for most companies, and a place often overlooked for tax savings," says the tax partner.
Salza talks about "fluxing the reserve" describing the rut some companies get into when they follow what they did last year, without examining new market conditions regarding bad debt reserves. In many cases, the end-of-year bad debt balance is reversed, and the current year balance is added back. "It just revolves every year, but there is an extra step that can be added that leads to cash," asserts Salza.
With some extra work, that likely can be supported by systems already in place, a company can prove to the IRS that some bad debt is "uncollectible," and therefore should be eligible for a tax deduction. The IRS will look for documentation regarding whether the company made a good faith effort to collect the money, and likely will examine the financial health of the debtor.
Another often overlooked tax play is the write-down of damaged, obsolete or subnormal goods for FIFO taxpayers — companies that use the first-in-first-out method of inventory accounting. Inventory that can't be sold at regular retail prices — think 8-track tapes or a television with a broken screen — are considered "bad" inventory for tax and accounting purposes. The value of the inventory is reduced for accounting purposes, but to claim a tax deduction, a company must establish a drop in value by offering the goods for sale within 30 days of the last inventory date. The write-off "is a gimme for FIFO taxpayers," insists Salza.
Companies get into ruts regarding state and local taxes too, says Auclair. When the markets and profits are up, companies that juggle multiple tax jurisdictions sometimes have a tendency to default to a higher tax rate and pay that percentage. They do so to avoid the time-consuming effort of distinguishing between rates and jurisdictions. But this may be the year to invest in the extra effort to unearth the cash.
Property taxes are another area in which staffers can become overwhelmed, and miss low-hanging liquidity. Companies trolling for cash should take a renewed interest in overvalued property, or real estate that has been sold. Schwarz says that even mid-size companies have literally tens of thousands of property tax bills flowing into the company. With that kind of volume, it is understandable why most of the invoices are paid without challenging the valuation or the existence of the property. "This is not to say anyone is a bad guy, but when you are dealing with this number of statements and reports, a percentage of them never catches up to reality," muses Schwarz.
Companies also fall into last year's patterns regarding payroll taxes. "Even states can make errors," quips Auclair, who suggests that since cash may be in short supply this year, taking time to recheck payroll records would be time well-spent.
As for as tax credits — such as the ones for research and development and energy initiatives — "Those will be handled by people looking back and seeing whether they did something to qualify," and filing for the credit as part of their annual tax return, says Schwarz. "So those issues will be a point of live discussion in March and April.