What are some deferral transactions and deductions that should be reconsidered?
Apart from installment sales, deferral transactions include like-kind exchanges of real property — where you swap one piece of property for another, and tax-free reorganizations where a shareholder selling his business will take stock of the acquiring company instead of cash. These types of transactions will be less attractive in the next year.
There is also the issue of deferring deductions. The American Reinvestment and Recovery Act provided several provisions that give a business the ability to take deductions quicker. Since you can only take the deduction once, accelerating the deduction into the current year means forgoing those deductions in the future, when rates may be higher. If you buy an asset that normally must be depreciated over five years, you may be able to take that entire deduction in 2010. The business should consider whether it would receive a bigger benefit by taking the deduction over the five-year period, when the business could be subject to higher tax rates.
Business owners should decide what is best for their specific tax situation. You have to make estimates about what your income will be in those years and what the tax rates will be. Also, take into account the time value of money.
How can you take advantage of the current low rates without a third-party transaction?
One way is transactions that will allow an owner to take money out of the company in a taxable transaction at the current low rates without having to sell to a third party. One example is a redemption of shares, where the company itself would buy some or all of a shareholders’ shares. This was more popular in past years, where it was easier for a company to borrow money from a bank or third party to redeem shareholders. This type of situation is much more difficult these days, without easy access to credit. But the business could buy the shareholder’s shares with a note. This transaction could be structured to trigger a gain that would be recognized this year at lower rates than what might be in effect in the future. The company could also pay a dividend to the shareholders using the company’s promissory note.
Now is a good time to consider these types of transactions, given the certainty of tax increases in the coming years. Even if the company needs to distribute a note to shareholders instead of cash, this type of payment should definitely be considered before the rate increases of 2011.
Mark D. Klimek is chair of the tax practice group and a member at McDonald Hopkins LLC. Reach him at (216) 348-5453 or [email protected].