(Thanks to Deemer Dana & Froehle, CPAs for sharing this article.)
2009 did not shape 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 has been 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.
If your 2009 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 the 2008 accounts receivable in 2009. 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 that may not be the case.
Does conserving cash seem prudent in these times? Think twice! The loss of a 2009 tax deduction must be considered. Tax trap two is delaying payments to vendors to conserve cash in 2009. Under the cash method of accounting, a tax deduction is only allowed when it is actually paid. The only significant exception is delaying 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.
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 2009 book shows a depreciation expense for an item that was already deducted for income tax purposes. Your taxable income will be greater in 2009. Watch out!
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.
Our recommendations for managing this issue 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 2010, but only if you are confident in the client’s ability to pay should that strategy be considered.
- 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 2009.
- Consider keeping more cash in the firm for 2009, because 2010 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. Mindy 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. Our 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.
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