Why would any steel distributor ignore perfectly good tax deductions? Our complex tax rules and an Internal Revenue Service consistently on the lookout for missed income and exaggerated deductions paint a one-sided picture of our tax laws.

It is not easy trying to break a life-long habit of minimizing income and maximizing deductions in order to produce a low tax bill. Surprisingly, however, the lowest tax bills often result from legitimate tax deductions postponed or ignored.

A new service center has the option of deducting up to $5,000 in start-up and organizational expenditures in the year the company opens its doors. But why would it want to? If the new business has income, it will likely find itself in the lowest tax bracket. If those start-up expenses are ignored in the first year, they—and any start-up expenses that exceed $5,000—will be available for deduction ratably over the following 180-months. Thus, the $5,000 deduction deferred until later, more-profitable years will help reduce income that, in all-likelihood, will be taxed at a higher rate than it would as a start-up.

Flexible tax laws
Tax laws offer a degree of flexibility that permits steel distributors to legitimately manipulate both income and deductions to achieve a consistently low tax bill. Deferring or postponing the receipt of income in a tax year when profits are up often results in a lower tax bill for that year, as well as in later years when a larger-than-usual amount of deductions can help offset income. As was the case with start-up expenses, deferring deductions until a tax year when profits—and a higher tax bracket—make them more valuable is a legitimate option.

Business entities damaged by hurricanes or other disasters often have an incentive not to claim deductions and thus report higher pre-catastrophe income. Higher pre-catastrophe income can lead to higher federal assistance and insurance settlements from damages due to loss of income.

Sometimes, steel distributors may ignore otherwise legitimate deductions in order to report higher income. Such situations often involve third-parties—potential investors, creditors or buyers—who have requested copies of the company’s tax return to assess the income potential of the entity.

If a steel distributor is applying for a loan, banks are usually wary of self-employment income because of the ability of individuals to manipulate such income. Likewise, individuals buying a business should be aware that a tax return is not necessarily a fair representation of the profitability of the business.

Is fraud committed by not voluntarily disclosing to a third party additional expenses that were not reported on the tax returns? Omitting expenses in financial statements is a violation of generally accepted accounting principles; however, small businesses do not always use GAAP-basis financial statements. Tax laws, as mentioned, do not require claiming all deductions for tax purposes.

Recovering costs
Every business claims a write-off for some capital assets. Whether the building that houses the service center, the fixtures, shelving or furniture within that building or the equipment used by the operation, the cost of these capital assets is usually recovered using a depreciation write-off.

Under the tax rules, the write-off period for newly acquired capital assets differs greatly between the period when the building, fixtures or equipment will contribute to the metal center’s profits and what lawmakers label an asset’s “useful” life.

In addition to shorter “useful life” write-off periods, the tax rules encourage investment in business assets by allowing accelerated depreciation methods. Investment in business assets is further encouraged by allowing an expensing allowance or first-year write-off of up to $100,000 of the cost of newly acquired equipment. Remember, however, neither accelerated depreciation nor the first-year write-off are mandatory.

While depreciation deductions do not have to be claimed, they do “accrue” and figure in the computation for gain or loss when property is sold, abandoned or otherwise disposed of.

It is also possible to ignore the standard system of depreciation, choosing instead a slower, more even write-off such as the straight-line method. The IRS reportedly looks more closely, however, at any business choosing an alternative depreciation method such as straight-line depreciation for newly acquired property rather than using the no-questions-asked modified asset cost recovery system.

Ignoring the small stuff
Although entitled to claim any deduction, no matter how small, steel distributors often ignore some for fear they will increase the likelihood of an audit. Or they may feel the paperwork and record keeping is not worth the amount of the deduction.

Keeping track of small items purchased for a service center is often too time consuming to be worth the trouble. Keep in mind, however, that for many expenses such as travel, entertainment and the like, physical receipts are not required for amounts less than $75. Of course, a contemporaneous record is necessary to support a claimed deduction, including the standard mileage deduction.

Expenses that keep property in an ordinarily efficient operating condition and do not add to its value or appreciably prolong its useful life are generally deductible as expenses. If, however, repairs such as painting, mending leaks, plastering and conditioning gutters are part of an overall plan to fix up, remodel or rehabilitate a building housing the company, a service center attempting to utilize those expenditures in a later tax year can legitimately classify them as capital improvements. In fact, the IRS will often label them as capital improvements whenever they feel they are part of a capital improvement plan.

Other side of the coin
Ignoring or postponing tax deductions is only one strategy and may not always be the correct one for a particular steel distributor. Frequently, a metal center operation needs more, not less, currently deductible expenses—thus the popularity of so-called “prepaid” expenses. Yes, even cash-basis steel distributors may deduct certain prepaid expenses in the year paid. If the payment creates an asset having a useful life extending substantially beyond the end of the tax year in which paid, the expenditure may not be deductible, or may be deductible only in part, in that year.

Ignoring perfectly legitimate tax deductions seems counterintuitive. However, matching available tax deductions with the metal center’s income can, if handled properly, increase the value of the deductions while ensuring a tax bill consistently in the lowest possible tax bracket.

A fluctuating economy combined with a tax system that takes progressively larger bites as taxable income increases often means deductions may be worth more next year than today. On the other side of the coin, an exceptionally profitable year might warrant claiming every tax deduction the service center is entitled to, or postponing income wherever possible to reduce the current tax bill.

With the end of the tax year fast approaching, it’s not too late to formulate a plan to maximize those deductions. To achieve consistently low tax bills year after year, however, tax planning should be a year-round strategy.

* Mark E. Battersby, Ardmore, Pa., is a freelance writer and editor specializing in finance and tax-related topics. He can be reached at 610-789-2480 or by e-mail at mebatt12@earthlink.net.