Monday, November 15, 2010

The Certainty of Tax Accounting

Over at the lefty Mother Jones, Kevin Drum is bewildered by the uncertainty meme:
The only significant real uncertainty that American businesses face right now is financial uncertainty: that is, whether there will be enough consumer demand next year to justify hiring more workers and buying more equipment today. PPACA and carbon taxes rank very far down the list.
Elsewhere, Kevin acknowledges that Congress really should've dealt with the Bush tax cuts before now; however, I don't think he understands why those tax cuts have introduced so much uncertainty.

I was self-employed for a few years. My accountant repeatedly advised me to "accelerate my expenses and defer my income." In practical terms, this meant that I'd try to make big purchases before the end of the year and I'd hope and pray that my clients would send the check for my December work the slowest way possible since the IRS doesn't require you to recognize revenue until it arrives in your mailbox. My clients, of course, wanted to realize the expense of paying me in the current year, but I didn't want to realize the revenue until the next year. My clients were accelerating their expense so that their adjusted revenue would be lower, thereby lowering their tax obligation. I wanted to defer that income so that I wasn't pushed into a higher tax bracket or so I could benefit from a lower tax bracket the following year.

All companies play this game. Some have entire accounting departments devoted to it.

The Bush tax cuts are set to expire January 1st. Obama does not want to extend the Bush tax cuts for people making over $250,000. I'd guess that most of those people making north of $250k are small business owners. Now the rule of thumb is "accelerate your expenses and defer your income," but that no longer works in the Twilight Zone of Obamanomics. If you expect your taxes to be higher next year and you know that the tax brackets under $250k aren't going to have higher rates if Obama has his way, two things that those $250k+ small business owners understand, then you should defer your expenses until next year and accelerate your income. That's precisely the opposite of the rule of thumb.

If the Bush tax cuts for people making over $250k are extended, then businesses would know how to handle their accounting: accelerate expenses and defer income. If the Bush tax cuts simply expire, then everyone can figure out what to do for their individual circumstance. The same applies for the Obama plan of only extending the tax cuts for people making under $250k; however, by promising lower rates for people under $250k, more small business owners will be inclined to defer expenses until next year.

The upshot of all of this is that the uncertainty that alludes Kevin Drum is what next year's tax rates will be. Once that's known, everyone will know whether or not income and expenses should be deferred or accelerated. Everything will become clear once Congress acts (or doesn't), but because of the uncertainty business decisions about income and expenses have been much harder to make this year. FWIW, if the left is right and the underlying economy is good, then businesses will ramp up early next year regardless of what Congress does... just in time for the Republican controlled House to claim credit.

Disclaimer: I'm not a tax accountant. Tax law is complicated and everyone's situation is a little bit different. Contact a tax professional for guidance on your tax obligation.

No comments: