Ignore a tax deduction? Sometimes it makes sense

Ignore a tax deduction? Sometimes it makes sense

Mar 01, 2008

Why would any veterinarian ignore perfectly good, legitimate deductions at tax-filing time?

Our complex tax rules and an Internal Revenue Service ever on the lookout for missed income and exaggerated deductions paint a one-sided picture of the nation's tax structure.

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

A start-up business has the option of deducting up to $5,000 in start-up and organizational expenditures the year it opens.

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 the first year, they - and any start-up expenses that exceed $5,000 - will be available for deduction gradually over the following 180 months. Thus, the $5,000 deduction deferred until more profitable years will help reduce income that at that time will in all likelihood be taxed at a higher rate.

Flexible tax laws

Tax laws offer a degree of flexibility that permits veterinarians and their practices to manipulate both income and deductions legitimately to achieve a consistently lower tax bill. Deferring or postponing receipt of income in a tax year when profits are up often results in a lower tax bill for both that year and later years when income can be offset by a larger-than-usual amount of deductions.

As was the case with our start-up expenses, deferring deductions until a tax year when profits - and a higher tax bracket - make them more valuable is a legitimate option.

Veterinary practices and other businesses damaged by a hurricane or other disaster often have an incentive not to claim deductions and thus report higher pre-catastrophe income, which can lead to higher federal assistance and insurance settlements covering loss of income.

Another situation that might prompt a veterinarian to ignore deductions to show a higher income might involve a potential investor, creditor or buyer, who may have requested copies of the practice's tax return to assess its income potential.

If a veterinarian or a practice principal is applying for a loan, banks usually are wary of self-employment income because of the ability of individuals to manipulate earnings on paper. Likewise, individuals buying a practice or business should be aware that a tax return is not always a fair gauge of profitability.

Is fraud committed by failure to disclose to a third party expenses that were not reported on a tax return? Omitting expenses in financial statements violates generally accepted accounting principles (GAAP), but small businesses do not always use GAAP-based financial statements. Tax laws, as mentioned, do not require claiming all deductions for tax purposes.

Recovering costs

Every practice claims a write-off for capital assets - the building, furniture, fixtures and equipment - usually on a depreciation schedule.

Tax rules allowing for recovery of money spent for equipment don't match tax depreciation with economic depreciation. The write-off period for newly acquired capital assets differs greatly between the period when the assets contribute to business profits and what is called an asset's "useful" life.

In addition to a shorter useful-life write-off period, rules encourage investment in assets by allowing accelerated depreciation methods, and by allowing an expensing allowance or first-year write-off of up to $100,000 of the cost of newly acquired equipment under Code Section 179. However, neither accelerated depreciation nor the first-year write-off are mandatory.

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

It is possible to ignore the standard system of depreciation, choosing instead a slower, more even write-off such as the straight-line method. But the IRS reportedly looks more closely at those who choose alternative depreciation methods instead of the no-questions-asked, modified-asset cost-recovery system (MACRS).