Tax StrategyThe obvious objective of tax strategy is to minimize the amount of cash paid out for taxes. However, this directly conflicts with the general desire to report as much income as possible to shareholders, since more reported income results in more taxes. Only in the case of privately owned firms do these conflicting problems go away, since the owners have no need to impress anyone with their reported level of earnings, and would simply prefer to retain as much cash in the company as possible by avoiding the payment of taxes.

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This post presents a set of general objective of tax strategy, and then proceeded directly into a series of specific tax topics that should be considered when creating and updating a tax strategy. Here are specific tax strategy revealed: Strategy For Cash Method of Accounting, Strategy for S Corporation, Strategy for Accumulated Earnings Tax, Net Operating Loss Carryforwards, Strategy for Sales and Use Tax, Strategy for Unemployment Taxes, Strategy for Inventory Valuation, Strategy for Project Costing, Transfer Pricing Strategy, and Strategy for Mergers and Acquisitions. Enjoy!
 

 

General Objective of Tax Strategy

For those Controllers who are intent on reducing their corporation’s tax burdens, there are five primary goals to include in their tax strategies, all of which involve increasing the number of differences between the book and tax records, so that reportable income for tax purposes is reduced. The five items are:

  • Accelerate deductions – By recognizing expenses sooner, one can force expenses into the current reporting year that would otherwise be deferred. The primary deduction acceleration involves depreciation, for which a company typically uses the modified accelerated cost recovery system (MACRS), an accelerated depreciation methodology acceptable for tax reporting purposes, and straight-line depreciation, which results in a higher level of reported earnings for other purposes.
  • Take all available tax credits – A credit results in a permanent reduction in taxes, and so is highly desirable. Unfortunately, credits are increasingly difficult to find, though one might qualify for the research and experimental tax credit, which is available to those companies that have increased their research activities over the previous year. The only type of expense that qualifies for this credit is that which is undertaken to discover information that is technical in nature, and its application must be intended for use in developing a new or improved business component for the taxpayer. Also, all of the research activities must be elements of a process of experimentation relating to a new or improved function, or which enhance the current level of performance, reliability, or quality. A credit cannot be taken for research conducted after the beginning of commercial production, for the customization of a product for a specific customer, the duplication of an existing process or product, or for research required for some types of software to be used internally. There are more tax credits available at the local level, where they are offered to those businesses willing to operate in economic development zones, or as part of specialized relocation deals (normally only available to larger companies).
  • Avoid nonallowable expenses – There are a few expenses, most notably meals and entertainment, that are completely or at least partially not allowed for purposes of computing taxable income. A key company strategy is to reduce these types of expenses to the bare minimum, thereby avoiding any lost benefits from nonallowable expenses.
  • Increase tax deferrals – There are a number of situations in which taxes can be deferred, such as when payments for acquisitions are made in stock or when revenue is deferred until all related services have been performed. This can shift a large part of the tax liability into the future, where the time value of money results in a smaller present value of the tax liability than would otherwise be the case.
  • Obtain tax-exempt income – The Controller should consider investing excess funds in municipal bonds, which are exempt from both federal income taxes and the income taxes of the state in which they were issued. The downside of this approach is that the return on municipal bonds is less than the return on other forms of investment, due to their inherent tax savings.

 

There is no single tax strategy that will be applicable to every company, since the tax laws are so complex that the Controller most construct a strategy that is tailored to the specific circumstances in which her company finds itself.

Nonetheless, there are a number of taxation areas that a Controller must be aware of when creating a tax strategy using the preceding five goals. Those areas are described on the next section ranging from the accumulated earnings tax to unemployment taxes. The Controller should carefully peruse these topics to see if they should be incorporated into her overall tax strategy. Read on…

 

 

Strategy For Cash Method Of Accounting

The normal method for reporting a company’s financial results is the accrual basis of accounting, under which expenses are matched to revenues within a reporting period. However, for tax purposes, it is sometimes possible to report income under the cash method of accounting. Under this approach, revenue is not recognized until payment for invoices is received, while expenses are not recognized until paid.

The cash basis of accounting can result in a great deal of manipulation from the perspective of the IRS, which discourages its use, but does not prohibit it. As an example of income manipulation, a company may realize that it will have a large amount of income to report in the current year, and will probably have less in the following year.

Accordingly, it prepays a number of supplier invoices at the end of the year, so that it recognizes them at once under the cash method of accounting as expenses in the current year. The IRS prohibits this type of behavior under the rule that cash payments recognized in the current period can only relate to current-year expenses. Nonetheless, it is a difficult issue for the IRS to police.

The same degree of manipulation can be applied to the recognition of revenue, simply by delaying billings to customers near the end of the tax year. Also, in situations where there is a sudden surge of business at the end of the tax year, possibly due to seasonality, the cash method of accounting will not reveal the sales until the following year, since payment on the invoices from customers will not arrive until the next year. Consequently, the cash method tends to underreport taxable income.

In order to limit the use of this method, the IRS prohibits it if a company has any inventories on hand at the end of the year. The reason for this is that expenditures for inventory can be so large and subject to manipulation at year-end that a company could theoretically alter its reported level of taxable income to an enormous extent.

The cash basis is also not allowable for any C corporation, partnership that has a C corporation for a partner, or a tax shelter. However, within these restrictions, it is allowable for an entity with average annual gross receipts of $5 million or less for the three tax years ending with the prior tax year, as well as for any personal service corporation that provides at least 95% of its activities in the services arena.

The IRS imposes some accrual accounting concepts on a cash-basis organization in order to avoid some of the more blatant forms of income avoidance. For example, if a cash-basis company receives a check at the end of its tax year, it may be tempted not to cash the check until the beginning of the next tax year, since this would push the revenue associated with that check into the next year. To avoid this problem, the IRS uses the concept of constructive receipt, which requires one to record the receipt when it is made available to one without restriction (whether or not it is actually recorded on the company’s books at that time). Besides the just-noted example, this would also require a company to record the interest on a bond that comes due prior to the end of the tax year, even if the associated coupon is not sent to the issuer until the next year.

 

Strategy for S Corporation

The S corporation is of considerable interest to the Controller, because it generally does not pay taxes. Instead, it passes reported earnings through to its shareholders, who report the income on their tax returns. This avoids the double taxation that arises in a C corporation, where a company’s income is taxed, and then the dividends it issues to its shareholders are taxed as income to them a second time.

The amount of income is allocated to each shareholder on a simple per-share basis. If a shareholder has held stock in the corporation for less than a full year, then the allocation is on a per-share, perday basis. The per-day part of this calculation assumes that a shareholder still holds the stock through and including the day when the stock is disposed of, while a deceased shareholder will be assumed to retain ownership through and including the day that he or she dies.

An S corporation has unique taxation and legal protection aspects that make it an ideal way to structure a business if there are a small number of shareholders. Specifically, it can only be created if there are no more than 75 shareholders, if only one class of stock is issued, and if all shareholders agree to the S corporation status. All of its shareholders must be either citizens or residents of the United States. Shareholders are also limited to individuals, estates, and some types of trusts and charities. Conversely, this means that C corporations and partnerships cannot be shareholders in an S corporation.

The requirement for a single class of stock may prevent some organizations from organizing in this manner, for it does not allow for preferential returns or special voting rights by some shareholders.

There are a few cases where an S corporation can owe taxes. For example, it can be taxed if it has accumulated earnings and profits from an earlier existence as a C corporation and its passive income is more than 25% of total gross receipts. It can also be liable for taxes on a few types of capital gains, recapture of the old investment tax credit, and LIFO recapture. If any of these taxes apply, then the S corporation must make quarterly estimated income tax payments. On the other hand, an S corporation is not subject to the alternative minimum tax.

If the management team of an S corporation wants to terminate its S status, the written consent of more than 50% of the shareholders is required, as well as a statement from the corporation to that effect. If the corporation wants to become an S corporation at a later date, there is a five-year waiting period from the last time before it can do so again, unless it obtains special permission from the IRS.

 

Strategy for Accumulated Earnings Tax

There is a double tax associated with a company’s payment of dividends to investors, because it must first pay an income tax from which dividends cannot be deducted as an expense, and then investors must pay income tax on the dividends received. Understandably, closely held companies prefer not to issue dividends in order to avoid the double taxation issue. However, this can result in a large amount of capital accumulating within a company.

The Internal Revenue Service (IRS) addresses this issue by imposing an accumulated earnings tax on what it considers to be an excessive amount of earnings that have not been distributed to shareholders. The IRS considers accumulated earnings of less than $150,000 to be sufficient for the working needs of service businesses, such as accounting, engineering, architecture, and consulting firms. It considers accumulations of anything under $250,000 to be sufficient for most other types of businesses. A company can argue that it needs a substantially larger amount of accumulated earnings if it can prove that it has specific, definite, and feasible plans that will require the use of the funds within the business.

Another valid argument is that a company needs a sufficient amount of accumulated earnings to buy back the company’s stock that is held by a deceased shareholder’s estate. If these conditions are not apparent, then the IRS will declare the accumulated earnings to be taxable at a rate of 39.6%. Also, interest payments to the IRS will be due from the date when the corporation’s annual return was originally due. The severity of this tax is designed to encourage organizations to issue dividends on a regular basis to their shareholders, so that the IRS can tax the shareholders for this form of income.

 

Net Operating Loss Carryforwards Strategy

Since income taxes can be the largest single expense on the income statement, the Controller should carefully track the use and applicability of net operating loss (NOL) carryforwards that were created as the result of reported losses in prior years. An NOL may be carried back and applied against profits recorded in the 2 preceding years, with any remaining amount being carried forward for the next 20 years, when it can be offset against any reported income. If there is still an NOL left after the 20 years have expired, then the remaining amount can no longer be used.

One can also irrevocably choose to ignore the carryback option and only use it for carryforward purposes. The standard procedure is to apply all of the NOL against the income reported in the earliest year, with the remainder carrying forward to each subsequent year in succession until the remaining NOL has been exhausted. If an NOL has been incurred in each of multiple years, then they should be applied against reported income (in either prior or later years) in order of the first NOL incurred. This rule is used because of the 20-year limitation on an NOL, so that an NOL incurred in an earlier year can be used before it expires.

The NOL is a valuable asset, since it can be used for many years to offset future earnings. A company buying another entity that has an NOL will certainly place a high value on the NOL, and may even buy the entity strictly in order to use its NOL. To curtail this type of behavior, the IRS has created the Section 382 limitation, under which there is a limitation on its use if there is at least a 50% change in the ownership of an entity that has an unused NOL. The limitation is derived through a complex formula that essentially multiplies the acquired corporation’s stock times the long-term tax exempt bond rate. To avoid this problem, a company with an unused NOL that is seeking to expand its equity should consider issuing straight preferred stock (no voting rights, no conversion privileges, and no participation in future earnings) in order to avoid any chance that the extra equity will be construed as a change in ownership.

If a company has incurred an NOL in a short tax year, it must deduct the NOL over a period of six years, starting with the first tax year after the short tax year. This limitation does not apply if the NOL is for $10,000 or less, or if the NOL is the result of a short tax year that is at least 9 months long and is less than the NOL for a full 12-month tax year beginning with the first day of the short tax year. This special NOL rule was designed to keep companies from deliberately changing their tax years in order to create an NOL within a short tax year. This situation is quite possible in a seasonal business where there are losses in all but a few months. Under such a scenario, a company would otherwise be able to declare an NOL during its short tax year, carry back the NOL to apply it against the previous two years of operations, and receive a rebate from the IRS.

 

Strategy for Sales and Use Tax

Sales taxes are imposed at the state, county, and city level—frequently by all three at once. It is also possible for a special tax to be added to the sales tax and applied to a unique region, such as for the construction of a baseball stadium or to support a regional mass transit system. The sales tax is multiplied by the price paid on goods and services on transactions occurring within the taxing area.

However, the definition of goods and services that are required to be taxed will vary by state (not usually at the county or city level), and so must be researched at the local level to determine the precise basis of calculation. For example, some states do not tax food sales, on the grounds that this is a necessity whose cost should be reduced as much as possible, while other states include it in their required list of items to be taxed.

A company is required to charge sales taxes to its customers and remit the resulting receipts to the local state government, which will split out the portions due to the local county and city governments and remit these taxes on the company’s behalf to those entities.

If the company does not charge its customers for these taxes, it is still liable for them, and must pay the unbilled amounts to the state government, though it has the right to attempt to bill its customers after the fact for the missing sales taxes. This can be a difficult collection chore, especially if sales are primarily over the counter, where there are few transaction records that identify the customer. Also, a company is obligated to keep abreast of all changes in sales tax rates and charge its customers for the correct amount; if it does not do so, then it is liable to the government for the difference between what it actually charged and the statutory rate. If a company overcharges its customers, the excess must also be remitted to the government.

The state in which a company is collecting sales taxes can decide how frequently it wants the company to remit taxes. If there are only modest sales, the state may decide that the cost of paperwork exceeds the value of the remittances, and will only require an annual remittance. It is more common to have quarterly or monthly remittances. The state will review the dollar amount of remittances from time to time, and adjust the required remittance frequency based on this information.

All government entities have the right to audit a company’s books to see if the proper sales taxes are being charged, and so a company can theoretically be subject to three sales tax audits per year—one each from the city, county, and state revenue departments. Also, since these audits can come from any taxing jurisdiction in which a company does business, there could literally be thousands of potential audits.

The obligation to collect sales taxes is based on the concept of nexus, which was covered earlier in this chapter. If nexus exists, then sales taxes must be collected by the seller. If not, the recipient of purchased goods instead has an obligation to compile a list of items purchased and remit a use tax to the appropriate authority. The use tax is in the same amount as the sales tax. The only difference is that the remitting party is the buyer instead of the seller. Use taxes are also subject to audits by all taxing jurisdictions.

If the buyer of a company’s products is including them in its own products for resale to another entity, then the buyer does not have to pay a sales tax to the seller. Instead, the buyer will charge a sales tax to the buyer of its final product. This approach is used under the theory that a sales tax should only be charged one time on the sale of a product.

However, it can be a difficult chore to explain the lack of sales tax billings during an audit, so sales taxes should only be halted if a buyer sends a sales tax exemption form to the company, which should then be kept on file. The sales tax exemption certificate can be named a resale certificate instead, depending on the issuing authority. It can also be issued to government entities, which are generally exempt from sales and use taxes. As a general rule, sales taxes should always be charged unless there is a sales tax exemption certificate on file—otherwise, the company will still be liable for the remittance of sales taxes in the event of an audit.

 

Strategy for Unemployment Taxes

Both the state and federal governments will charge a company a fixed percentage of its payroll each year for the expense of unemployment funds that are used to pay former employees who have been released from employment. The state governments administer the distribution of these funds and will compile an experience rating on each company, based on the number of employees it has laid off in the recent past.

Based on this experience rating, it can require a company to submit larger or smaller amounts to the state unemployment fund in future years. This can become a considerable burden if a company has a long history of layoffs. Consequently, one should consider the use of temporary employees or outsourcing if this will give a firm the ability to retain a small number of key employees and avoid layoffs while still handling seasonal changes in workloads. Also, if a company is planning to acquire another entity, but plans to lay off a large number of the acquiree’s staff once the acquisition is completed, it may make more sense to only acquire the acquiree’s assets and selectively hire a few of its employees, thereby retaining a pristine unemployment experience rating with the local state government.

The federal unemployment tax is imposed on a company if it has paid employees at least $1,500 in any calendar quarter, or had at least one employee for some portion of a day within at least 20 weeks of the year. In short, nearly all companies will be required to remit federal unemployment taxes. For the 2001 calendar year, the tax rate is 6.2% of the first $7,000 paid to each employee. This tends to concentrate most federal unemployment tax remittances into the first quarter of the calendar year. In many states, one can take a credit against the federal unemployment tax for up to 5.4% of taxable wages, which results in a net federal unemployment tax of only 0.8%.

If a company is shifting to a new legal entity, perhaps because of a shift from a partnership to a corporation, or from an S corporation to a C corporation, it will have to apply for a new unemployment tax identification number with the local state authorities. This is a problem if the organization being closed down had an unusually good experience rating, since the company will be assigned a poorer one until a new experience rating can be built up over time, which will result in higher unemployment taxes in the short term. To avoid this problem, one should contact the local unemployment taxation office to request that the old company’s experience rating be shifted to the new one.

 

Strategy for Inventory Valuation

It is allowable to value a company’s inventory using one method for book purposes and another for tax purposes, except in the case of the last-in first-out (LIFO) inventory valuation method. In this case, the tax advantages to be gained from the use of LIFO are so significant that the IRS requires a user to employ it for both book and tax purposes.

Furthermore, if LIFO is used in any one of a group of financially related companies, the entire group is assumed to be a single entity for tax reporting purposes, which means that they must all use the LIFO valuation approach for both book and tax reporting. This rule was engendered in order to stop the practice of having LIFO-valuation companies roll their results into a parent company that used some other method of reporting, thereby giving astute companies high levels of reportable income and lower levels of taxable income at the same time.

 

Strategy for Project Costing

A company that regularly develops large infrastructure systems, such as enterprise resource planning (ERP) systems, for its own use will usually cluster all costs related to that project into a single account and then capitalize its full cost, with amortization occurring over a number of years. Though this approach will certainly increase reported income over the short term, it also increases income taxes.

If the avoidance of income taxes is a higher priority for the Controller than reported profits, then it would be useful to separate the various components of each project into different accounts, and expense those that more closely relate to ongoing operational activities. For example, a strong case can be made for expensing all training associated with a major system installation, on the grounds that training is an ongoing activity.

Another approach is to charge subsidiaries for the cost of a development project, especially if the charging entity is located in a low-tax region and the subsidiaries are in high-tax regions. This transfer pricing approach would reduce the reported income in high-tax areas, effectively shifting that income to a location where the tax rate is lower. However, these cost-shifting strategies must be carefully documented with proof that the systems are really being used by subsidiaries and that the fees charged are reasonable.

A variation on the last approach is to create a data center in a tax haven that stores and analyzes company data, and then issues reports back to other corporate divisions for a substantial fee. This approach has to involve more than simply locating a file server in a low-tax location, since the IRS will claim that there is no business purpose for the arrangement. Instead, a small business must be set up around the data center that provides some added value to the information being collected and disseminated. This approach is especially attractive if a company acquires another entity with a data center in a low-tax location and simply shifts its own facilities to the preestablished location.

 

Transfer Pricing Strategy

Transfer pricing is a key tax consideration, because it can result in the permanent reduction of an organization’s tax liability. The permanent reduction is caused by the recognition of income in different taxing jurisdictions that may have different tax rates. The basic concept behind the use of transfer pricing to reduce one’s overall taxes is that a company transfers its products to a division in another country at the lowest possible price if the income tax rate is lower in the other country, or at the highest possible price if the tax rate is higher. By selling to the division at a low price, the company will report a very high profit on the final sale of products in the other country, which is where that income will be taxed at a presumably lower income tax rate.

The IRS is well aware of this tax avoidance strategy, and has developed tax rules that do not eliminate it, but which will reduce the leeway that a Controller has in altering reportable income. Under Section 482 of the IRS Code, the IRS’ preferred approach for developing transfer prices is to use the market rate as its basis. However, very few products can be reliably and consistently compared to the market rate, with the exception of commodities, because there are costing differences between them.

Also, in many cases, products are so specialized (especially components that are custom-designed to fit into a larger product) that there is no market rate against which they can be compared. Even if there is some basis of comparison between a product and the average market prices for similar products, the Controller still has some leeway in which to alter transfer prices, because the IRS will allow one to add special charges that are based on the cost of transferring the products, or extra fees, such as royalty or licensing fees that are imposed for the subsidiary’s use of the parent company’s patents or trademarks, or for administrative charges related to the preparation of any documentation required to move products between countries. It is also possible to slightly alter the interest rates charged to subsidiaries (though not too far from market rates) for the use of funds sent to them from the parent organization.

If there is no basis on which to create prices based on market rates, then the IRS’ next most favored approach is to calculate the prices based on the work-back method. Under this approach, one begins at the end of the sales cycle by determining the price at which a product is sold to an outside customer, and then subtracts the subsidiary’s standard markup percentage and its added cost of materials, labor, and overhead, which results in the theoretical transfer price. The work-back method can result in a wide array of transfer prices, since a number of different costs can be subtracted from the final sale price, such as standard costs, actual costs, overhead costs based on different allocation measures, and overhead costs based on cost pools that contain different types of costs.

If that approach does not work, then the IRS’ third most favored approach is the cost plus method. As the name implies, this approach begins at the other end of the production process and compiles costs from a product’s initiation point. After all costs are added before the point of transfer, one then adds a profit margin to the product, thereby arriving at a transfer cost that is acceptable by the IRS. However, once again, the costs that are included in a product are subject to the same points of variation that were noted for the work-back method. In addition, the profit margin added should be the standard margin added for any other company customer, but can be quite difficult to determine if there are a multitude of volume discounts, seasonal discounts, and so on. Consequently, the profit margin added to a product’s initial costs can be subject to a great deal of negotiation.

An overriding issue to consider, no matter what approach is used to derive transfer prices, is that taxing authorities can become highly irritated if a company continually pushes the outer limits of acceptable transfer pricing rules in order to maximize its tax savings. When this happens, a company can expect continual audits and penalties on disputed items, as well as less favorable judgments related to any taxation issues. Consequently, it makes a great deal of sense to consistently adopt pricing policies that result in reasonable tax savings, are fully justifiable to the taxing authorities of all involved countries, and which do not push the boundaries of acceptable pricing behavior.

Another transfer pricing issue that can modify a company’s pricing strategy is the presence of any restrictions on cash flows out of a country in which it has a subsidiary. In these instances, it may be necessary to report the minimum possible amount of taxable income at the subsidiary, irrespective of the local tax rate. The reason is that the only way for a company to retrieve funds from the country is through the medium of an account receivable, which must be maximized by billing the subsidiary the highest possible amount for transferred goods. In this case, tax planning takes a back seat to cash-flow planning.

Yet another issue that may drive a company to set pricing levels that do not result in reduced income taxes is that a subsidiary may have to report high levels of income in order to qualify for a loan from a local credit institution. This is especially important if the country in which the subsidiary is located has restrictions on the movement of cash, so that the parent company would be unable to withdraw loans that it makes to the subsidiary. As was the case for the last item, cash-flow planning is likely to be more important than income tax reduction.

A final transfer pricing issue to be aware of is that the method for calculating taxable income may vary in other countries. This may falsely lead one to believe that another country has a lower tax rate. A closer examination of how taxable income is calculated might reveal that some expenses are restricted or not allowed at all, resulting in an actual tax rate that is much higher than originally expected. Consultation with a tax expert for the country in question prior to setting up any transfer pricing arrangements is the best way to avoid this problem.

 

Strategy for Mergers and Acquisitions

A key factor to consider in corporate acquisitions is the determination of what size taxable gain will be incurred by the seller (if any), as well as how the buyer can reduce the tax impact of the transaction in the current and future years. In this section, we will briefly discuss the various types of transactions involved in an acquisition, the tax implications of each transaction, and whose interests are best served by the use of each one.

There are two ways in which an acquisition can be made, each with different tax implications. First, one can purchase the acquiree’s stock, which may trigger a taxable gain to the seller. Second, one can purchase the acquiree’s assets, which triggers a gain on sale of the assets, as well as another tax to the shareholders of the selling company, who must recognize a gain when the proceeds from liquidation of the business are distributed to them. Because of the additional taxation, a seller will generally want to sell a corporation’s stock rather than its assets.

When stock is sold to the buyer in exchange for cash or property, the buyer establishes a tax basis in the stock that equals the amount of the cash paid or fair market value of the property transferred to the seller. Meanwhile, the seller recognizes a gain or loss on the eventual sale of the stock that is based on its original tax basis in the stock, which is subtracted from the ultimate sale price of the stock.

It is also possible for the seller to recognize no taxable gain on sale of a business if it takes some of the acquiring company’s stock as full compensation for the sale. However, there will be no tax only if continuity of interest in the business can be proven by giving the sellers a sufficient amount of the buyer’s stock to prove that they have a continuing financial interest in the buying company. A variation on this approach is to make an acquisition over a period of months, using nothing but voting stock as compensation to the seller’s shareholders, but for which a clear plan of ultimate control over the acquiree can be proven. Another variation is to purchase at least 80% of the fair market value of the acquiree’s assets solely in exchange for stock.

When only the assets are sold to the buyer, the buyer can apportion the total price among the assets purchased, up to their fair market value (with any excess portion of the price being apportioned to goodwill). This is highly favorable from a taxation perspective, since the buyer has now adjusted its basis in the assets substantially higher; it can now claim a much larger accelerated depreciation expense in the upcoming years, thereby reducing both its reported level of taxable income and tax burden. From the seller’s perspective, the sale price is allocated to each asset sold for the purposes of determining a gain or loss; as much of this as possible should be characterized as a capital gain (since the related tax is lower) or as an ordinary loss (since it can offset ordinary income, which has a higher tax rate).

The structuring of an acquisition transaction so that no income taxes are paid must have a reasonable business purpose besides the avoidance of taxes. Otherwise, the IRS has been known to require tax payments on the grounds that the structure of the transaction has no reasonable business purpose besides tax avoidance. Its review of the substance of a transaction over its form leads the Controller to consider such transactions in the same manner, and to restructure acquisition deals accordingly.

There is a specialized tax reduction available for the holders of stock in a small business, on which they experience a gain when the business is sold. Specifically, they are entitled to a 50% reduction in their reportable gain on sale of that stock, though it is limited to the greater of a $10 million gain or 10 times the stockholder’s basis in the stock. This exclusion is reserved for C corporations, and only applies to stock that was acquired at its original issuance. There are a number of other exclusions, such as its inapplicability to personal service corporations, real estate investment trusts, domestic international sales corporations, and mutual funds. This type of stock is called qualified small business stock. The unique set of conditions surrounding this stock make it clear that it is intended to be a tax break specifically for the owners of small businesses.

A Controller must have a broad-based knowledge of a variety of taxation topics, which in turn allows her/him to construct a tax strategy that considers all aspects of company operations, financing methods, locations, and corporate structure.