Checklist for preparing and reviewing business tax returns.

The following checklist focuses on tax planning issues associated with business tax returns. The checklist can serve as a supplement to the AICPA's Tax Practice Guides and Checklists, as it provides only general guidance. It can also serve as a training guide for less experienced professionals, enabling them to identify key tax issues.

                                       Applicable   Nonapplicable
Income Issues

1. Tax accounting. Evaluate whether
a client's use of the cash method
of accounting is appropriate, In
light of recent IRS examinations,
consider Regs. Sec. 1.446-1(c)
(2)(i), which requires the accrual
method of accounting for purchases
and sales in any case in which
inventory is necessary; see also
Regs. Sec. 1.471-1.

Caution: The IRS often challenges
traditional service businesses that
also sell merchandise. It issued
Rev. Proc. 98-60, which states
that a taxpayer may obtain automatic
consent to change accounting
methods. This is the current
statement of procedures. Rev. Proc.
71-21 also provides deferral
opportunities for certain advance
payments for services.                      --        --

2. Inventory. Consider recent court
decisions when advising a client on
the effects of a bargain purchase of
inventory on a client's LIFO
inventory pools. Hamilton Industries,
Inc., 97 TC 120 (1991), Kohler Co.,
124 F3d 1451 (Fed. Cir. 1997) and
LaCrosse Footware, Inc., Ct. Fed.
Cl. (1998), focused attention on the
issue of so-called bargain purchases
of inventory. Generally, the IRS
treats bargain purchase items as a
separate LIFO pool.                         --        --

3. Sec. 263A, uniform capitalization
rules. Consider application of the
UNICAP rules. Rev. Proc. 98-60
provides accounting method change
procedures.                                 --        --

4. Capital gains versus ordinary
income. Address the choice of
entity, with a long-term view of
when a business is sold. Choice of
entity is particularly important
for passthrough entities, ensuring
that a taxpayer is maximizing
capital gains treatment. For
example, using an S corporation or
partnership (including a limited
liability company (LLC)) instead of
a C corporation allows gains
associated with intangible assets
(such as goodwill) to receive
long-term capital gains treatment
at the individual-owner level.              --        --

5. Deferral opportunities. Be on
guard for opportunities to discuss
deferral provisions, such as (1)
like-kind exchange rules, if a
taxpayer plans to sell business
property, (2) sale of qualified
small business stock and (3)
rollovers associated with sales of
publicly traded securities. A
deferral opportunity is also
available for certain service
businesses under Rev. Proc. 71-21
(i.e., for advance receipts of
services to be performed by the end
of the next tax year).

Caution: Like-kind exchanges
involving partnerships need careful
consideration in light of recent IRS
rulings. A special election under
Sec. 761(a) may provide rebel for
certain joint ventures to elect out
of partnership tax treatment.               --        --

6. Related-party transactions.
Evaluate related-party transactions
and provide guidance as to
appropriate documentation and
structuring. Transfer-pricing
evaluation opportunities may
exist, both for international
affiliated transactions and
multistate activities.                      --        --

7. Passive activity rules. Evaluate
the "structure" of a taxpayer's
passive activities. For example,
treating a real estate
professional's real estate
activities on a separate-activity
basis, as opposed to an aggregate
approach, will likely trigger
different tax results on partial
dispositions if the taxpayer has
"suspended" passive losses. Thus,
thorough and careful planning for
passive activities is a must.               --        --

8. Foreign-income sources. Identify
foreign-income sources to ensure
compliance with U.S. income
"repatriation" rules, transfer
pricing and international
jurisdictions. For example,
determine if a taxpayer has a
sufficient presence in a foreign
country to be treated as doing
business in that country. Foreign
business activities also create
planning opportunities, such as
evaluating whether to incorporate
the foreign activity as a
subsidiary. Other planning
opportunities include the possible
use of hybrid entities, such as
LLCs.                                       --        --

Deduction Issues

1. Unreasonable compensation/
dividend challenges by IRS.
Evaluate salary remuneration paid
to shareholder-employees in light
of unreasonable compensation
challenges normally associated
with C corporations. (An S
corporation subject to built-in
gains tax could also be subject
to unreasonable compensation
scrutiny.)                                  --        --

2. Consider nonqualified deferred
compensation arrangements for
officers. Consider "wealth-building"
opportunities through the use
of nonqualified arrangements.               --        --

3. Employee status. Evaluate
compliance with independent
contractor versus employee
status. The IRS and state tax
authorities (and states'
Departments of Labor) may have
differences in defining employee
status for tax purposes.                    --        --

4. Retaining valuable employees.
Evaluate opportunities for business
owners to retain
key employees. Through the use of
creative plans, such as stock
appreciation rights and other
similar "phantom ownership" plans,
owners can allow key employees to
participate in business
growth without relinquishing
business control. Such plans can
also help avoid the
one-class-of-stock restrictions
(applicable to S corporations).             --        --

5. International payroll. Explore
payroll compliance and tax savings
in areas such as immigration (i.e.,
treatment associated with special
work visas for students, teachers
and certain trades such as
architects), transfer pricing,
retirement plans and Social
Security rules for employees
working abroad.                             --        --

6. Federal and state tax credits
for certain employees. Evaluate tax
benefits associated with the
Federal work opportunities tax
credit. In addition, many states
have corporate business tax credits
for hiring workers who meet certain
criteria (e.g., persons residing
within urban areas).                        --        --

7. Retirement plans and employee
fringe benefits. Consider the
following opportunities for
maximizing use of retirement plans:
(1) coordination of business
owner's personal wealth-building
with business planning (this may
also include evaluating whether a
Roth IRA conversion is advisable),
(2) compliance with
nondiscrimination testing and (3)
compliance with reporting rules
(i.e., Form 5500 filing). The use
of other fringe benefits (such as
life insurance and health care
plans) should also be considered.
(This includes an evaluation of
compliance with governmental
provisions, such as the COBRA
coverage rules.)                            --        --

8. Capital expenditures. Consider a
taxpayer's "capitalization versus
current expense" policies, by
evaluating fixed asset reporting
systems, depreciation methods and
obsolescence considerations.                --        --

9. Timing of deductions. Evaluate
year-end tax planning for optimal
timing of certain deductions, such
as expenditures for business
equipment and compensation. This
evaluation also includes compliance
associated with applicable year-end
bonus limitation rules.                     --        --

Entity Structuring/Choice of Entity
Issues

Perhaps the most fundamental and
essential issue that business
owners must address is selecting
the choice of entity for their
particular business. Thus, care
needs to be exercised to properly
identify and capture opportunities
to evaluate a taxpayer's entity
structure.                                  --        --

1. S corporation versus C
corporation tax treatment for new
entities.

2. Conversions of C corporations to
S status. Thoroughly analyze
applicable "toll charges"
associated with conversions (such
as the built-in gains tax and LIFO
recapture rules). A proper
evaluation involves the
determination of the aggregate tax
results associated with a potential
sale of the business, distribution
of company earnings or both.                --        --

3. Use of S corporation versus LLC.
An analysis of C corporation versus
S corporation treatment should also
include an evaluation of an LLC as
a passthrough entity alternative.           --        --

4. Consolidated versus separate
return filing. Analyze key tax
issues, such as the application of
loss limitation rules (e.g., under
separate return limitation year
rules) when evaluating whether
consolidated filing is beneficial.
Under C corporation tax treatment,
affiliated companies may elect to
file on a consolidated basis.               --        --

5. Use of qualified S corporation
subsidiaries. Intended to ease the
administrative burden of filing
multiple S returns for
"brother-sister" groups of S
corporations, the Federal and state
"consolidated" filing requirements
may prove more burdensome after
careful analysis.                           --        --

Other Issues

The following tax issues create
excellent tax planning
opportunities.

Estate planning. Recent law changes
have expanded the use of trusts as
eligible S shareholders. The use of
trusts, gifts with appropriate
valuation discounts, and possible
income shining, are among the
possible tax planning services that
could be performed.                         --        --

Business succession planning.
Advisory services should include an
evaluation of buy-sell agreements.
Special care is required to avoid
certain tax traps associated with
the use of life insurance policies
(e.g., corporate alternative
minimum tax and transfer for value
rules).                                     --        --

Sale of business. As noted, the
choice of entity greatly affects
tax planning when a business is
ultimately sold. Care should be
exercised to maximize use of
favorable capital gains rates
(e.g., by using passthrough
entities, gain associated with
intangible assets (such as
goodwill) is taxed at favorable
capital gains rates).                       --        --

Purchase of business. Opportunities
exist to evaluate allocation of
purchase price, choice of entity
for acquisition and a transaction's
appropriate structure (e.g., asset
versus stock deal).                         --        --

FROM EDWARD P. RIGBY, CPA, MS, DIRECTOR, TAX DEPARTMENT, WITHUM, SMITH & BROWN, RED BANK, NJ