Large investments are required in order to own and effectively operate radio, cable, and television properties. As a result, a business manager or financial manager must take an active role in the daily management of the company. The financial manager knows that better planning and prudent, aggressive decision making can save significant amounts of money. Taxes are one such area.
It’s not unusual to think that most taxes are fixed, at least to a degree so what can be done to change things? Even if a manager does not prepare a single return, he or she will make or influence decisions that affect the outcome of the taxes that the company owes. In fact, a company may spend a higher percentage of its gross revenue on taxes than on any other single item of expense, with the exception of personnel and program costs. It is management’s responsibility to keep that percentage as low as possible, within the bounds of applicable tax rules.
Obviously, a few pages in this book will hardly make a dent in the tax laws. In an attempt to be as efficient as possible, this chapter will cover these ideas on a topical basis. Remember, these are general concepts. Actual tax-planning ideas are best implemented after management evaluates both the potential long-term benefits and how the idea applies to the specific company.
Property taxes are a local issue, with rules varying from one area to another. However, as federal aid to state and municipal governments shrinks, local governments increasingly target property taxes as a rich source for revenue increases. Property taxes are traditionally categorized into three areas: real property, personal property, and inventory. Real property (land and buildings) tax assessments are generally based on construction cost, purchase price, or market valuation, and offer only limited room for negotiation. Special features such as the studios of a broadcast facility, if taxed on a fair market value, may reduce the feature’s value to any buyer except to another broadcaster. On the other hand, personal property taxes offer many opportunities for savings. Most personal property taxing authorities offer suggested guidelines for useful asset lives. Shifting assets from a category with a long useful life to a category with a shorter useful life can result in reduced taxes. Companies may benefit from careful evaluation of the category or class to which assets are assigned. Often the local assessor has some flexibility. Maintaining good records will help in ending tax payments on assets that are no longer being utilized. When allowed by local ordinance, company records will assist in removing assets that are sold, otherwise disposed of, or no longer in use. Inventory taxes, though normally not a significant cost item except perhaps to cable operators, are similar to personal property taxes. Normally based on an average year-end cost, inventory taxes are reduced by keeping year-end inventory to a minimum. Some assessors will also allow reductions based on the cost of waste incurred in inventory use.
As discussed in the next section, Depreciation, expensing assets of relatively small amounts is a common practice. Typically, property tax returns (or renditions, as they are sometimes called) are based on fixed asset records. If low-dollar assets are expensed rather than capitalized, the items are not captured in the fixed asset records, and most likely will be left off the property tax return unless a procedure is in place to add those items to the return. The auditors may review common expense categories with a view toward adding back expensed assets.
Media companies may hire an outside consulting or accounting firm to assist in classifying assets, evaluating idle assets and obsolete inventory, and challenging assessments. The involvement of these firms can range from simply providing assistance to assuming the property tax function completely. Fee arrangements vary depending upon the level of involvement of the outside firm, so it is important to take the potential savings generated by improved classification and reporting and compare those savings to the fees for the service.
The regulations governing depreciation and amortization have been the subject of frequent legislative changes. Whereas business seeks to reduce the acceptable length of time over which an asset may be depreciated, preferring to use more-accelerated, or front-loaded, methods, the government takes in tax revenue earlier if the depreciation period is lengthened and straight-line or less-accelerated methods are used. As a consequence of this tug-of-war, depreciation rules have become a complex maze. Like any maze, though, one who knows the correct path can spend the least time and achieve the best available result.
Although really a component of the income tax computation, tangible and intangible asset depreciation (usually called “amortization” in the case of intangible assets) is significant enough in its impact that it will be discussed here on its own. The three primary Internal Revenue Code sections governing depreciation are Code Sections 167, 168, and 197. Depreciation periods and methods can vary greatly by the type of asset and its intended use. Because this is a complex area, companies should review the preliminary determinations with a tax adviser before establishing the depreciation (or “cost recovery”) categories of assets.
For assets placed in service before 1981, there were several allowable methods of depreciation generally the methods allowed for accounting purposes. Tangible assets placed in service from 1981 through 1986 are depreciated using ACRS (Accelerated Cost Recovery System). Tangible assets placed in service after 1986 are depreciated using MACRS (Modified Accelerated Cost Recovery System). ACRS and MACRS are both methods that assign specific depreciable lives and accelerated-recovery methods to classes of assets. The amount of depreciation allowable each year is computed using percentages from IRS-provided tables.
Because of the use of accelerated methods instead of straight-line depreciation for most tangible personal property (such as equipment and vehicles), the difference between the accelerated amounts and the straight-line amounts must be computed and reported as an income tax preference item for purposes of the Alternative Minimum Tax (AMT). If presented in accordance with Generally Accepted Accounting Principles (GAAP), the financial statements will likely require another depreciation computation. With the very real prospect of a number of depreciation calculations per asset, the computerization of asset depreciation records will almost certainly be required in order to manage the volume of data.
One way media companies look to reduce the volume of calculations is to expense small-asset purchases instead of capitalizing them. By immediately expensing small items, the company gains immediate deductibility and reduces the record keeping associated with depreciation. It is important to establish a capitalization policy that provides this flexibility. This policy should be in writing, and should state that all capital assets purchased with a cost less than a specified amount per item must be charged to expense when acquired, without exception. The IRS has generally approved “reasonable” capitalization policies. It would be prudent to check with a tax adviser before implementing a minimum-capitalization policy.
In addition, Code Section 179 allows a taxpayer to expense in the year of acquisition certain amounts of the qualifying personal property purchased and placed in service that would otherwise be capitalized. However, there are restrictions under Section 179 that could limit the amount that can be expensed, and this provision is subject to legislative change.
Another area of potential tax relief deals with real property component depreciation. The cost of identifiable tangible personal property components of real property such as heating, ventilation, and air-conditioning systems; and elevators and escalators can be separated from the real estate and depreciated over a shorter life. With real property depreciated over a relatively long useful life of 39 years, this is an important technique to accelerate the depreciation of capitalized items.
Another area that may apply is the depreciation of luxury vehicles. The IRS places limits on the amount of depreciation allowed on luxury cars. The dollar limits defining a luxury car and the dollar limits on the depreciation allowed change annually. This information can be obtained from the IRS or the company’s tax adviser. With these limits, it could take a significant number of years to fully depreciate a luxury car. In order to recapture some of the reduced depreciation, the business may consider selling luxury autos instead of trading them in. Under Section 1245 of the Code, the loss on the sale of such a business asset is considered an ordinary loss, provided total losses exceed gains from the disposition of such property.
Leasing vehicles has become a popular alternative to purchase for both tax and financial outlay reasons, and should be regularly considered to determine if it might be an advantage.
In 1993, a new section of the Internal Revenue Code was added that proved to be very beneficial to most broadcasters and cable operators. Section 197 provides that intangible assets acquired in connection with the purchase of the assets of a business are generally amortizable over 15 years on a straight-line basis. Almost all intangibles are eligible for such amortization, including FCC licenses, network affiliation agreements, program contracts, cable television franchises, going-concern value, workforce in place, customer- and market-based intangibles, patents, copyrights, trademarks, and trade names. Self-created intangibles generally are not eligible for the amortization deduction.
However, program costs may continue to be recovered under the more favorable income forecast method. This method is now detailed, with limitations, in Section 167(g).
Following are a few income tax items, in addition to depreciation and amortization, that will affect most taxpaying entities on a regular basis.
If a business is not using an allowance for doubtful accounts (a method of calculating bad debt losses for tax purposes), the IRS does not usually allow a write-off until all reasonable means of collection have been attempted. This suggests an additional tax incentive to aggressively pursue bad accounts. In this case, the media company must be certain to document the reasons for its inability to collect the receivable (e.g., business terminated, bankruptcy, etc.).
Although the limit on corporate charitable contributions is 10 percent of taxable income, charitable contributions in excess of this amount may be carried forward to future returns. Accumulating excess contributions subject to carryforward may not be prudent from a tax perspective, however, because the benefit of their tax deduction will not be realized until future periods.
Entertainment and Business Expenses
With few exceptions, only 50 percent of all food and entertainment expense is deductible. When expense reports are submitted, employees must document who was entertained, where, when, and for what business purpose. If a flat entertainment and travel allowance is provided, the business must report these amounts on each employee’s W-2 form.
A standard mileage rate for individuals for deducting automobile expenses is published annually by the IRS. Companies may reimburse employees using this rate without issuing a W-2 if mileage reports are submitted. Companies often compare this method with the relative advantages and disadvantages of leased or company-owned and -maintained vehicles.
Estimated Income Tax Payments
To avoid penalties for underpayment of income tax, a corporation must make quarterly payments of estimated taxes. Accurately calculating such estimates is important to cash management. Estimated payments are generally due on the 15th day of the month of the 4th, 6th, 9th, and 12th months of the company’s fiscal year. If taxable income existed in the prior fiscal year, and the company is not a large corporation as defined by Code Section 6655 (a corporation that has had $1 million in taxable income in any one of the prior three tax years), the quarterly estimated payments should be at least 25 percent of the lesser of the current year tax or the prior year’s tax as shown on the prior-year return.
Alternatively, quarterly estimated tax payments may be based on estimated annualized earnings, a method that may be advantageous if earnings are not level over the year. These annualized-earnings estimated payments must be for 100 percent of the tax estimated through that portion of the year. For example, for the first installment, based on the first three months of the year, pay one-quarter of the tax estimated to be due for the entire year.
Except for group term life insurance benefiting employees, life insurance premiums are not deductible, and life insurance proceeds are not included in income; however, they may be considered in Alternative Minimum Tax calculations.
If a company is a member of a “controlled group of corporations,” as defined in Code Section 1563, the company must make an election to apportion the surtax exemption, the Alternative Minimum Tax exemption, the environmental tax exemption, and the Code Section 6655 limitation. The apportionment is at company discretion. In addition, component members of a controlled group are treated as one taxpayer for the purposes of determining the tax imposed under Section 11. Each graduated income bracket is divided equally among the members unless they consent to an apportionment plan.
Sales and Use Taxes
The majority of U.S. states impose some form of sales and/or use tax on sales transactions. Traditionally, sales taxes have applied to retail sales of tangible personal property. Sales of services, including advertising services, were generally not subject to sales tax. Thus, many electronic communication operators had no duty to collect sales taxes from customers except when selling tangible property such as tapes or promotional items. Cable operators pay local or state franchise fees, and may also be subject to taxes similar to telephone or sales taxes on some or all cable subscriber charges. Similarly, on the buying side, such operators traditionally pay sales taxes on tangible property used in the business. However, the states have always had important differences among themselves, and the pressure for revenue has caused the scope of these taxes to be expanded and exemptions to be cut back.
Each year, most states have some sort of legislative activity adding, changing, or deleting transactions subject to sales tax, as well as possibly changing the tax rates imposed on transactions. This is an area that smart media companies will monitor closely. As state revenues decline, states look for ways to boost tax revenue, and sales tax is one of the targets, particularly now that Internet sales have made a dent in state sales-tax revenues. Technology has impacted sales taxes in ways never dreamed of in decades past. New technology and the new products that follow create new sales-tax issues faster than they can be resolved. Each state must determine whether and how to tax sales of both tangible and intangible property that never existed before, and so may not fit the definitions of existing law and regulations.
The Streamlined Sales Tax Project, sponsor of the Streamlined Sales and Use Tax Agreement is an example of states’ efforts to respond to the rapidly changing tax environment. While fewer than half of U.S. states are members as of this writing, more states are slated to join in future years. The purpose of the agreement is to simplify sales-tax administration for both sellers and the states. Each company must have in place procedures to collect tax in each “member” state where the company may have a sales tax collection or use tax payment responsibility. Visit www.streamlinedsalestax.org for more information.
Because many states offer a variety of targeted exemptions from sales and use tax, media companies must be familiar with the exemption statutes in the state(s) where they operate or provide services. For example, Georgia provides radio stations with an exemption from sales tax for digital-broadcasting equipment purchased before the earlier of the date on which the radio station ceases analog broadcasting or November 1, 2008. Louisiana, on the other hand, allows television broadcasters an exemption for one purchase of digital-transmission equipment from each category provided in their statutes. To emphasize, all states do not tax or exempt the same services and/or purchases in the same way. The form in which charges are incurred can significantly impact the ultimate sales-tax liability from state to state. For example, if freight and/or labor costs are separately stated on an invoice, these charges may be exempt from tax in certain states. Again, it is imperative for media companies’ financial managers to understand each state’s application of their respective sales- and use-tax rules to their particular business operations in order to avoid overpayment.
All businesses with employees pay Federal Insurance Contributions Act (FICA) payments, Federal Unemployment Tax Act (FUTA) payments, and state unemployment tax. The wage bases for the Social Security tax and the Medicare tax are published annually by the IRS. Company finance employees are responsible for making all payroll tax deposits on a timely basis. For large corporations (deposits in excess of $100,000), deposits must be made within 24 hours of the date the payroll is paid. Failure to make federal deposits on a timely basis can result in substantial statutory penalties that are unlikely to be waived. For corporate officers, an added incentive to make timely deposits is Code Section 6672. This section allows the IRS to assess a penalty (equal to the total not collected) against anyone who is required, and who willfully fails, to collect, account for, or pay any tax due. The IRS shows little restraint or leniency when collecting payroll related taxes and penalties.
In some payroll situations, employers attempt to avoid the burden associated with payroll taxes by classifying employees as independent contractors, who then must themselves pay the taxes applicable to their earnings. A general rule for the distinction is that the employer has the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result. Studies have shown that many workers are incorrectly classified, resulting in large tax losses to the government. Consequently, the government is continuing strong enforcement efforts to stem this flood of lost revenue.
Media company managers are advised to consult a tax adviser before making extensive use of independent contractors. If determined to have incorrectly handled independent contractors, the company may be held liable for all FICA and withholding taxes due for those contractors. However, if reporting requirements were followed in good faith, Code Section 3509 provides a lesser liability compared to cases where the requirements have been disregarded.
Many businesses have insurance, particularly slander and libel, through a foreign carrier. In this case, unless exempted by the provisions of an income tax treaty, a federal excise tax must be paid based on the premium. Additionally, federal excise tax is charged on local telephone charges. Federal excise tax is no longer imposed on toll (long distance) charges.
There are a number of information returns required to be filed annually, including Forms W-2, 1099 (for independent contractors, interest, dividends, and other miscellaneous income), and 5500 (for pension and profit-sharing plans and health-and-welfare plans). Even though these returns require no tax payments, failure to file on a timely basis can result in substantial penalties.
Accumulated Earnings Tax
If a business is fortunate enough to have a large retained earnings balance, the company should schedule and hold regular board meetings and carefully document in detail its future plans with regard to accumulated earnings. Code Section 531 imposes a 15 percent tax on excess accumulated earnings.
Although a business can never avoid taxation completely, being aware of and alert to planning business operations within the limits of laws and regulations can minimize tax expense. Companies are responsible not only for federal taxes, but also for adhering to the requirements of state and local tax codes for each state in which they do business. In the post-Enron business environment, the Sarbanes-Oxley Act of 2002 has imposed stricter standards on public companies for ethical business practices by requiring detailed explanations of and procedures for sufficient internal controls (see Chapter 10). In this environment, it is imperative to closely analyze and clearly disclose the risk of tax positions taken. Although nonpublic companies are not currently required to follow Sarbanes-Oxley, the statute’s standards are increasingly being voluntarily applied by businesses and their advisers, especially the accountants who audit their financial statements. Generally, the overall business environment is much less tolerant of highly aggressive tax planning. Given the complicated nature of taxes, many media companies have found that dollars spent on a professional tax adviser are a wise investment.