Press Room: Tax Release
2013 Top 10 Year-End Opportunities
Higher tax rates may be imposed on an owner’s distributive share of income from pass-throughs or on corporate distributions in 2013. Other factors that influence year-end tax planning include the final tangible property regulations and a traditional concern over tax incentives set to expire after December 31, 2013. Companies returning to profitability after the economic downturn should consider an accounting methods review to identify opportunities for cash tax savings through the deferral of income or acceleration of deductions. Below is a list of 10 accounting method considerations for year-end.
1. Asset acquisitions and depreciation deductions – 50% bonus depreciation, including the additional $8,000 first-year depreciation cap for passenger automobiles, is scheduled to end after 2013 (2014 for long production period property and certain non-commercial aircraft). An enhanced small business expensing dollar limitation of $500,000 applies in 2013, as well as the eligibility of qualified real property (up to $250,000). A 15-year recovery period for qualified leasehold improvements, retail and restaurant property also expires in 2013, reverting to a 39-year recovery period. Placing qualified property in service in 2013 as opposed to 2014 can provide a significant cash flow benefit as a result of these expiring provisions. In addition, a taxpayer who failed to take allowable bonus depreciation or used incorrect asset classes may catch up depreciation to the amount that would have been properly allowed by filing for a change in method of accounting.
2. Evaluate implementation of the tangible property regulations, also known as the repair regulations – Final regulations effective January 1, 2014 will touch most taxpayers in one way or another. They provide the opportunity to currently deduct many costs that taxpayers have traditionally capitalized and depreciated. A de minimis safe harbor election allows a taxpayer with an applicable financial statement and a written capitalization policy as of the first day of the tax year to expense amounts paid for tangible property up to $5,000 ($500 for taxpayers without an applicable financial statement) when the amount is expensed for financial statement purposes. Taxpayers should review and evaluate their financial statement capitalization policies in place before year-end to take advantage of the de minimis election in 2014, as well as to consider other aspects of the final regulations which require upfront analysis of expected use and maintenance of capital property. Taxpayers who prefer to follow book accounting may make an annual election to capitalize costs capitalized for book purposes where capitalization is not required for tax purposes. Savvy taxpayers may find it beneficial to early adopt the final regulations in 2012 and 2013.
3. Conforming to financial accounting method changes (or not) – Many assume that financial accounting methods are proper for tax and, when the financial accounting methods change, that the tax accounting method may change as well. Neither of these assumptions is necessarily true. Taxpayers must obtain permission to follow a new book method for tax purposes. Further, the new book method may not be an appropriate tax method, or may be disadvantageous, and a book/tax difference may be the end result of a book method change. In either situation, it is important to be aware of any financial accounting method changes, including those that are not disclosed in audited financial statements, and to consider what tax filings are appropriate.
4. Determining whether accrual of bonuses is appropriate – Many expect that bonuses are currently deductible if paid within 2-1/2 months of year-end. This is not always true. Bonus plans must also meet the all events test at year-end (i.e., the bonus must be an absolute liability that is payable in all events). In situations where, for example, the bonus is paid only if the employee is still employed on the date of payment or where a judgmental evaluation occurs after year-end, the bonus plan may not satisfy the all events test at year-end and it is possible that none of the bonus accrual is permitted for tax. In these cases, if the taxpayer is accruing the bonus, the method is improper and a method change may be appropriate. Further, it may be possible to reform the plan so that it qualifies for current accrual.
5. Coping with advance payments – Many are familiar with the rule in Rev. Proc. 2004-34 that only one year deferral is permitted for tax purposes for certain advance payments. This simple rule presents many separate issues for taxpayers. Is the payment received a refundable deposit or a true advance payment? Does the advance payment meet the strict terms of Rev. Proc. 2004-34? Are there applicable financial statements that report the advance payment? What difference does it make if there is an accrued reserve rather than an advance payment reported in the balance sheet section of the financial statements? All of these issues require careful analysis and each is pertinent to determining whether the taxpayer’s method of tax accounting for advance payments is proper.
6. Identifying original issue discount – Often, original issue discount (OID) arises in connection with loans between family members and their closely-held businesses because interest is not paid at least annually. IRS requires that the interest on OID loans be accounted for on an accrual method. Because the treatment of OID is an accounting method, erroneous treatment is corrected through a method change with a catch-up adjustment to bring current the accrued interest. That catch-up adjustment is spread over four years to provide an incentive for the taxpayer to come forward and file the method change application. Where loans have remained outstanding for decades, the interest accrual may be substantial and the failure to accrue interest may present significant exposure to the lenders. This exposure can be easily cured by filing a Form 3115 with IRS before the taxpayer is contacted for examination.
7. Considering the cash method of accounting – Companies operating in partnership, S corporation, or LLC form are generally able to use the cash method of accounting unless they produce inventory or have a C corporation as a partner. The cash method of accounting may be very favorable to service providers who bill in arrears. Except in a few rare situations, a change to the cash method requires prior IRS permission. Alternatively, service providers who use the accrual method may change to the non-accrual experience method.
8. Deducting prepaids, intangibles, software development – Many prepaids and intangibles are currently deductible. Analysis is necessary to determine the nature of the items and to sort through the various economic performance rules that may apply. This analysis is complicated by confusion over when the payment liability, 3-1/2 month and 8-1/2 month rules apply. Software development costs that are capitalized and amortized for financial accounting purposes are often currently deductible for tax purposes.
9. Distinguishing bad debts from disputes – Are you treating disputes as bad debts? If so, it may be possible to accelerate the deduction for disputes that are identified before year-end. Disputes “unfix” the right to income and therefore reduce income, avoiding the need to report a bad debt at all. However, a method change is necessary to take advantage of this opportunity.
10. Deducting reserves – Taxpayers often assume that no reserves may be deducted for tax purposes. This is not always the case. Employee self-insured medical and sales incentives are two examples of reserves that may be deductible because the filing of a claim form is considered merely ministerial. It is always a good idea to look at reserves that are routinely reversed for tax purposes to see if deduction of the reserve is appropriate.