Press Room: Tax Release
2015 Top Ten Year-End Opportunities
Factors that influence year-end tax planning this year include a concern over whether traditional tax incentives, which expired December 31, 2014, will be retroactively reinstated for 2015. 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. Taxpayers who are carrying forward net operating losses can use accounting method changes to manage alternative minimum tax liability. New accounting method change procedures make major modifications for taxpayers making a change in method of accounting while under IRS examination. These procedures also provide the ability for taxpayers undergoing a transaction to elect to include the entire adjustment on the seller’s tax return, rather than carry forward an adjustment into the buyer’s tax return. Below is a list of ten accounting method considerations for year-end.
1. Consider the impact of traditional tax incentives
This year, like many others, taxpayers wait anxiously for traditional tax extenders legislation to be enacted for 2015. The Senate Finance Committee approved legislation that would extend most lapsed provisions for 2015 and 2016. The House Ways and Means Committee has approved a series of measures that would permanently extend select measures, but has not taken up traditional extenders legislation that would extend the expired provisions for 2015 or 2016. There are a number of steps that businesses can take to reduce taxes even without these expired provisions.
2. Evaluate annual elections under the final tangible property regulations
Final regulations, effective January 1, 2014, provided taxpayers with the opportunity to take a retroactive adjustment to deduct expenses that taxpayers have traditionally capitalized and depreciated as repairs. In 2015, the final regulations allow taxpayers who implemented the final regulations to deduct current year expenditures for repairs, or to make an election to capitalize expenditures in accordance with book accounting. This annual election is one lever that taxpayers can use to manage taxable income for 2015. An annual 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. For 2016 the de minimis safe harbor for taxpayers without an applicable financial statement has been increased from $500 to $2,500. Forgot to file a Form 3115 for 2014? A change in method of accounting can generally be filed for 2015 to implement the final tangible property regulations with back year audit protection.
3. Evaluate the impact of accounting methods in a transaction
Tax risk related to a target company’s method of accounting is often identified by the buyer either as part of the due diligence process or subsequent to a transaction. The seller can accelerate an unfavorable adjustment resulting from a change in method of accounting into the pre-acquisition tax year by making an eligible acquisition transaction election. In addition to simplifying the transaction, the election also opens a new planning opportunity for target companies with net operating losses that will be limited following the transaction. Unfavorable adjustments in the pre-acquisition year can be offset by NOLs that would otherwise be limited, potentially creating additional tax basis for the buyer.
4. Conform 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. Such changes may require that a Form 3115 be filed under the non-automatic consent procedure before year-end.
5. Review advance payments
Many are familiar with the rule in Rev. Proc. 2004-34 that only a 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. Identify 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. 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 remedied by filing a Form 3115 with IRS before the taxpayer is contacted for examination.
7. Consider 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. Certain small taxpayers may change from the accrual to the cash method of accounting under the automatic consent procedure. For other taxpayers, 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. Deduct prepaids, intangibles, software development
Many prepaids and intangibles are currently deductible under the 12-month rule. 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. Review methods of accounting for foreign subsidiaries
U.S. multinationals must use U.S. tax accounting methods to compute the income or loss of their foreign subsidiaries. Maximizing tax accounting methods for foreign subsidiaries tends to be overlooked because companies tend to use book financial statement results. Consider using accounting methods to adjust the foreign subsidiary’s earnings and profits in order to realize tax benefits such as increasing foreign tax credit utilization, minimizing an income inclusion from actual or deemed dividends, etc.
10. Deduct 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. Taxpayers should review reserves that are routinely reversed for tax purposes to determine if deduction of the reserve is appropriate.