Press Room: Tax Release
Top Year-End Tax Accounting Method Considerations for Businesses
As we approach the end of the 2017 calendar year, tax reform is at the forefront in the news and year-end tax planning has never been more important. Year-end tax planning in 2017 should take into account your business strategy, tax position (foreign and domestic), as well as expected tax legislative changes. Deferral of taxable income into a later period when a lower tax rate may be in effect provides an opportunity for permanent tax savings for items that typically would result in a benefit via the time value of money. Consequently, we recommend considering accounting method changes or elections that defer income and accelerate deductions. Taxpayers should evaluate changes for 2017 as soon as possible and identify changes that can be filed under the non-automatic or automatic procedures for 2017. Any non-automatic change must be filed by the end of the taxable year (December 31, 2017 for calendar year taxpayers). Any automatic Form 3115 must be filed by the time the tax return is due. Below is a discussion of some of the ways accounting methods can help meet these objectives.
Consider planning to accelerate deductions:
- Deduct prepaid expenses. In light of expected tax reform in 2018, businesses should consider any expenses they can proactively prepay in 2017 to accelerate the tax deduction from 2018 into 2017. Common items include insurance, service liabilities that will be performed within 3 ½ months, and dues and subscriptions. Many prepaid expenditures and intangibles are currently deductible under the 12-month rule for cash and accrual basis taxpayers. Analysis is necessary to determine the nature of the items and to sort through the various economic performance rules that may apply for accrual method taxpayers. This analysis is complicated by confusion over when the payment liability, 3-1/2 month and 8-1/2 month, rules apply.
- Make pension contributions. Pension plan sponsors should consider making plan contributions before the end of 2017 as current contributions are tax-deductible.
- Accelerate deductions for property taxes. Adoption of the lien-date method with recurring item exception for property taxes may allow taxpayers to accelerate deductions for property taxes paid after year end but before the tax return is filed.
- Consider the extension and expansion of bonus depreciation. The PATH Act extended the bonus depreciation deduction through 2019. In addition, the Act added a new class of property eligible for bonus depreciation as of tax year 2016. The new class of nonresidential real property, qualified improvement property, allows taxpayers to claim bonus depreciation for qualifying nonresidential real property expenditures, as long as the building was already placed in service. Bonus depreciation on nonresidential real property improvements was previously limited to improvements where the building was at least three years old and subject to a lease.
- Evaluate current year fixed asset additions and consider annual elections under the final tangible property regulations. Most businesses have adopted the final regulations, which were effective January 1, 2014. Each year a taxpayer must evaluate its current year fixed asset expenditures to determine whether the expenditure may be deducted as a repair or is capitalizable as an improvement. Many expenditures to be deducted for tax purposes are typically capitalized for book purposes. 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. The de minimis safe harbor for 2017 for taxpayers without an applicable financial statement is $2,500. If a business does not have written policies in place, consider formalizing a policy in writing by the end of the 2017 tax year in order to take advantage of the de minimis safe harbor in 2018. Did you forget to file a Form 3115? A change in method of accounting can generally be filed for 2017 to implement the final tangible property regulations with back-year audit protection.
- Perform a cost segregation study. Cost segregation studies have long been known as a tax planning strategy to increase current cash flow and generate net-present-value savings. A current year cost segregation study can provide a company with significant benefit by minimizing the costs allocated to the building and its structure and instead allocating them to personal property, land improvements or qualified improvement property that may be eligible for bonus depreciation. Already placed the building in service? A retroactive change with a cumulative catch-up adjustment can be made by filing Form 3115.
- Deduct software development expenditures. Software development costs that are capitalized and amortized for financial accounting purposes are often currently deductible for tax purposes and can be deducted by requesting a change in method of accounting.
- Consider 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 or minimizing an income inclusion from actual or deemed dividends. With international tax implicated significantly in the pending tax reform bills, a clear understanding of foreign earnings and profits will also be essential for business taxpayers in terms of executing tax planning strategies ahead of any expected end of year legislative changes.
Consider alternative methods of accounting to defer income:
- Consider the timing of income recognition for advance payments. As a general rule, an accrual basis taxpayer is required to recognize income upon receipt as it relates to advance payments for goods or services to be provided in the future. For financial reporting purposes, revenue is generally recognized in the period the costs to generate the revenue are incurred. As a result, this is an area that may result in a significant divergence between book and tax treatment. There are several optional methods of accounting for advance payments that a company may adopt to obtain a deferral of income for tax purposes. Many are familiar with the rule in Rev. Proc. 2004-34, which provides a one-year deferral for tax purposes for certain advance payments. A taxpayer may be eligible for a longer deferral for advance payments for goods. To the extent your business is not optimizing a deferral method, this year is a good time to consider these alternative methods.
- Evaluate use of the cash or accrual method of accounting. Businesses operating in partnership, S corporation, or LLC form are generally able to use the cash method of accounting unless they hold inventoriable goods or have a C corporation as a partner. The cash method of accounting may be very favorable to service providers who bill in arrears. Service providers who use the accrual method may change to the non-accrual experience method. Alternatively, businesses that receive advance payments may find the accrual method to be beneficial and could make a change from the cash method to the accrual method.
- Evaluate the impact of accounting methods in a transaction. Tax risk related to an acquired business'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 businesses with net operating losses (NOLs) 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.
- Conform to financial accounting method changes (or not) for ASC 606 or other items. 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. For companies that follow GAAP, the new revenue recognition standard, which will be adopted in 2018 for public companies and 2019 for private companies, may result in changes that require the filing of an accounting method change application. Businesses should determine how this new book standard will impact them from both a book and tax perspective.
Andersen Tax can provide assistance in evaluating your business’s methods of accounting and pending tax reform proposals might impact your end-of-year decisions in terms of accounting method changes.