Press Room: Tax Release
10 Accounting Method Changes to Consider Before Year-End
Tax accounting method planning is a means of taking advantage of differences between book accounting methods and tax accounting methods to defer taxable income or to accelerate taxable income. It also allows taxpayers the opportunity to manage risk by changing from erroneous methods with back-year audit protection—a prospective change, and usually with a four-year spread of the related catch-up adjustment—for increases to taxable income and an opportunity to take a favorable catch-up adjustment into consideration in the year of change. This year, we add to the list the opportunity to achieve a permanent tax savings by managing the recognition of income or expense between 2012 and future years. Depending on your particular situation, you may be interested in accelerating income into 2012 or deferring income. With that background, here are 10 accounting method opportunities or issues to consider before year-end.
- Accelerate capital gains into 2012 and elect out of installment sale reporting. It is possible that capital gains will be taxed at a higher rate beginning in 2013. Taxpayers who contemplate such transactions in the near future should consider accelerating them into 2012. If the sale is a 2012 installment sale, electing out of the installment method has the additional benefit of accelerating all of that gain into 2012.
- Make favorable 2012 tax elections. The tax code allows a number of one-time elections that may be beneficial to taxpayers. For example, one-time elections are available to elect out of installment reporting; capitalize and amortize engineering and other costs over 10 years; elect out of bonus depreciation; depreciate assets on a straight-line basis; compute inventory on a last-in, first-out basis; capitalize the cost of materials and supplies; and forgo carry-back of net operating losses. If tax rates go up in 2013, such elections may be beneficial.
- Accelerate or defer income or expense using existing rules of tax accounting. Income is generally reportable when a payment is received or when there is a fixed unconditional legal right to the income under the terms of the contract. Deductions, by contrast, are often deferred when prepaid and may require payment within a given period—such as 2 ½ months or 8 ½ months of year-end—to be deductible, or may be deferred until payment even when there is a fixed obligation. In the case of both income and deductions, there are opportunities to change the timing of transactions for tax purposes by modifying the date of payment. Where a fact is changed, such as the timing of a payment, no filing with IRS is necessary or appropriate to take advantage of potentially different tax treatment.
- Change from a proper tax accounting method to another proper method to optimize the timing of reporting an item of income or expense. There are numerous opportunities to change the timing of reporting items of income or expense by filing a request with IRS to change a tax accounting method. Some of these requests must be filed before year-end and others can be filed up to the due date of the related tax return. The accounting for certain prepaid expenses, intangible assets, website costs, expense reserves, deferred revenue and inventories are a few of the most commonly filed accounting method changes. Because some accounting method change applications are due before year-end, a review of tax accounting methods should be completed in December. Such changes can be used to optimize the timing of reporting items of income or expense.
- Evaluate the timing of implementing the tangible property regulations, also known as “the repair regulations.” These regulations will touch most taxpayers in one way or another. They provide the opportunity to deduct many costs that taxpayers have traditionally capitalized to depreciable property. They also modify the rules with respect to depreciation and the treatment of materials and supplies. Some taxpayers will find these rules beneficial, others will abhor their complexity. Because of the complexity, IRS permits taxpayers to defer implementation until the 2013 tax year. Savvy taxpayers may find early adoption in 2012 beneficial if they expect rates to go down in 2013.
- Review related-party debt to see if interest is required to be accrued by cash-basis taxpayers. Even though it may seem counterintuitive, cash-basis taxpayers are required to accrue interest income and interest expense in certain situations. Specifically, if interest is not required to be paid at least annually, or is not in fact paid at least annually, the interest on these loans is generally reportable for tax purposes on an accrual method by all taxpayers regardless of their overall methods of accounting. The tax rules consider such interest to be original issue discount that is accrued even when the obligor is unable to pay the interest. Affected taxpayers may correct the underreporting of interest income and interest deductions by filing a request to change the tax accounting method for this item by year-end. If you are the lender in one of these transactions, it may be beneficial to correct this problem in 2012 if you believe your tax rate will go up in 2013.
- Pay bonuses to highly compensated employees before year-end. Such employees may be paying a higher tax rate in 2013 and therefore may achieve a permanent tax savings from being able to report this income in 2012. The deduction for the company paying the bonus will not change from such acceleration.
- Consider rescission of transactions that may have an adverse tax impact. If a transaction in 2012 is determined to be disadvantageous before the end of the year, application of the tax rescission doctrine may provide possible relief. The rescission doctrine allows “do-overs” if a transaction is unwound in the same tax year as the original transaction and both parties can be put back in the same position as before the transaction.
- Complete construction that qualifies for energy credits in 2012. If you have begun construction that qualifies for a significant energy credit, the assets under construction should be placed in service before year-end. If it is unlikely construction will be complete before year-end, consider the possibility of a temporary or partial occupancy permit. This allows you to secure a benefit that may be unavailable for construction that is completed next year.
- Consider the tax consequences of 2012 casualty losses. Casualty losses create a number of tax issues including the timing of reporting income from insurance settlements that are undocumented or disputed at year-end, the identification of replacement property, and the decision whether to deduct or capitalize resulting repair costs. Each of these decisions can have a tax consequence if tax rates in 2012 and 2013 are different.
Determining whether an opportunity adds value in any particular fact pattern requires modeling the alternatives based on various assumptions. Your WTAS tax advisor can help you decide whether any of the above actions are right for you.