Press Room: Tax Release
2014 Top Ten Year-End Opportunities
Factors that influence year-end tax planning this year include the requirement to adopt the final tangible property regulations and a concern over whether traditional tax incentives, which expired December 31, 2013, will be retroactively reinstated for 2014. 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. Below is a list of ten accounting method considerations for year-end.
1.) Consider the impact of traditional tax incentives
Now that the election is over, will Congress finally pass a tax extenders package? Competing proposals came out of the Senate Finance Committee and House Ways and Means Committee earlier this year. The Senate proposed a two year extension of virtually the entire set of traditional tax extenders, including popular items like 50-percent bonus depreciation, research credit (with modifications), active financing exception, small business expensing, and the 100-percent exclusion for gain from small business stock. The House has proposed to make select items permanent, including 50-percent bonus depreciation, research credit, small business expensing, CFC look-through treatment, active financing exception, among other items.
2.) Evaluate implementation of the tangible property regulations, also known as the repair regulations
Final regulations effective January 1, 2014 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 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. Most taxpayers who own tangible property will be required to file Form 3115 to implement the final regulations in 2014. IRS officials have indicated that they do not intend to scrutinize filings containing a zero Sec. 481(a) adjustment for those taxpayers who have traditionally followed book capitalization and who do not want to expend time and resources analyzing assets placed in service in prior years.
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 two and a half 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 before the end of the 2014 year 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. 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. 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.) Deducting prepaids, intangibles, software development
Many expenditures for prepaid items 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.) 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.) Deducting reserves
Taxpayers often assume that no reserves may be deducted for tax purposes. This is not always the case. Employee self-insured medical costs 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.
Andersen Tax can provide assistance in evaluating and implementing the new tangible property regulations and with respect to an accounting methods review.