Press Room: Tax Release

November 30, 2018

Top Year-End Tax Accounting Method Considerations for Businesses

As we approach the end of the 2018 calendar year, the tax implications of tax reform and ASC 606 adoption are still being evaluated and year-end tax planning has never been more important. Year-end tax planning in 2018 should take into account your business strategy, tax position (foreign and domestic), as well as the impact of tax legislative changes that took effect in 2018. Taxpayers should evaluate changes for 2018 as soon as possible and identify changes that can be filed under the non-automatic or automatic procedures for 2018 by filing Form 3115, Application for Change in Accounting Method. Fiscal year corporations may receive permanent tax savings by accelerating tax deductions or deferring income into the fiscal year where a lower pro-rated tax rate applies. Any non-automatic change must be filed by the end of the taxable year (i.e., December 31, 2018, 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 or Defer Income

  • Deduct prepaid expenses. Businesses should consider any expenses they can proactively prepay in 2018 to accelerate the tax deduction from 2019 into 2018. Common items include insurance, service liabilities that will be performed within 3 ½ months of year end, and dues and subscriptions. Many prepaid expenditures and intangibles are currently deductible under the 12-month rule for cash and accrual basis taxpayers.
  • Make pension contributions. Pension plan sponsors should consider making plan contributions before the end of 2018 as current year contributions are tax deductible.
  • Accelerate deductions for property taxes. Adoption of the lien-date method with the 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 Tax Cuts and Job Act (TCJA) allows taxpayers to expense the entire cost of certain depreciable assets acquired or placed in service after September 27, 2017, and before January 1, 2023 (with an additional year for aircraft and longer production period property). The requirement of original use is repealed, and the property qualifies for bonus depreciation if it is purchased from an unrelated party and it is the first use of the property by the taxpayer. Proposed regulations provide rules for determining when there is a written binding contract and also treat self-constructed property as subject to the written binding contract constraint, thus an assessment must be made of whether property is treated as acquired after September 27, 2017, under these new rules.
  • 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 longer-lived building and its structure and instead allocating them to personal property, land improvements or qualified improvement property that may be eligible for bonus depreciation. Has the building already been placed in service? A retroactive change from a cost segregation study with a cumulative catch-up adjustment can be made by filing Form 3115. A change with respect to assets placed in service in the prior year can also be made by filing an amended tax return, which may allow the additional depreciation deduction against income taxed at higher rates in effect for 2017.
  • 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.
  • Evaluate use of the cash or accrual method of accounting or new special methods for small taxpayers. Previously, C corporations or partnerships with a C corporation partner could only use the cash method of accounting if their average annual gross receipts for the prior three tax years did not exceed $5 million for all prior tax years. The TCJA increased the threshold to $25 million and the requirement that such businesses satisfy the gross receipts requirement for all prior tax years is repealed. The TCJA also exempts these taxpayers from the requirement to use an inventory method under Sec. 471 or Sec. 263A. The cash method of accounting may be very favorable to service providers who bill in arrears. Service providers who use the accrual method may also 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. Eligible small businesses should consider the benefit of changing to the new methods of accounting for 2018.

Other Considerations

  • Assess the new financial statement conformity requirement for unbilled revenues. The TCJA revises Sec. 451 by requiring accrual-method taxpayers to recognize an item of income no later than the tax year in which it is recognized as revenue in the taxpayer’s financial statement, thus eliminating the possibility of a favorable book/tax difference for unbilled revenue. The occurrence of unbilled revenue will become much more common following the implementation of ASC 606 / IAS 15, which is required for public businesses in 2018 and private businesses in 2019. Businesses should determine how the new law and new book standard will impact them from both a book and tax perspective. Note that although Rev. Procs. 2018-29, 2018-49, and 2018-60 provide for automatic accounting method changes necessary to implement ASC 606 in the year of adoption and new Sec. 451(b), certain scope limitations may apply and a non-automatic accounting method change may be needed.
  • 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 create a significant divergence between book and tax treatment. New Sec. 451(c) codified a one-year deferral rule and repealed the longer deferral that may have been available under the regulations for taxable years beginning after December 31, 2017. Notice 2018-35 allows taxpayers to continue to rely on Rev. Proc. 2004-34 until further guidance is effective for new Sec. 451(c). To the extent your business is not optimizing the deferral method, this year is a good time to consider this alternative method.
  • 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.

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