Authored by: Kathleen Meade
Business taxpayers that have not yet filed their 2016 federal income tax return may have an opportunity to reduce taxable income for 2016, via potential tax rate reductions under tax reform proposals presented by the President and various Republican Congressional leaders. These taxpayers may consider the accounting method opportunities highlighted below to accelerate deductions into and/or defer revenue recognition beyond 2016.
Businesses may generate one-time permanent tax savings by taking deductions in 2016 at the current higher tax rates and deferring revenue to future years when tax rates could be lower.
If a corporation subject to the top tax rate of 35percent recognizes $100,000 of advance payments in 2016, the tax liability on this income would be $35,000. Alternatively, deferring these advance payments until 2017 when the top rate could be lowered to 15percent or 20 percent (under the President’s and Congressional plans, respectively) could reduce the tax liability to $15,000 or $20,000, resulting in substantial permanent savings.
Similarly, owners of pass-through entities should also consider potential accounting method opportunities in light of the proposed reductions to individual rates and the elective flat rates for pass-through owners (e.g., individual top rates would drop from 39.6 percent to 33 percent; rates of 15 percent and 25 percent apply to pass-through businesses under the President’s and Congressional leaders’ plans, respectively).
These potential savings are based on the assumption that any tax reform legislation is both enacted and effective in 2017 versus becoming effective in 2018. It further presumes rate reductions are retroactive to Jan. 1, 2017.
Accounting method planning opportunities
Previously overlooked or foregone accounting method planning opportunities may now be worth considering to potentially realize a one-time permanent tax rate benefit. The following summary highlights some of the most common and easily implemented automatic accounting method changes and elections to accelerate deductions or defer revenue recognition for taxpayers with the appropriate facts. All the accounting methods outlined below are automatic changes; you’ll still need to file for a method change using form 3115, but approval is automatic and you will not be subject to a filing fee. The elections for tangible property and success-based fees do not require a form 3115.
Accrual method taxpayers that receive certain advance payments (e.g., common items include gift cards, services and subscriptions) that are deferred for book/financial reporting purposes but are recognized for tax purposes in the year of receipt may be able to defer recognition for these payments to the next succeeding tax year.
Prepaid payment liabilities
Taxpayers that currently are capitalizing prepaid expenses such as prepaid insurance, warranties/service contracts, licenses, fees, and permits with a useful life of 12 months or less may be eligible to currently deduct these expenses in the year paid under the “12-month rule.”
Self-insured medical accruals
Taxpayers that deduct incurred but not reported (IBNR) medical expense accruals in the year the claim is paid may qualify to accelerate the deduction for these expenses to the year the services are rendered, provided the liability relates to self-insured medical/dental plans where the provider (not the employee) submits the medical claim. In addition to IBNR accruals for regular medical expenses incurred by active employees, this method also applies to eligible IBNR accruals pertaining to retired employees and worker compensation medical claims.
Cash or accrual overall accounting method
Accrual method pass-through entities with no C corporation owners that do not maintain inventory (e.g., service providers) and bill for their services in arrears (significant account receivables), such as healthcare and transportation providers, may be able to defer income recognition by changing to the cash method of accounting. Conversely, taxpayers currently using the cash overall method of accounting that routinely incur significant AP and deductible accrued expenses may want to consider changing to the accrual method to accelerate deduction of these expenses and reduce taxable income. Of course, such taxpayers will also need to recognize their accounts receivable as revenue.
Cost segregation and depreciation
Taxpayers that constructed or acquired a building placed in service in 2016 may want to consider a cost segregation study to determine the most optimal tax treatment. Alternatively, if the building was placed in service prior to 2016, and no cost segregation study was done at the time, a retroactive cost segregation study can be done in 2016. In addition to cost segregation, depreciation schedules should be reviewed for misclassified items that may have a more beneficial depreciable life (part of construction cost incorrectly included in land category, construction in progress that has been completed but was not placed in service for depreciation purposes, etc.).
The IRS recently extended the transition rule for taxpayers making certain automatic changes made to comply with the final tangible property (repair) regulations. Recent IRS guidance extends the waiver of the eligibility rule for one year to any taxable year beginning before January 1, 2017. Common changes made under these provisions to reduce taxable income include the change to deduct repair and maintenance costs and changes related to dispositions of building structural components.
In addition, taxpayers can make various elections to accelerate the write-off of tangible property, including the de minimis safe harbor election to follow book expensing of tangible property and the election to recognize gain or loss on partial dispositions of assets. Prior to making an election, taxpayers should carefully analyze their facts as well as the various eligibility and compliance requirements.
Success-based fees safe harbor election
Taxpayers that have incurred significant success-based fees in connection with a merger and acquisition (M&A) transaction may be eligible to deduct 70 percent of these fees by electing the safe harbor allocation method. In addition to potentially increasing the transaction costs deduction amount, the election may provide additional benefits of reduced administrative burden and controversy risk related to complying with the documentation standards described in the transaction cost rules. If you engaged in an M&A transaction, you should discuss with us if your costs are eligible for this election.
For more information or any questions you might have on this topic, please contact your Baker Tilly advisor or e-mail firstname.lastname@example.org.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.