Business Tax Reform – A Commentary
In September, the Trump Administration, together with the House Ways and Means Committee and the Senate Finance Committee, released its long-awaited Unified Framework for Fixing Our Broken Tax Code. The centerpiece of the business tax provisions focused on two key areas: (1) reducing corporate tax rates for both C corporations and flow-through entities and (2) expensing capital investments at 100%. Rate reduction will let businesses receive a permanent tax benefit for items that would normally result in a temporary one via the time value of money. Businesses should plan now to take advantage of accounting methods that accelerate deductions or defer revenue. Many accounting method changes receive automatic IRS consent; the method may be changed by the filer’s timely filed (including extensions) tax return for the year of change. Businesses should consider several changes that would allow it to arbitrage the tax rates, such as capital expenditures, revenue recognition, inventory valuation and more.
Businesses may consider numerous capital expenditure items that would accelerate their deductions. First, the framework allows businesses to immediately write-off the cost of new assets in depreciable assets other than structures made after September 27, 2017. Businesses may want to accelerate new asset purchases to take advantage of this deduction prior to 2017 year-end.
Second, if a business has purchased real estate in the current year, it may want to consider completing a cost segregation study. This is essentially an engineering study that permits a building owner to depreciate an existing structure over the shortest amount of time permissible under the current tax laws.
Lastly, the IRS promulgated extensive regulations several years ago that address repairs and maintenance. These regulations provided a de minimus safe harbor that allows a business to deduct certain limited amounts paid for tangible property that are expensed for financial accounting purposes. The safe harbor amount depends on whether the business has an applicable financial statement. A business with an applicable financial statement may expense $5,000 per item; a business without an applicable financial statement may expense $2,500. For example, if a business purchased 20 laptop computers for $2,000 each, it could expense the full amount ($40,000) provided it was expensing them for financial statement purposes.
Businesses can also defer income into a subsequent tax year. They receive a limited deferral beyond the tax year of receipt for certain advance payments. Businesses can generally defer the inclusion of gross income of advance payments to the next succeeding tax year, to the extent these payments are not recognized in revenues in the tax year of receipt. The IRS allows certain small businesses with gross receipts of up to $10 million or less to use the cash method for their income and expenses. This rule allows relief for small businesses, especially service providers, where it is unclear whether they are selling merchandise and if that merchandise was an income-producing factor. Businesses that qualify for the cash method should consider changing from an accrual method of accounting to cash in order to defer income into a subsequent year.
Numerous methodologies exist for valuing inventories: cost, lower of cost or market, LIFO and FIFO. Businesses should consider changing their inventory valuation method in order to accelerate deductions. For example, during periods of rising costs, businesses may want to change from FIFO to LIFO cost accounting. Under LIFO, a business records its newest products and inventory as being sold first.
Businesses should capitalize prepaid expenses where possible. However, there are exceptions. Businesses can deduct prepaid expenses when their benefit does not extend beyond the earlier of (1) 12 months after the first date on which the corporation realizes a benefit from the expenses; or (2) the end of the tax year following the tax year in which payment is made. For example, if a business prepays insurance, it must capitalize it to the extent it benefits the succeeding tax year. Under the 12-month rule, the business would be allowed to expense the full amount in the current year. Businesses should review their prepaid expenses and determine if they meet the 12-month rule. If so, they can file for a change in accounting method and take an immediate deduction.
These are just several strategies corporations should think about in order to leverage tax rate changes. Other accounting methods exist that corporations can use to accelerate deductions and defer income. Contact your tax advisor to discuss these methods.