Five Key Year-End Tax Considerations
As 2017 winds down, tax professionals, chief financial officers, and corporate officials should carefully analyze their year-end tax positions to plan for 2018 and beyond. Here are five major areas of concern that every business should consider.
1. Prepare for New Revenue Recognition Rules
The revenue recognition rules commonly referred to as ASC 606, “Revenue from Contracts with Customers,” were originally issued by the Financial Accounting Standards Board and the International Accounting Standards Board in May 2014, but are only now going into effect for public businesses for annual reporting periods beginning after December 15, 2017. The new rules are designed to remove inconsistencies in existing revenue requirements of the two boards; address revenue issues in a manner designed to improve comparability of practices across entities, jurisdictions, and markets; and require businesses to provide more informative disclosures in financial statements.
“Businesses should be aware that the adoption of the new standard is likely to affect their income tax accounting, because the timing of revenue recognition for financial reporting purposes may no longer be in line with their tax accounting treatment and a change in accounting method for tax is likely,” adds EisnerAmper. In such instances, companies must recognize a temporary difference for reporting purposes. The adoption of ASC 606 may require a company adopt a new temporary difference or modify an existing one to account for changes in revenue recognition for financial reporting.
Under ASC 740, automatic changes in accounting methods are reported in financial statements in the period in which such position is decided and measurable which for most will be in the fourth quarter of 2017 when numerical disclosures of the impending Q1 2018 ASC 606 adoption entry are expected.
Such changes may be required or a company may want to consider whether the new standards would make a change in their tax accounting method desirable. Finally, companies should monitor the transition to the new standard closely, including any guidance eventually issued by the Internal Revenue Service. And, let’s not forget tax reform’s proposed changes for deferred revenue rules under Rev. Proc. 2004-34.
2. Accounting for Bonuses
Providing employee bonuses at holiday time is a great way to improve employee engagement and to recognize outstanding achievement during the year, particularly for those businesses that can afford them. Like most good things, however, there could be unintended consequences involved in the provision of these perks from a tax perspective.
For example, companies must determine whether a bonus is “fixed and determinable” for purposes of deducting the expense. For companies using accrual-based accounting, the timing of the deduction is heavily dependent on the specific terms of the bonus plan. In many cases, bonuses are intended to award activity incurred in a current taxable year but are not scheduled to be paid until the following year—say, for example, a short-term incentive plan bonus that is tied to specified revenue goals achieved in 2016 but is not paid until the first quarter of 2017.
In such a case, if a company’s policy can show that a fixed and determined amount was definitely paid by March 15, 2017, based on the employee’s continued employment on December 31, 2016, it would likely be able to deduct the expense in 2016 because the employee will be considered to have satisfied all the conditions for receiving the bonus in 2016.
However, in many (if not most) cases, a company will retain the right to modify or rescind the bonus up to the date that it is paid under terms specified in the bonus plan. When such conditions are present, the IRS has consistently held that, under the all-events test set forth at 26 C.F.R. § 1.461-1(a)(2), the bonus payment is not fixed and determinable prior to payment, and would not be deductible in 2016. Accordingly, businesses should review their bonus plans and policies to ensure that deductions are properly recorded.
3. Be Aware of State and Local Tax Changes
In conducting year-end tax planning, businesses tend to focus on federal corporate income taxes, but pay limited attention to state corporate income taxes. Companies should be aware that a few states, including North Carolina, Arizona, New Mexico, and the District of Columbia, enacted tax decreases recently that will be fully effective for the 2017 tax year. The Tax Foundation has compiled a list of state corporate income tax rates and brackets for 2017.
Businesses should also be aware of ongoing efforts by states to push the envelope of their taxing authority through use of doctrines such as sales factor presence nexus to subject a business to tax in a given state. Ohio has been a leader in asserting this doctrine, which essentially posits that any business with a threshold level of sales in a state is deemed to have nexus and is subject to tax in the state, without regard to any physical presence. In the case of Ohio, sales of $500,000 are sufficient to allow the imposition of the state’s commercial activity tax, a position upheld by the Ohio Supreme Court in Crutchfield Corp. v. Testa in November 2016. At least eight other states have adopted some sort of sales factor presence nexus standard, and others are expected to follow. Companies should monitor 2017 legislative activity in states where they operate or sell in order to prepare for additional assertions of state authority, as well as any efforts on the federal level to impose a uniform national nexus standard.
4. Don’t Leave Any Tax Credits on the Table
Every year, companies fail to take advantage of tax credits that have been provided by the IRS or States. For example, it’s a common misperception that research and development (R&D) tax credits are only available to large corporations conducting significant research activities, but any company, regardless of size, that meets certain requirements can qualify. In a nutshell, under IRC § 461(d)(1), if a company’s activities are: a) conducted for a qualified purpose (i.e., to create a new or improved product or process resulting in increased performance or quality); b) involve a process of experimentation that relies on engineering, physics, computer science, or other hard science and c) are undertaken to resolve a technical uncertainty through the evaluation of alternative solutions, the activities may qualify for the credit.
Below are some credits to consider (federal or industry state specific):
- R&D credits. As mentioned above companies should carefully evaluate their business processes to determine whether their activities meet the R&D qualification. Please note that effective in 2017, Small Business may be able to use up to $250,000 of R&D Credits to offset payroll taxes up to 5 years for a total of $1,250,000. (For more information: PATH Act Provides Significant Benefits to Life Sciences and Technology Industries)
- Disaster recovery. Depending on their location, companies may be eligible for tax credits in the wake of recent hurricanes affecting Texas, Florida, Georgia, South Carolina, Puerto Rico, and the U.S. Virgin Islands. Under the Disaster Tax Relief and Airport and Airway Extension Act of 2017 (H.B. 3823), signed into law on September 29, disaster-affected employers are eligible for a tax credit of up to 40% of wages up to $6,000 (or $2,400) for wages paid to each employee whose principal place of employment was in the hurricane disaster zone.
- Industry-specific credits. For instance, in New York technology and life science companies can explore the NYC biotech credit, the NYS Excelsior Jobs Credit and the NYS Qualified Emerging Tech Company credit.
5. Don’t Forget About Tax Reform
As the tax reform process unfolds, every business needs to be prepared for changes in the current version of the proposed legislation. The current proposals would, if enacted, reduce the corporate income tax rate from 35% to 20%, create a 25% top rate for pass-through entities (with safeguards to prevent abuse that would assume 70% of pass-through income is personal income subject to personal income tax rates), allow immediate write-offs of new equipment for five years, limit certain interest expenses and net operating losses (while allowing for unlimited carryforwards), and allow the repatriation of overseas income at reduced rates, among other items.
Items such as 100% expensing for equipment and the repatriation provisions could provide an immediate opportunity for tax savings for certain companies, while many other provisions will lead to outcomes that are less clear. Businesses might want to consider paying all their outstanding bills before year’s end, for example, to accelerate deductions that may go away under reform. In addition, the timing of the effective date of the expensing provision could prove critical. If the 100% write off isn’t effective until on or after January 1, 2018, a business may want to delay a capital expenditure to take full advantage of the deduction.
Companies may wish to wait until the reform picture clarifies to set their planning strategies, and there probably is some wiggle room from a timing perspective. Unfortunately, however, at some point companies will need to make their best guesses as to where reform will land and implement strategies designed to take advantage of whatever provisions are enacted.
Additional tax reform considerations include:
- Tax Reform Revenue Raising Provisions Will Affect Some Companies More Than Others
- Impact of Proposed Tax Reform on Financial Statements and Effective Tax Rates
Here’s the latest on tax reform.
Business Tax Quarterly - Fall 2017