Reducing 2016 Taxable Business Income via Accounting Method Changes

If you are a business taxpayer who has not filed your 2016 federal income tax returns, you may have the opportunity to take advantage of some last minute tax saving techniques.  These tax reductions are available to you now because of the new Republican administration in the White House and a Congress with a Republican majority.  The primary area where we see potential savings is within your current accounting structure.  Please note that these possible 2016 tax savings are entirely based on forward thinking, which assumes that new tax reform regulations are effective and enacted in the year 2017; it also presumes that such legislation is retroactive to January 1, 2017.  Should any new possible legislation only be enacted and effective in 2018, the savings would not be relevant to your 2016 business taxes.  These potential accounting structure saving changes are outlined in this post.

Some Background

line-orangeIt is a likelihood that future year tax rates will be lower than current business tax rates.  A one-time definitive tax saving could be realized if your business chooses to defer revenue recognition and accelerate its deductions.  If the current administration’s tax reduction plans are approved and implemented, deferring revenue from 2016 to 2017 will allow you to have this deferred income taxed at a lower rate.

Let’s take a look at a hypothetical example where you operate a corporation which is taxed at the highest corporate tax rate of 35%.  This means that, under current tax legislation, your $200,000 of advance payments made in 2016, would warrant a $70,000 tax liability ($200,000 x 35% = $75,000).  On the flip side, if you choose to defer these advance payments until 2017, there might be a drastic reduction in this 35% rate to anything as low as 15%.  If taxed at 15%, your liability would only be $30,000 ($200,000 x 15% = $30,000)- dramatically lower than $75,000, not to mention a permanent tax savings.

Along the same line, the owners of pass-through entities might also want to take advantage of method changes in their accounting areas.  Individuals could witness the highest individual tax rate drop to 33% from 39.6%.  Current pass-through businesses could also see a reduction from 25% to 15%.  

The Details on Accounting Planning Opportunities

Outlined below, you will see a list of highlights which describe some useful and easily implemented ways to accelerate deductions and defer revenue recognition for business taxpayers.  You might notice that some of these ideas were all but obsolete, but understanding the possibility for a reduction in taxes for 2017, these methods are now just as relevant as ever.  Although all of the methods we will discuss are automatic changes, an accounting change method, Form 3115 will be necessary.  This form is not required for success-based fees and tangible property elections

Overall Accounting Method- Cash or Accrual?

Pass-through entities which use accrual-based accounting and have no C corporation owners may benefit by switching to cash-based accounting.  This is provided that these entities bill for services in arrears and do not maintain any inventory.  

Taxpayers already using cash-based accounting may want to consider a change to accrual- based accounting provided that they incur significant accounts payable (AP) figures and deductible accrued expenses.  In order for this to meet approved accounting standards, those taxpayers would also need to recognize any accounts receivable as revenue.  If implemented successfully, the accrual method will accelerate deductions and reduce income for the tax year 2016.

Depreciation & Cost Segregation

Did your business purchase or construct a building in 2016?  If this building was put into service last year, then you may want to implement a cost segregation study.  Your cost segregation study is your most valuable tool when deciding the best tax treatment for your entity.  If said building was placed into service before 2016, you can conduct a retroactive cost segregation study now.  Also, take a deep dive into your depreciation schedule because items on that list may be classified improperly or more cost beneficial if accounted for in an alternate way.  

Tangible Property

A recent IRS announcement pertained to final tangible property regulation and the taxation law that governs it.  Effective January 1, 2017, the IRS will extend the transition rule, for those who pay taxes on tangible property, from one year to any taxable year before the commencement of 2017.  A benefit that taxpayers may see in this area is a reduction in taxable income because taxpayers can deduct repair and maintenance costs in addition to alterations surrounding structural component dispositions.  Taxpayers may also have the option tocaution accelerate the writing-off of tangible property.  The tangible property arena can get very confusing so taxpayers ought to make their elections carefully and preferably with the help of a financial advisor or CPA.  

The Safe Harbor Election & Success-based Fees

Mergers and acquisitions (M&As) are very expensive, especially the fees associated with an M&A.  Under the safe harbor allocation method, taxpayers could have the option to deduct up to 70% of these fees.  Furthermore, qualifiers may also be able to garner additional benefits such as a reduction in administrative costs.

Advance Payments

Certain advance payments such as subscriptions, gift cards, and other items, which are normally recognized for tax purposes in the year they are received, but deferred for bookkeeping purposes, could also benefit the taxpayer.  Should you decide to defer recognition for the items to the next year, you could see a lower tax rate.  

Conclusion

Business accounting method conversions require accuracy and heavy analysis. As a business taxpayer, you want to make sure that your transition is seamless and in strict compliance with legal and accounting standards.   Consulting a professional CPA is the safest way to avoid any negative implications, and can virtually guarantee that the job gets done right. Contact us for a tax accounting method review today to see if you can take advantage of any of these strategies.   

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