Tax accounting method planning is ordinarily focused on generating cash tax benefits by accelerating tax deductions and deferring taxable income to reduce the amount of tax owed in the current year. Where statutory tax rates remain constant, taxpayers often overlook the benefits of accounting method planning because moving income or expense items into different periods generally does not result in permanent tax savings. Instead, it merely generates a timing benefit that will reverse in future years.
However, the possibility of a change in the statutory tax rate presents an opportunity for businesses to re-evaluate their accounting methods for income, expenses, inventory and fixed assets, potentially generating a permanent tax benefit by making an accounting method change.
Possible Tax Benefit from Tax Reform
Accounting method changes that accelerate deductions or defer revenue provide corporations with the opportunity to take deductions at the current 35 percent rate and recognize revenue at a proposed lower rate in a future tax year, generating permanent tax savings. Pass-through entities and their owners may also benefit in the same manner from accounting method changes if their effective tax rates decrease under the tax reform proposals. Implementing these planning techniques could provide significant permanent tax rate benefits and cash tax savings to both corporations and pass-through entities as illustrated by the examples below:
*Illustration of Cash Savings Opportunity for U.S. Corporations
Smaller business taxpayers should also watch for opportunities to take advantage of increased small taxpayer safe harbor thresholds to simplify their tax accounting methods. For example, several tax reform proposals have proposed raising the gross receipts thresholds for requiring use of the accrual method of accounting as well as the requirements to maintain inventories and apply the uniform capitalization rules (i.e., UNICAP). Taxpayers qualifying for the increased safe harbors may also see a reduction in their tax burden as a result of tax reform.
Impact on U.S.-Owned Foreign Entities
Accounting method planning may also be important for foreign entities owned by U.S. taxpayers. Several tax reform proposals contain provisions that would subject accumulated earnings held in U.S.-owned foreign entities to a one-time tax. The accumulated earnings of these foreign entities are determined using many of the same accounting methods that apply to U.S. businesses. By adopting or changing to favorable accounting methods, taxpayers may be able to reduce the accumulated earnings of these foreign entities and thereby reduce the amount of tax owed. Taxpayers should review the current earnings and profits (E&P) calculations for these entities and the potential to adopt or file accounting method changes to reduce the foreign entity’s accumulated E&P.
Although accounting method changes generally provide a temporary benefit, in periods where tax rates are declining, taxpayers can generate a permanent tax benefit to the extent that income can be deferred and recognized in a tax year subsequent to a rate reduction or deductions can be accelerated into a tax year when the tax rates are higher. To request an accounting method change and take advantage of the changing tax rates, taxpayers must generally file Form 3115, Application for Change in Accounting Method, and satisfy the IRS’ procedural requirements which vary depending on the specific accounting method change being requested.
Please contact your Eide Bailly professional or a member of our accounting methods team to learn more about accounting method opportunities and planning.
Learn more about recent developments in the area of accounting methods and periods and the potential opportunities and risks to your business.