As businesses complete their 2020 tax returns and compliance, it is never too early to begin tax planning for 2021. There are a number of ways that there are incentives for taxpayers to assess and change accounting policies. With most of the changes, taxpayers are afforded audit protection such that the IRS could not challenge previous years on an unauthorized method and could not charge interest and penalties for improper processing of a element.
Taxpayers may also benefit from current year adjustments that would reduce taxable income, and accounting methods provide an opportunity for tax planning around optimal methods of accounting for income and expenditure.
One notable element to take into account for tax planning for 2021: the likelihood of an increase in tax rates. Since accounting policies are simply the timing of recognizing income or expense in taxable income, they are considered a temporal or temporary element. There are many accounting policies and planning elements that can move the recognition of revenue or expense to another tax year. Although, if recognition only moves from year to year, many taxpayers may not want to bear the administrative burden of maintaining separate working papers for the ledger and tax for a specific item when the timing does not translate into a significant benefit.
However, when tax rates change, there is an opportunity for near-permanent tax savings to recognize an expense in a higher tax rate year or to recognize income in a lower tax rate year. . See the examples below, which show how a $ 1,000 deduction for a prepaid expense does not equal when tax rates change:
As shown in the examples above, a $ 1,000 deduction to accelerate a deductible expense in year 1 does not necessarily provide a tax benefit by recognizing the deduction in the first tax year – an accelerated deduction that the book would not recognize until year 2. In the first year. For example, when tax rates remain the same, a taxpayer may wish to accelerate the deduction to be recognized in a previous tax year.
However, when tax rates change, a taxpayer may wish to defer an expense to a subsequent tax year to recognize a cash tax benefit. In Example 2 above, the taxpayer’s tax benefit is an additional tax savings of $ 70 — by simply recognizing the expense in a different tax year. This difference of $ 70 is a permanent tax benefit that the taxpayer would not have recognized otherwise.
Common accounting methods to analyze
Taxpayers should consider reviewing all accounting methods as part of tax planning for the 2021 tax year. Here is a list of common methods and notable things to consider for 2021:
- Prepaid Expenses – Under the 12 month rule, taxpayers may be allowed to expedite the deduction of certain prepaid expenses, such as insurance, business licenses, and professional dues (not social or lobbying ). Certain prepaid expenses are not eligible for acceleration, including software, materials and supplies, professional services, insurance, and rent.
- Revenue recognition: Taxpayers should review and confirm the eligible revenue recognition methods for the time of recognition and the eligibility of deferral for advance payments under the new rules codified in the tax code Article 451 under the Tax Cuts and Jobs Act (TCJA).
- Research and Experimentation Expenses — This is a notable change for tax years beginning after December 31, 2021, which will affect many taxpayers who incur R&E expenses. Article 174 no longer allows a direct expense, or immediate tax deduction, for R&E expenses.
- Taxpayers will now be required to capitalize and amortize R&E expenses over a five-year period (15-year period for foreign research) from the middle of the tax year in which these expenses are incurred. .
- Taxpayers should be proactive in reviewing the tax treatment of R&E expenditures in order to understand current accounting methods and how they may be required to change the tax treatment of R&E expenditures from the current method due to changes in the code. applicable taxes for the following tax year.
- A change in accounting policy may be necessary for most taxpayers who have historically expensed R&E costs incurred to change their accounting method for the treatment of section 174 expenses.
- Accumulation of State Taxes — Taxpayers have two options as to the timing of the deduction for taxes on real estate, personal property, and income taxes or state deductibles. They can deduct in the tax year when paid, or they can deduct as accrued on the taxpayer’s financial statements.
- Fixed Assets / Capitalization — Taxpayers have a number of items they can consider for depreciation and amortization, including:
- carry out a cost separation on new construction or acquired goods;
- review fixed asset ledgers for an appropriate fiscal life;
- review the improvement properties qualified for a 15-year depreciation, which has now been fixed;
- assess the required or optional alternative treatment of the cushioning system;
- ensure appropriate tax depreciation on goodwill or other intangible assets acquired; and
- other tangible and intangible fixed assets.
- Inventory / Article 263A Uniform Capitalization (UNICAP) —Ensure tax compliance and methods of inventory identification and valuation.
- Evaluate the requirements and authorized methods for UNICAP, including simplified methods: simplified production method, simplified resale method and modified simplified production method.
- Accumulated premium / Accumulated time off — Salary obligations that may be deducted under the 2.5 month rule for economic performance; however, the other two eligibility criteria for the deduction are often overlooked, namely that the expense is fixed and determinable.
- Evaluate the vacation postponement policy. The following should all be evaluated to determine whether taxpayers can accelerate the accumulated bonus:
- Is everything paid within 2.5 months of the end of the year?
- Is the total amount of the accumulated bonus guaranteed to be paid?
- Does that require board approval, and is that board approval done before or after the end of the year?
- Does management have the discretion to change bonus amounts after year end?
- Does an employee still have to be employed on the date of payment to receive the bonus awarded to him; and, if so, will the amount revert to the company or will it always be paid and distributed among current employees?
- All of these must be evaluated to determine whether taxpayers can expedite this deduction. In addition, bonuses and vacation accrued for shareholders of S corporations are not eligible for deduction, even if they are fixed, determinable and paid within 2.5 months of year end.
- Incurred But Not Reported (IBNR): Self-funded medical expenses for self-insured taxpayers, including any amount not covered by insurance, such as amounts “deductible” under an employee medical expense insurance policy. Taxpayers can deduct the cost of medical services when the service is rendered, which may be in a taxable year before payment.
- Methods of accounting for small business taxpayers — TCJA has broadened the definition of a small business taxpayer; for 2021, these are defined as taxpayers with average gross receipts for the previous three years of less than $ 26 million (and not a tax shelter). Taxpayers may be eligible for the following simplified accounting methods:
Taxpayers who have switched to one of these simplified accounting methods after the expansion of eligibility to the TCJA, or who have always used these simplified methods, should assess whether they are still eligible for these methods, and if not, they will have to switch to an authorized method. .
- Bad debts – Taxpayers should ensure that they are not impermissibly following their accounting policy to deduct bad debts using a provisioning method.
- Non-Accrual Experience (NAE) —An exception to the above bad debt method applies to specifically defined service areas such as healthcare, law, engineering, architecture, accounting, actuarial, performing arts and consulting. Taxpayers in these areas do not have to accumulate income attributable to the provision of services that they do not expect to receive according to the defined NAE methods.
- Deferred Rent / Leasehold Improvements – Taxpayers need to assess whether they are appropriately deducting rent expenses for tax purposes, which may not follow the accounting method when there is deferred rent. In addition, taxpayers should review leases to determine whether the tenant or lessor owns the leasehold improvements, whether the lessee needs to record income for receiving lease allowances, and to determine who records capital cost allowance on those improvements.
The above list is not an exhaustive list of accounting policies and only provides a sample of some of the more common methods that taxpayers may or may not address in a permitted manner. Now is the time for taxpayers to assess current methods and any potential impact of likely tax rate increases.
This column does not necessarily reflect the opinion of the Bureau of National Affairs Inc. or its owners.
Ryan Vaughan leads the Chicago Tax Practice and the Global Tax Credits and Incentives Practice of Mazars, providing expert tax services to businesses in a multitude of industries including manufacturing and distribution, energy, technology, real estate, retail, financial services and healthcare.
Andrew Kosoy is a leader in the practice of tax credits and incentives and has provided federal tax planning, business advisory and consulting services for over 13 years, with a specialization in projects and studies related to the research and development tax credit, to tax accounting methods. , income and expense accounting, fixed assets and depreciation, inventory accounting and the deduction for meals and entertainment.
Bloomberg Tax Insights articles are written by seasoned practitioners, academics, and policy experts who discuss current tax developments and issues. To contribute, please contact us at TaxInsights@bloombergindustry.com.