In a year of so many uncertainties, it has become more important than ever to plan for the future. With tax rates predicted to rise in the next few years, businesses are likely thinking about how to accelerate revenue and defer expenses. On the other hand, it might make sense for companies to increase current year losses to facilitate the carryback of net operating losses.
Background on Legislation
Under the CARES Act, net operating losses (NOLs) arising in tax years beginning after December 31, 2017, and before January 1, 2021, may be carried back to each of the five tax years preceding the tax year of such loss. Since the enactment of the Tax Cuts and Jobs Act (TCJA), NOLs generally could not be carried back but could be carried forward indefinitely. Further, the TCJA limited NOL absorption to 80% of taxable income. The CARES Act temporarily removes the 80% limitation, reinstating it for tax years beginning after 2020.
Methods of Accounting for Small Business Taxpayers
The overall method of accounting should also be considered. The TCJA created an additional opportunity for small business taxpayers to choose the cash method of accounting. Small business taxpayers are taxpayers who have an average annual gross receipts for the previous three tax years that do not exceed $25 million. Typically, a change from the accrual to cash method of accounting is beneficial if a taxpayer has more accounts receivables and prepaid expenses compared to accounts payable and accrued expenses. The change in accrual to cash accounting method is filed on Form 3115, Application for Change in Accounting Method.
Additional tax strategies to consider with the timing of income and expenses include the following:
Revenue Acceleration Strategies
- Advance payments received can be recognized as revenue in the year received. Section 451(c), as amended by the TCJA, provides a general rule requiring accrual-method taxpayers to take advance payments into income in the tax year of receipt. This is known as the full-inclusion method.
- On an installment sale, you can elect not to use the installment method and report the entire gain in the year of sale, even though all the sale proceeds are not received in that year. To make this election, the sale would be reported for the year the sale takes place on Form 8949, Form 4797, or both in place of using Form 6252.
Revenue Deferral Strategies
- Advance payments received can be deferred. The TCJA amended 451(c) providing accrual-method taxpayers with an election to defer the inclusion of income from certain advance payments for goods, services, and other specified items to the subsequent tax year of receipt if that income is also deferred for applicable financial statement purposes.
Expense Acceleration Strategies
- Elect to capitalize prepaid expenses to accelerate deductions into 2020. The general rule for prepaid expenses is that any prepayment for a service or benefit must be capitalized and amortized over the useful life of such payment. The “12-month rule” allows for the deduction of a prepaid expense in the current year if the right or benefit paid for does not extend beyond the earlier of 12 months or the end of the taxable year following the taxable year in which the payment is made. This election can be made by filing Form 3115, Application for Change in Accounting Method.
- Take bonus depreciation on qualifying assets. The TCJA removed the rule that made bonus depreciation available only for new property and allows businesses to immediately deduct 100% of the cost of eligible property in the year it is placed in service, through 2022. The amount of allowable bonus depreciation is then phased down over four years: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
- Cost segregation studies can allow for depreciation on real property to be recovered over a shorter life by reclassifying portions of the building that would generally be 39-year property to be eligible for treatment as 5-, 7-, or 15-year property.
- Bonus plan requirements can be structured to support the deductibility in the year that they are earned. A very common strategy is to operate as a bonus pool. Under a bonus pool, to receive the bonus payment, the employees must be employed on the bonus payment date. Upon an employee’s forfeiture, their bonus is reallocated to the other employees who remain with the company on that date.
Expense Deferral Strategies
- Electing out of bonus depreciation. Earlier this year, the IRS issued Proc. 2019-33, which allows taxpayers to make a late election, or to revoke an election, under Sec. 168(k) for certain property acquired by the taxpayer after September 27, 2017, and placed in service during a tax year that includes September 28, 2017. The late election or revocation can be made by filing an amended tax return, administrative adjustment request if your business is a partnership subject to the centralized partnership audit regime, or by filing Form 3115, Application for Change in Accounting Method.
- Bonus deduction timing can be planned in such a way to support the deductibility in the year paid. This means delaying the actual payment of the bonus until after March 15 or structuring the plan in a way that it will not meet the “all events test” or economic performance is not satisfied.
How DHJJ Can Help
For any questions, please reach out to your DHJJ professional at 630-420-1360.