Tax accounting methods: Income and expense planning in uncertain times
Accounting methods determine when income and expenses are recognized for tax purposes. With year-end approaching, now is the time to review your tax accounting methods and make sure they’re helping you achieve your business’s goals.
Accounting methods determine when income and expenses are recognized for tax purposes. A taxpayer’s choice in which accounting methods are used in determining taxable income can be a very powerful tax planning tool. Any strategy should consider the many competing factors, including current cash flow, longer-term tax implications, international tax implications, and the potential for future changes in tax policy. Accounting methods provide businesses the opportunity to strategically recognize revenue and expenses by:
- Providing overall cash-tax planning. A fresh look at tax accounting methods may provide opportunities to accelerate tax deductions, reducing the current tax burden and freeing up cash for business needs. While some tax method opportunities will provide a benefit that will reverse over several years, like accelerated tax depreciation, some methods like the cash method and inventory methods will result in perpetual tax deferral that would generally not reverse while the business continues operation.
- Maximizing NOL carrybacks to higher tax rate years. While tax reform eliminated net operating loss (NOL) carrybacks of losses to an earlier year with taxable income, the CARES Act provided new flexibility to carryback losses. A taxpayer carrying back losses incurred in 2018 through 2020 can carryback five years, which could include pre-2018 years when tax rates were higher than the present rates. Therefore, in addition to providing cash flow now when companies may need it most, maximizing NOLs in 2020 could create permanent tax rates savings by allowing a deduction at 35–40% rates rather than the current rates that may be 21–30%, depending on entity type.
- Planning for potential tax rate increases. Changes in the federal administration could result in tax rate changes going forward. If tax rates do increase, taxpayers generating taxable income could see significant permanent tax rate savings by accelerating income into low tax rate years and deferring deductions to higher tax rate years. Taxpayers identifying unfavorable changes are generally required to spread the unfavorable adjustment over four tax years, but there may be opportunities to accelerate these adjustments to take advantage of the present historically low tax rates.
- Reducing GILTI and BEAT liabilities. Taxpayers with foreign subsidiaries and related parties may be subject to the global intangible low-taxed income (GILTI) and base erosion anti-avoidance tax (BEAT) tax regimes. Taxpayers with foreign subsidiaries can look for opportunities to reduce their GILTI inclusion by deferring income and accelerating deductions at their foreign subsidiary. BEAT is assessed on certain taxpayers with payments made to a foreign-related party. However, BEAT doesn’t include expenses that are recovered as cost of goods sold (COGS) on the sale of inventory. Therefore, taxpayers can review their inventory costing methods to include all allowable costs in COGS, exempting the payments from BEAT.
Planning opportunities and considerations
Below is a list of accounting method opportunities, both for increasing and decreasing taxable income, depending on the tax strategy of the taxpayer. It’s important to note that accounting methods must be applied consistently, and, once adopted, generally can’t be changed again for five years. Most accounting methods are changed by filing Form 3115 with a timely filed tax return. Other planning opportunities provide for an election made with the tax return. However, some method changes may require IRS review and approval, which must be filed by tax year-end. Consequently, taxpayers should review their accounting methods before the year closes to ensure all necessary requirements for using the methods are made on time.
Accelerate deductions (decrease income)
|Defer deductions (increase income)|
Materials & supplies
Compensation accruals (bonus, vacation, payroll tax)
Other accruals (property taxes, self-insured health, rebates)
Research & development (R&D) expenses
Overall income & expense recognition
Small business taxpayer inventory methods
Percentage-of-completion: Small business taxpayer
Percentage-of-completion: Larger taxpayers
How we can help with tax accounting methods
Our team will work with you to identify and implement accounting method opportunities to meet your business needs. We’ll also help you:
- Evaluate the accounting methods and their indirect impacts on other tax strategies
- Navigate the complex procedural rules in implementing a tax accounting method change
- File accounting method changes with the IRS and represent your business in the approval process