Timing is everything: Revisiting accounting methods in a changing tax landscape
The importance of strategic accounting methods
Accounting methods determine the timing of when income and deductions are recognized. Specifically, accounting methods will dictate the year in which revenue, accruals, and depreciation are recognized. Many taxpayers have the flexibility to choose the accounting methods that are right for their business. With the possibility of rising tax rates on the horizon, a taxpayer’s review of their accounting methods is important for getting the most out of their tax planning.
Changes in tax accounting methods generally require filing Form 3115 with the IRS. If taxpayers want to realize the benefits on their 2021 tax returns, many of the most impactful changes must be filed by tax year-end. As such, taxpayers should review tax-planning strategies now. Any accounting method change plan should consider all relevant factors such as cash flow, changes in tax policy, potential increasing tax rates, and international tax implications, among others.
Key time frames for reviewing accounting methods
Accounting methods should be addressed at four key points throughout the year to maximize planning:
- At the beginning of the tax year: Having a plan for a taxpayer’s capital expenditures (capex) and setting a capex policy for the year will help taxpayers define their goals for business expense activity and help them avoid tax surprises at year-end. A capex policy should address the threshold for capitalizing purchases as fixed assets versus current expenses. A written policy must be in place as of the beginning of the tax year to take advantage of fixed asset and supplies de minimis elections.
- During the tax year: Throughout the tax year, taxpayers should keep tax accounting in mind when timing capital investments, items of income, capital expenses, and deductions for their business. The choices taxpayers make throughout the year can make a significant difference in their tax bill.
- At tax year-end: As tax year-end approaches, taxpayers should evaluate tax items they need to complete before the close of the tax year, including filing any nonautomatic accounting method changes due by the end of the tax year that require IRS approval, establishing the facts they want in place for their tax year, and managing their cash flow. For example, cash method taxpayers should consider whether to pay payables before the close of the year or defer such payments to take deductions in a future year. Accrual method taxpayers might consider fixing or unfixing bonus plans to change the year in which bonuses are recognized. Taxpayers can also use the timing of pension contributions, repayment of deferred payroll taxes under the CARES Act, and the recognition of receivables and payables to recognize items of income and deductions in the tax year that’s most beneficial to their tax position.
- When the federal income tax return is due: Elections and automatic accounting method changes must be filed no later than when the federal income tax return is filed. Many tax elections can also dictate the timing of when deductions are recognized. For instance, taxpayers may elect out of bonus depreciation in 2021, allowing the use of their depreciation deductions in later tax years that may be subject to potentially higher tax rates. Taxpayers may also elect to capitalize research and development costs over five or more years instead of taking a current-year expense deduction or elect into the Alternative Depreciation System (ADS) depreciation method.
There are various ways that accounting methods planning can help taxpayers prepare for a changing tax landscape and get the most out of tax planning. The appropriate accounting methods strategy for taxpayers will depend on the specific facts and circumstances of their business. Timing is critical and, with the end of the year approaching, now is the time for taxpayers to consider accounting methods planning and determine if their current tax strategy is providing the most benefit for their business.
How we can help with tax accounting methods
Our team of specialists will work with taxpayers to identify planning opportunities regarding their business’s tax accounting methods. Specifically, we’ll help taxpayers:
- Understand their overall tax situation and motivations to accelerate or defer income.
- Evaluate accounting methods and their indirect impacts on other tax strategies.
- Identify potential changes to their business’s tax accounting methods strategy.
- Navigate the complex procedural rules in implementing a tax accounting method change and determine when the accounting method change is due.
- File accounting method changes with the IRS and represent the taxpayer’s business in the approval process, if applicable.
If you’d like to work with one of our tax accounting methods specialists, please give us a call.