Adopt a Divergent Strategy Regarding Income and Deductions
Posted by Michē Needham on April 22, 2024
Typically, businesses aim to defer recognition of taxable income into subsequent years while expediting deductions into the current fiscal year. However, there are circumstances where it may be prudent to pursue an alternative approach. What are the instances where such a strategy is advisable, and what motivates this decision?
One compelling factor could be impending changes in tax legislation that may result in higher tax rates. For instance, the Biden administration has proposed increasing the federal corporate income tax rate from its current level of 21% to 28%. Additionally, anticipation of elevated tax rates for noncorporate pass-through entities, where pass-through income is taxed on personal returns, might prompt such a shift in strategy. Discussions in Washington regarding potential hikes in individual federal income tax rates further underscore this consideration.
If there's a belief that business income could be subjected to increased tax rates, accelerating income recognition into the current tax year to leverage existing lower tax rates becomes appealing. Simultaneously, deferring deductions to a later tax year, when rates are anticipated to be higher, can enhance their tax-saving potential.
Expediting Income Recognition
Explore the following avenues to accelerate revenue recognition into the current tax year:
- Sell appreciated assets with capital gains in the current fiscal year, rather than postponing until a subsequent year.
- Assess the company's roster of depreciable assets to identify fully depreciated assets requiring replacement. Selling such assets triggers taxable gains in the year of sale.
- For installment sales of appreciated assets, opt out of installment sale treatment to recognize gains in the year of sale.
- Instead of opting for tax-deferred transactions like a like-kind Section 1031 exchange, consider selling real property in a taxable transaction.
- Contemplate converting an S corporation into a partnership or an LLC treated as a partnership for tax purposes. This triggers gains from appreciated assets due to the conversion's treatment as a taxable liquidation of the S corp, subsequently increasing the partnership's tax basis in the assets.
- For construction firms with long-term contracts previously exempt from the percentage-of-completion method of accounting, consider adopting the percentage-of-completion method to accelerate income recognition compared to the completed contract method, which defers income recognition until project completion.
Postponing Deductions
Consider the following measures to delay deductions into a higher-rate tax year, thereby optimizing their value:
- Postpone the acquisition of capital equipment and fixed assets to defer depreciation deductions.
- Abstain from claiming substantial first-year Section 179 deductions or bonus depreciation deductions on new depreciable assets and instead depreciate them over several years.
- Evaluate whether professional fees and employee salaries associated with long-term projects could be capitalized, thus spreading out costs over time.
- Purchase discounted bonds this year to augment interest income in future years.
- If permissible, delay inventory shrinkage or other write-downs until a year with higher tax rates.
- Defer charitable contributions to a year with a higher tax rate, if feasible.
- If permissible, postpone accounts receivable charge-offs to a year with a higher tax rate.
- Delay payment of liabilities where the associated deduction is contingent on the timing of payment.
Feel free to reach out to us to explore the optimal tax planning strategies tailored to your business's unique tax circumstances.
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Michē has more than 21 years of experience providing tax and advisory services to commercial businesses and individuals. She has extensive experience with pass-through taxation of partnerships and S corporations and individual taxation, specializing in the areas of real estate, energy, and professional services. Additionally, Michē is responsible for providing services such as business tax planning, individual tax planning, personal wealth, and succession planning.