While the typical strategy for businesses is to defer taxable income to subsequent years and expedite deductions in the current year, there are instances where an alternative approach can be advantageous. As a leading tax firm, we guide businesses to navigate these complex scenarios effectively. So, why might a business opt for this contrary strategy, and when does it make sense?
Tax law modifications can be a driving factor. For instance, the Biden administration has proposed an increase in the corporate federal income tax rate from 21% to 28%. Additionally, if you anticipate higher tax rates in the future, especially for noncorporate pass-through entities where income is taxed on personal returns, adjusting your tax strategy accordingly can be beneficial.
Should you foresee potential tax rate hikes affecting your business income, accelerating income recognition in the current tax year to leverage the current lower rates could be advantageous. Simultaneously, deferring deductions to a later year when rates are anticipated to be higher can maximize their value.
Strategies to Accelerate Income Recognition:
If you aim to fast-track revenue recognition into the current tax year, consider these strategies:
- Sell appreciated assets with capital gains this year instead of postponing to a later year.
- Evaluate the company’s depreciable assets list to identify fully depreciated assets requiring replacement. Selling such assets triggers taxable gains in the sale year.
- For installment sales of appreciated assets, opt out of installment sale treatment to recognize gain in the sale year.
- Instead of utilizing a tax-deferred Section 1031 like-kind exchange, sell real property in a taxable transaction.
- Ponder converting your S corporation to a partnership or an LLC taxed as a partnership. This conversion treats the transaction as a taxable liquidation of the S corp, triggering gains from the company’s appreciated assets. The partnership will benefit from an increased tax basis in these assets.
- For construction firms with long-term construction contracts previously exempt from the percentage-of-completion method: consider adopting the percentage-of-completion method to recognize income earlier, as opposed to the completed contract method which defers income recognition until project completion.
Strategies to Postpone Deductions:
To defer deductions to a higher-rate tax year and optimize their value, consider these approaches:
- Postpone the purchase of capital equipment and fixed assets, delaying depreciation deductions.
- Abstain from claiming significant first-year Section 179 deductions or bonus depreciation deductions on new depreciable assets, opting to depreciate these assets over several years.
- Evaluate if professional fees and employee salaries associated with long-term projects can be capitalized, spreading out costs over time.
- Purchase bonds at a discount this year to enhance interest income in subsequent years.
- If permissible, defer inventory shrinkage or other write-downs to a year with a higher tax rate.
- Postpone charitable contributions to a year with anticipated higher tax rates.
- If permissible, delay accounts receivable charge-offs to a year with a higher tax rate.
- Postpone payment of liabilities where the associated deduction is contingent on the payment timing.
Reach out to our tax experts to devise the optimal tax planning strategies tailored to your business’s unique tax situation.
