Accounting Methods
The IRS requires that businesses adopt and consistently use proper accounting methods in determining taxable income. A company must obtain IRS consent to change its accounting method by following either the automatic or non-automatic IRS procedural rules, which usually require the filing of a Form 3115 with detailed calculations. The IRS provides an incentive for companies to change to a proper accounting method before an examination starts by voluntarily filing Form 3115 with a four-year spread of an unfavorable catch-up adjustment. The IRS provides an incentive for companies to identify and change to a proper accounting method before an examination starts by voluntarily filing Form 3115 with a four-year spread of an unfavorable adjustment.
If a company fails to follow the IRS procedural rules for filing a Form 3115, the company is often stuck with an improper or unauthorized change that may not be corrected either my amending the return or filing a subsequent change. This may lead to valuation issues with the company’s financial auditor or exposure from the IRS on examination. If the IRS identifies an improper method on examination, an agent has discretion to calculate and impose a catch-up adjustment entirely in the earliest open year and add interest and potentially penalties.
Planning
Proactively planning an accounting methods review to either increase or decrease taxable income can result in significant tax savings in a number of situations. Traditional tax planning focuses on the timing benefit of filing accounting method changes to accelerate tax deductions or defer income to reduce a current tax liability and generate cash tax savings (for example, the tax savings from a method change to accelerate depreciation will reverse in a future period). However, certain method changes and elections effectively provide a perpetual benefit, such as the LIFO method for inventories or the overall cash method.
Legislative changes in tax rates present opportunities to create permanent financial statement benefits by filing accounting method changes to shift deductions or income to more beneficial periods. If tax rates are reduced, a method change filed for the year prior to the rate change becoming effective (e.g., to accelerate deductions to the high-rate year or shift income to the low rate year) will generate a one time permanent benefit in the financial statements. If tax rates increase, similar benefits may be achieved by “reverse planning,” or filing a method change to accelerate income to the low rate year or defer deductions to the high rate year. Reverse planning may also be beneficial to utilize net operating losses (NOLs) or expiring tax credit carryforwards. Proactive planning may also achieve tax savings by minimizing the impact of the international tax rules and avoiding surprises in the transactional context.
As part of the overall planning process, a taxpayer should also consider transactional planning (e.g., changing contract terms) and optimizing tax elections. For example, companies subject to the interest limitation under section 163(j) may elect to capitalize interest expense to other property, such as inventory under section 263(a) or section 266 to minimize the amount subject to the limitation (until 2026).
Examples
Revenue Recognition
Advance payments
Book conformity
Cost offset
Percentage of completion Completed contract
Expense Accruals
Bonus expense
Vacation pay Commissions Payroll taxes
Self insured medical
Property taxes
Rebates and refunds
Prepaid expenses
Inventory
Section 263A – UNICAP
Section 472 - LIFO (IPIC)
Section 471 - lower of cost or market (LCM) & subnormal goods
"Repair” Regulations - Section 263(a)
Repairs expense deductions
Routine maintenance safe harbor
Unit of property determinations
De minimis expensing policy
Materials and supplies
Overall Accrual and Cash Methods
Small taxpayer changes
Depreciation
Cost segregation
Method changes
Partial disposition elections
Bonus depreciation changes - elections out
Section 179 expensing analysis
Section 163(j) Planning
Interest capitalization under sections 266 and 263(a)
Interest capitalization under 263A(f) - avoided cost computations
Section 174 - R&D cost
Contract/cost analysis
Contract research - foreign or U.S.
Method changes
Rent Expense
Section 467 leases
Non-section 467 leases
Transactional Planning
Prepay or defer deductible expenses
Structure an installment sale
Modify contract terms / payment
Accelerate or defer employee bonuses
National Tax
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