As Congress grapples with tax proposals and the pandemic continues to create uncertainty for businesses, corporations and pass-through entities can leverage tax accounting methods to effectively improve their federal income tax posture and, in turn, enhance cash tax savings. When assessing their tax situations for 2021 and subsequent years, taxpayers should consider whether they can benefit from traditional tax accounting methods planning, which aims to defer income recognition and accelerate deductions, or “reverse” tax accounting methods planning, which does the opposite.
Whether it makes sense to change a method of accounting depends on the taxpayer’s tax posture, future company performance, and goals. Taxpayers should keep in mind that current tax proposals seek to raise tax rates and make other changes to the federal income tax system for corporations and individuals. These proposals should be monitored and their potential effects considered when evaluating the short- and long-term benefits of a tax accounting method change.
Companies that want to reduce their 2021 tax liability should consider traditional accounting method changes that accelerate deductions and defer income recognition. As an added benefit, these method changes often result in favorable “catch-up” adjustments that are recognized entirely in the initial year of change.
Traditional accounting method changes also may be used to generate or increase a net operating loss (NOL). Losses generated in 2021 may be carried forward. In addition, certain method changes may still be made with the 2020 extended federal tax return filing to potentially generate losses that can be carried back to a higher rate tax year. Businesses that are emerging out of losses and expect to be taxable in the near term also should consider traditional accounting methods planning.
Possible traditional accounting method changes include:
Businesses planning for a potential future tax rate increase (as under current proposals supported by the Biden Administration) may choose to undertake reverse tax accounting methods planning to accelerate revenue into a tax year with a lower tax rate or defer deductions to a tax year with a higher tax rate. Regardless of tax rates, a company that is in an NOL position may wish to engage in reverse accounting methods planning to optimize the utilization of their NOLs.
Some of the more common method changes used in reverse accounting methods planning include:
In addition, reverse accounting method planning opportunities that do not require a Form 3115 to be filed (see Form 3115 filing requirements below) include:
Generally, tax accounting method change requests require filing a Form 3115 Application for Change in Accounting Method with the IRS under one of two procedures:
Certain planning opportunities may be implemented without a Form 3115. Note that tax accounting method changes falling under automatic change procedure can still be made for the 2020 tax year with the 2020 federal return.