The time is now for both public and private companies to take advantage of the opportunities provided by the extensive tax reform in 2017 from the Tax Cuts and Jobs Act (TCJA), according to Grant Thornton.
The Act revolutionized tax planning for public businesses, and the provisions for private businesses required significant subsequent interpretations from the Internal Revenue Service. The IRS has now made clarifying guidance for interpreting the TCJA available for most of the new rules. Companies need to understand and use this guidance now to create new tax planning strategies that can yield significant tax savings.
Grant Thornton has released Tax Planning Guides for both public and private companies that include tax developments as of mid-January 2020. They suggest companies change their tax planning approach now and get started by asking the right questions. The following considerations and tips are some of the ones they think are the most important.
Examine your tax function. Now is the time to review the tax function’s overall effectiveness. Rather than focusing on repetitive compliance and number crunching, tax processes should be reassessed to make data gathering and workpaper preparation more efficient. The tax department should spend more time on forward-looking planning and strategy and increase their use of data analytics and automation.
Use timing to your advantage. There are new tax rules that provide current tax savings by accelerating deductions and deferring income, including deducting advance payments, the timing of recognizing revenue, and capitalizing inventory costs. A review of accounting methods for tax purposes can provide potential tax timing benefits that do not affect reported book income.
Tax reform made major changes to how public companies recognize revenue for tax purposes to require that revenues for tax purposes be recognized no later than for financial statement purposes. Public companies that recently changed book accounting revenue recognition as a result of Accounting Standards Codification Topic 606 need to consider the impacts to their tax planning. In addition, the TCJA allows the deferral of income recognition of certain advance payments.
On the asset side, the rate for bonus depreciation doubled from 50 percent to 100 percent for property placed in service through the end of 2022, and the rules were expanded to include used property. Also, there were changes to rules relating to capitalization of direct and indirect costs relating to inventory under Section 263A.
Scrub your one-time tax calculation for unrepatriated offshore earnings. Many companies were required by tax reform to pay a one-time transition tax on previously unrepatriated earnings. The final tax rules were not available at the time most companies filed for 2017 or 2018. Many companies may have overstated earnings held in cash under Section 965, which includes a narrow definition of “cash position.” Cash earnings and equivalents are taxed at a higher effective rate of 15.5 percent than all other earnings that are taxed at 8 percent.
Using book balances of accounts receivable and payable to calculate cash position may have significantly overstated it. The final rules permit adjustments to accounts receivable and payable that may lower the calculated amounts of cash and may potentially generate large tax refunds.
Make sure you’re not overpaying on exempted purchases. The 2018 U.S. Supreme Court decision in South Dakota v Wayfair, Inc. changed the rules to require sellers to collect state and local sales taxes in states where they do not have a physical presence. As a result of this decision, most public companies that are sellers are assessing where their products and services are sold and how they are taxed. But this issue should also be considered from the perspective of a purchaser.
State and local sales and use tax exemptions may be available for certain property and equipment purchased for further manufacturing or resale. A review of purchase records for the past several years to look for missed exemptions, overpayments, and misapplied tax rates may generate significant refunds and identify potential tax exposures.
Look to accelerate deductions after M&A activity. M&A activity has continued to be strong, and tax consequences should be considered in every deal. The costs of purchase and sales transactions, including professional fees, can be significant. IRS rules in general require buyers to capitalize certain transaction costs. For asset acquisitions, costs are generally added to the acquired assets’ basis and depreciated or amortized. For stock acquisitions, costs are generally added to the acquired stock’s basis and cannot be depreciated.
There are exceptions to capitalization. Investigatory costs may be deducted if the acquisition expands the buyer’s business or amortized over 15 years if they do not.
Success-based transaction fees are subject to unique rules for their deduction or capitalization and amortization. Being aware of these tax rules and analyzing M&A transaction costs can result in tax savings.
Organize business activities to boost pass-through deduction. The Section 199A pass-through deduction provides a deduction of up to 20 percent for qualifying pass-through income. The deduction is not available for certain service businesses and can be limited based on wages paid to employees and the cost basis of depreciable property.
There is the potential to maximize this deduction by understanding the new rules and limits. Taking the time to plan and reorganize company activities by dividing qualifying and non-qualifying activities into separate businesses can result in higher tax benefits.
Re-examine entity choice. The form of entity—individual, partnership, S Corp, or C Corp—impacts the tax rate on earnings. A key aspect of tax planning for private companies after tax reform is understanding how a business’ organization affects how it is taxed.
The new tax rate for C Corps is 21 percent, down significantly from 35 percent. This is more favorable than the top rate of up to 37 percent on pass-through business income to individuals. However, C Corp income is taxed at both the corporate level and again to individuals only if it is distributed to shareholders as dividends. Income from pass-through entities is usually only taxed at the owner level for federal taxes. Before making a change in entity, it is important to consider the cost of converting, any difference in rules related to accounting methods, and deductibility of state taxes, among others.
Supercharge your investment with opportunity zones. Congress created more than 8,000 opportunity zones in the United States to incentivize investing in specific targeted geographic areas. The TCJA creates a new program that allows deferral of capital gain recognition if proceeds from the sale of assets is invested into a dedicated Opportunity Zone fund within six months. All of the gain can be deferred until as late as Dec. 31, 2026, unless the asset is sold, or 90 percent of the deferred gain is recognized for investments held for five years. In addition, there is the potential of paying no tax on appreciation of the Opportunity Zone investment if it is held for at least 10 years. There are many types of businesses and activities than can qualify, so companies should consider whether these investments would be right for them.
Leverage business assets in unique estate planning opportunity. Private businesses are frequently transferred by their owners to family members. Tax reform doubled the estate and gift tax exemptions, and interest rates are low, so it is a very favorable estate planning environment. But these current exemptions are scheduled to expire in 2026, and they may not be extended or could be repealed. Now is a good time to update estate plans and consider potential asset transfers.
Consider state sales tax requirements. As a result of the Wayfair decision, sellers have additional collection and remittance obligations that differ state by state. Manufacturers and distributors who do not sell to the final consumer may still have to register and report in most states. There may be opportunities for refunds because of exclusions in certain states. To substantiate exempt transactions, customer resale and exemption certificate documentation may need to be collected and retained for the first time.
Grant Thornton encourages both public and private companies to use these guides now as roadmaps to begin their 2020 tax season planning and maximize tax savings they are entitled to. The guides include explanations of these and other tax law changes, tables of tax rules and rates, and planning tips. Besides its many implementation challenges, the TCJA creates new opportunities. Now that extensive IRS guidance is available, companies are encouraged to go on the offensive.