- Changing your accounting method could be worthwhile with the current high interest rates.
- It’s a good time to work on your business succession plan considering the lifetime gift tax exemption is scheduled to be cut in half starting in 2026.
- The additional bonus depreciation available in 2023 provides an extra incentive for taxpayers subject to a Section 179 limit to place assets in service before year end.
Could your business save with year-end tax planning strategies?
Year end is a good time to explore strategies to unlock potential tax saving opportunities. This is especially true in 2023, when high interest rates and the upcoming expiration of certain tax benefits make some strategies particularly beneficial.
Learn what tax strategies businesses should consider before year end 2023, including changing your accounting method, the timing of fixed asset purchases, and business succession planning.
Weigh accounting method changes considering high interest rates
There are pros and cons to changing accounting methods, which can help your organization save money in some cases. When the cost of capital was low, there were fewer benefits, but now that interest rates have risen significantly, considering a new method may be worth revisiting.
Another consideration to factor in are upcoming tax rate and deduction changes. The lower individual tax rates from the Tax Cuts and Jobs Act and the Section 199A deduction are scheduled to sunset on December 31, 2025. Barring congressional action, the top tax rates on pass-through income from a non-specified service business will increase from 29.6% to 39.6%. Depending on your cost of capital, a deduction against 39.6% income in 2026 may be more valuable than a deduction in 2023 against 29.6% income. Businesses with a relatively low cost of capital that anticipate future tax rate increases may prefer to take a wait-and-see approach.
Explore some of the following common accounting method changes worth considering before year end:
Overall cash method of accounting
Tax reform expanded the availability of the cash method of accounting, yet some eligible businesses have remained on the accrual method. The cash method of accounting generally defers recognition of income relative to the accrual method because most taxpayers have more receivables than payables.
Advance payments for goods
Accrual-method taxpayers can either account for certain advance payments and include them in taxable income in the year received (the full-inclusion method) or include the payments in taxable income in the year of receipt to the extent included in revenue for financial statement purposes and include the remaining amount in income in the next tax year (the deferral method). The deferral method requires businesses to determine the portion of deferred revenue earned in the year after receipt, so the administrative burden should be considered.
Accrual-method taxpayers can generally deduct certain prepaid expenses, such as insurance, taxes, and warranty or maintenance service contracts, if the term covered by the prepayment does not extend beyond the earlier of 12 months after the first date on which the taxpayer realizes the right or the end of the tax year following the year of payment.
Fixed asset methods
Taxpayers who own real estate may be able to accelerate deductions by performing a cost-segregation analysis to determine the appropriate tax life of various real estate assets or a repair analysis to identify costs that can be expensed rather than capitalized. Likewise, they may be able to accelerate deductions related to an energy-efficient building by performing a Section 179D analysis.
There are generally two acceptable inventory valuation methods: cost or lower-of-cost-or-market. The lower-of-cost-or-market inventory method takes more time but may reduce the value of the taxpayer’s inventory and thus accelerate deductions.
A business may be able to deduct obsolete or damaged inventory if it can no longer sell the inventory in a normal manner or at its normal price. The deduction for obsolete inventory is available only if the inventory is disposed of or the taxpayer establishes the reduction in its value by offering the inventory for sale to the public at a reduced price within 30 days after the inventory date. Taxpayers may want to evaluate their inventory for potential valuation-related adjustments.
The uniform capitalization rules are complex; however, opportunities exist for taxpayers to accelerate tax deductions by analyzing their capitalization methodologies. As just one example, many taxpayers have not fully explored the tax benefits of the new modified simplified production method uniform capitalization (UNICAP) calculation included as an option in final regulations issued in November 2018.
Retirement plan selection
Many businesses keep using the same retirement plan year after year, such as a SEP IRA or 401(k) plan. Your business may have outgrown its existing plan or your tax objectives may have changed. Consider whether another retirement plan is a better option (e.g., 401(k), profit sharing, SIMPLE IRA, SEP IRA, ESOP, cash balance plan, non-qualified deferred compensation, personal traditional or Roth IRA).
Employee Retention Credit (ERC)
Have you filed for an Employee Retention Credit? Either way, now is a good time to revisit eligibility for the benefit. As a refresher, the ERC is a lucrative tax credit offered to businesses who were negatively affected by COVID-19 restrictions.
For those who have filed, don’t forget ERC factors into your annual financial statement review. If you’ve filed but have yet to receive your credit, the IRS has warned payments may take more time and the agency has put a moratorium on processing new claims until 2024. If you haven’t yet filed for a credit, there may be eligibility paths you haven’t considered that are worth exploring.
Timing of fixed asset purchases
Bonus depreciation for equipment and other assets is set to drop to 60% in 2024 from its current 80%. If you use immediate expensing under Section 179 and not bonus depreciation, this isn’t a major concern, but it’s something to be aware of for the future.
For 2023, the Section 179 limit is $1.16 million with a phaseout beginning when purchases exceed $2.89 million. The additional bonus depreciation available in 2023 provides an extra incentive for taxpayers subject to a Section 179 limit to place assets in service before year end. Anticipated tax rates in 2023 and future years should be considered as well.
Business and wealth succession planning
Year end is a key time for future planning. For business owners, that may mean looking at what’s next for your business. There are significant tax consequences associated with selling or transitioning a business.
If you’re considering a business transition in the next few years, be aware that the lifetime gift tax exemption is scheduled to be cut in half starting in 2026 (from $12.92 million per person in 2023 to $6.46 million in 2026, adjusted for inflation). Gifts made prior to 2026 will be eligible for the higher exemption — even if the law subsequently changes — so there may be an incentive for taxpayers to make gifts before the rules change. Though tax rules are hard to predict — Congress has extended the enhanced exemption in the past and may do so again.
Considering the current high interest rates, there are some wealth transfer strategies worth considering. Here’s an example:
- A qualified personal residence trust (QPRT) is a trust that holds the taxpayer’s principal residence.
- The taxpayer retains the right to use the residence for a fixed period, after which the residence transfers to the trust’s beneficiaries. The taxpayer can continue to live in the property after the trust ends, but must pay a fair market value rent to the beneficiaries.
- The trust reduces the taxable amount of the gift in two ways: the value is discounted for the grantor’s retained interest and the value of the gift is frozen based on the value of the property at the time the QPRT is established.
- Higher interest rates increase the discount for the grantor’s retained interest, thereby reducing the amount of the taxable gift.
How we can help
These are just five of many tax strategies that could help your business situation. At CLA, we believe proactive, personalized planning is key to helping you navigate tax liabilities and identify new opportunities for savings. Contact us to explore whether these suggestions could help your business.