Tax reform is now at the top of the Republican agenda, and leaders from the House, Senate, and Administration recently released a framework for tax reform with agreements on the major pillars of tax reform.
Many businesses are struggling to understand what the proposals mean to them, and what they should be doing to prepare. The legislative process is still ongoing, and it’s easy to be paralyzed by the uncertainty, but the “wait-and-see” approach is a mistake.
There are important reasons businesses need to act now. The prospect of tax reform creates tremendous new planning opportunities, and many of these are effective only if done before tax reform is enacted. Many other strategies need significant planning in advance, and tax reform can also create significant risks.
No company should be making long-term business decisions without understanding how tax reform could affect the economic impact. Additionally, shareholders of public companies expect management to understand how tax reform could affect the business, and disclose the possible risks.
Below are five things the smartest businesses are doing right now to prepare for tax reform:
Assessing the impact – The first step to planning for tax reform is to understand how it affects your business. The framework for tax reform released by Republicans would dramatically alter how businesses are taxed. Smart businesses are assessing how the proposals would impact their specific circumstances so they can make good business decisions and identify planning opportunities.
Accelerating deductions – The prospect of a rate cut creates a big planning opportunity. You want to accelerate deductions so you can take them now against today’s higher rates, rather than in the future when rates might be lower. Businesses can often control the timing of many types of expenses, including compensation, bonus pools and benefit payments. Many large public companies are already taking advantage of this kind of opportunity and have publicly accelerated payments to retirement plans.
Building assets provide another great opportunity because they represent such a large expense for so many taxpayers. Taxpayers often incorrectly believe that all costs associated with a building must be capitalized and depreciated over a 39-year schedule. Many building assets can be reclassified and depreciated using shorter lives, while other costs may qualify for an immediate deduction as repairs or maintenance. Smart businesses are performing fixed asset reviews to identify significant deductions that could be taken now against today’s high rates.
- Reviewing accounting methods – Rate arbitrage opportunities don’t end there, and top businesses are already putting various strategies into play. The Congressional Budget Office reported that tax receipts are down this year because so many taxpayers are deferring income into the next year while recognizing additional deductions this year. One of the best ways to accomplish this is to review your accounting methods.
Most businesses employ dozens of separate accounting methods on everything from inventory to software development. Identifying a better method often results in a favorable adjustment that is taken fully in the year of change. The Internal Revenue Service (IRS) has identified more than 150 method changes that can be made automatically, and there are scores of others that can be made after IRS approval. Some of the best opportunities to defer income and accelerate deductions include:
- Deferring recognition on advanced payments or disputed income; and
- Accelerating deductions for computer software, self-insured medical expenses, property taxes, payroll taxes, prepaid expenses and rebates.
The good news is that a favorable change also provides a cash flow benefit and offers the time value of money. Despite this, many public companies are reluctant to bother with timing changes if they provide no book benefit for financial accounting purposes. But the possibility of a rate cut could turn these timing changes into permanent benefits.
- Planning for one-time tax – The Republican framework for tax reform would impose a one-time tax on all unrepatriated earnings as part of a transition to a territorial tax system. No rate is specified, but earlier proposals for this one-time tax ranged from 10% on all earnings to 8.75% on cash and cash equivalent, and 3.5% on reinvested earnings.
Smart businesses are implementing plans to reduce the impact of this one-time tax. The same rate arbitrage opportunities used before a domestic rate cut also work here. Companies should accelerate deductions and defer income in foreign subsidiaries so that earnings are recognized after the one-time tax hits and could instead be repatriated tax-free under the framework’s proposal for 100% dividends received deduction.
Many businesses could also actually pay less tax by bringing earnings home early and using foreign tax credits even though current rates are higher than the proposed rates for the one-time tax. This determination will be heavily dependent on the rates included in final legislation and each company’s individual tax situation. The most nimble multinationals are already assessing their foreign earnings and tax credits to gauge the tax cost of repatriating various pools of earnings under current law. That way, once the final legislative outcome becomes clear, they can act quickly before the one-time tax is effective, if necessary.
Discussing risk on the financial statement – The impact of legislative changes aren’t recorded in the financial statement until enacted, but shareholders of public companies expect management to understand, plan for, and disclose risks. Businesses with SEC disclosure requirements should consider whether to include a discussion of the potential impact of tax reform in the Management Disclosure and Analysis. Many top companies already have – with many statements showing up in recent disclosures discussing the potential for the border adjustment tax to have a material adverse effect on business – the potential for a rate cut to reduce the value of deferred tax assets, and the potential adverse effect of a one-time tax on repatriated earnings.
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Director, Washington National Tax Office
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