Leveraging Tax Accounting Methods to Support Strategic Business Planning

 

When it comes to income taxes, some organizations may miss opportunities to plan beyond their next tax return. However, integrating tax accounting methods into business planning can empower organizations to manage cash flow more effectively, align tax and financial strategies with long-term business goals, and improve the organization’s overall tax position. Tax accounting methods are not just about compliance with tax regulations; they also provide a framework for making financial decisions by accelerating tax deductions, deferring taxable income, recharacterizing revenue and expense for tax purposes, and more.

In this article, we illustrate how the strategic use of tax accounting methods can address specific business scenarios, thereby helping organizations thrive in a competitive market.

Tackling Business Issues with Tax Accounting Methods

The tax code has become increasingly complex, with intertwined rules that often seem to conflict. Navigating these rules can feel like operating a Rube Goldberg machine — where pulling one lever sets off a chain reaction in a complex fashion. Yet, when viewed holistically, these overlapping rules can present planning opportunities to help address business challenges that might initially seem unrelated to tax functions.

Organizations apply tax accounting methods planning in various situations, including to:

• Reduce taxable income
• Increase cash flow
• Use tax attributes or implement other reverse tax planning
• Find administrative relief while remaining in compliance
• Prepare for undergoing tax due diligence
• Mitigate exposure from and rectify impermissible methods
• Adapt to changes in tax laws and regulations

Identifying the challenge is key to choosing the appropriate tax accounting method: Is the organization dealing with burdensome limitations, such as restrictions on the deductibility of interest expense or net operating losses? Is a beneficial tax attribute about to expire? Has the organization been confronted with an unexpected tax liability or a consistently high tax burden that is siphoning off cash reserves? Often, issues are exacerbated by an overextended tax department that needs additional time and resources to identify tax accounting methods that fit within the company’s overall business planning.

Connecting business needs with tax planning generally takes one of the following paths: traditional tax planning, reverse tax planning, or a strategic combination of both approaches.

Traditional Tax Planning: Accounting Methods to Reduce Cash Tax Liability

Accounting methods address the “when” and “how” of recognizing both income and expense, potentially providing relief from current tax obligations. Taxpayers typically seek traditional tax planning opportunities that use accounting methods to defer income or accelerate deductions to reduce their current tax burden.

However, these planning opportunities may require changes to one or more of the organization’s tax accounting methods. If available, “automatic” method changes (changes that are allowed without the IRS’s advance consent) can be included with a timely filed return, including applicable extensions. This convenient feature can also open planning opportunities to accelerate deductions and/or defer income from prior tax years, including closed tax years. For taxpayers discovering unanticipated tax liabilities well after year end, automatic changes can be critically valuable.

Other planning opportunities may require annual elections, such as the ability to deduct de minimis capital expenditures or capitalize interest expense to property. Often, such elections may be made as frequently as desired and normally with a timely filed return. However, elections are generally unavailable for past tax returns; therefore, their advantages are prospective. In contrast, accounting method changes typically provide for a catch-up adjustment that allows taxpayers to account for any cumulative differences between their old and new methods for prior tax years.

Moreover, organizations should consider revisiting underlying facts within existing accounting methods because reviewing and considering different outcomes can lead to more desirable results.

Planning that uses traditional tax accounting methods might address tax concerns in the following ways:

• Deferring the recognition of advance payments.
• Decoupling from revenue recognition for books.
• Accelerating the deduction of costs to fulfill a contract.
• Evaluating the tax ownership of tangible property versus the existence of a lease.
• Recovering the cost of inventory before sale.
• Examining the deductibility of costs for tangible property versus capitalization and depreciation.

Strategic planning through tax accounting methods can be a powerful tool to help reduce a taxpayer’s cash tax liability. However, in some scenarios, alternative approaches may result in more favorable business outcomes.

Reverse Tax Planning: Defying Conventional Logic with Tax Accounting Methods

Issue-specific tax planning often challenges traditional thinking. In certain situations, taxpayers may want to use tax accounting methods to accelerate income recognition or defer deductions — often referred to as reverse tax planning — for example:

• To unlock expiring tax attributes, such as net operating losses or tax credits;
• To mitigate unfavorable limitations, such as the limitation on the deduction for business interest expense; or
• To reduce the base erosion and anti-abuse tax (BEAT) liability associated with certain payments made to related foreign parties.

The following scenarios are typically ripe with opportunities for reverse planning with tax accounting methods:

To Manage Expiring Tax Attributes

Some crucial tax benefits and deductions have expiration dates. For example, tax attributes such as carryforwards of losses, limitations, and tax credits may be usable only during a specific timeframe or under certain circumstances (for example, the existence of sufficient U.S. income or tax). Some M&A transactions must be structured to preserve the tax attributes of the acquired company. In these situations, accelerating income or deferring deductions might be a way to avoid the permanent loss of valuable tax attributes.

To Leverage Tax Credits

Organizations operating across multiple countries face a dizzying array of federal and international tax regulations. In addition to managing existing tax provisions — such as those relating to global intangible low tax income (GILTI), BEAT, the foreign tax credit (FTC), and the deduction for foreign-derived intangible income (FDII) — tax leaders must also prepare for upcoming scheduled  changes to these provisions (for example, an increase in GILTI and BEAT rates, and a decrease in the FDII deduction percentage, all in 2026). Reverse planning by recognizing income or deferring deductions might enhance the benefits of these provisions before their impact is narrowed. Taxpayers can help position themselves as forward-thinking and well-prepared by developing roadmaps or timelines for implementing accounting method changes or elections that align with anticipated changes in GILTI, BEAT, and FDII. BDO International Tax Horizon, a quantitative analysis tool, can provide tax compliance, forecasting, and planning services to aid in that planning and preparation. It gives multinational businesses a comprehensive view of their international tax profile with an emphasis on U.S. calculations.

To Help Manage Section 382 Limitations

Internal Revenue Code Section 382 limits the amount of taxable income a company can offset with a net operating loss after an ownership change. Taxpayers may deploy accounting methods to utilize attributes such as net operating losses in advance of an ownership change to mitigate potential Section 382 limitations that might otherwise apply.

For example, buyers may discount or overlook favorable tax attributes of target companies due to Section 382 limitations. However, with advance d accounting methods planning, sellers can enhance the value of their tax attributes by using them beforehand or by converting them from a less valuable attribute to a more valuable one. By strategically timing the recognition of income and deductions, organizations may improve their taxable income position and fully capitalize on their tax attributes.

To Enhance the Value of Renewable Energy Credits

The Inflation Reduction Act of 2022 includes provisions that promote clean energy and introduces the ability for certain taxpayers to transfer eligible renewable energy tax credits to unrelated taxpayers for cash.   A holistic approach leveraging tax accounting methods can benefit the stakeholders in these transfers in several ways, including by:

• Enhancing the value of the credits.
• Expanding the marketability of the credits.
• Generating cash flow to fund the purchase of the credits.

Tax accounting methods can offer a variety of improvements to the renewable energy credit ecosystem. Timing the implementation of these methods is key.

To Anticipate Tax Rate Changes

Reverse tax planning can generate permanent benefits when strategically implemented in the face of fluctuating tax rates, which can be brought on by changes in political leadership and other factors. Even minor rate movements can impact an organization’s tax liability and its ability to manage cash flow.

By considering potential tax rate changes across federal, state, and international levels during business planning, organizations can make informed decisions about tax-related issues, potentially leading to cost savings. Generally, organizations can look for ways to accelerate income or defer deductions if tax rates are set to increase, with the reverse being true if tax rates are set to decrease. When tax rates remain the same, leaders can evaluate current strategies, monitor legislative changes, and seek to optimize deductions and credits.

Tax Accounting Methods Can Play a Major Role in Business Planning

The strategic use of tax accounting methods during the formulation and execution of business plans can have a positive impact on an organization’s financial performance. A deep understanding of tax accounting methods and how to align them with business objectives can bolster business goals like improving cash flow and addressing or responding to changes in the business, legislative, and regulatory environments that impact tax positions.

Written by Peter Pentland. Copyright © 2024 BDO USA, P.C. All rights reserved. www.bdo.com