Tax proposals provide accounting method planning opportunities for businesses in 2021

Business taxpayers facing potential tax rate increases under the proposed House Ways and Means reconciliation bill may benefit from making accounting method changes to generate permanent cash tax savings by accelerating income to a lower rate tax year. To illustrate, if the top corporate tax rate increases to 26.5% from 21% in 2022 (as currently proposed under the House Ways and Means reconciliation bill), a taxpayer can realize permanent cash tax savings of 5.5% by accelerating income into the lower rate 2021 year or, conversely, by deferring deductions until 2022 to offset higher-taxed income in that year.

Accelerating taxable income may provide additional tax benefits in the form of increased deduction limits under the global intangible low-taxed income (GILTI) regime and the section 163(j) interest expense provisions as well as reduced exposure to the base erosion and anti-abuse tax (BEAT) minimum tax. Similarly, a taxpayer that incurred a significant COVID-19-related net operating loss (NOL) in 2020 may need to increase income in 2021 in order to use expiring tax attributes (e.g., foreign tax credits, pre-2018 NOLs, deductions and losses limited under section 382). However, taxpayers should carefully evaluate alternative scenarios and monitor the status of pending legislation before implementing strategies to increase taxable income because the tax rules governing the various provisions are complex and are subject to change under the proposed reconciliation bill. See the legislative update for details.

The following discussion highlights some widely applicable and easily implemented ideas to increase taxable income by filing an automatic method change (Form 3115), making an election or taking certain action(s) to defer deductions to a later tax year. See also the list of automatic method changes in Rev. Proc. 2019-43 for additional changes that may increase taxable income depending on the taxpayer’s facts.

Automatic method changes

Automatic changes are made by attaching Form 3115 to the timely filed (including extensions) federal income tax return for the change year and filing a duplicate copy with the IRS national office. No user fee is required.

The accounting method changes discussed below require a section 481(a) “catch-up” adjustment. Taxpayers filing changes for 2021 should be aware that the permanent rate arbitrage savings for these changes will be limited to the amount reportable in 2021 (25%) because a positive adjustment (increase to taxable income) must be spread ratably over four tax years rather than reported entirely in the year of change. The remaining three installments will be recognized in higher tax rate years (2022-24).