Last call for 2017 permanent tax deductions
INSIGHT ARTICLE |
As the 2017 extended tax-filing season marches toward conclusion, time is running out for auto industry OEMs and suppliers to cash in on permanent tax saving opportunities. Through tax reform legislation, tax rates have significantly decreased from 2017 to 2018. For corporations, the top tax rate has been reduced from 35 percent to 21 percent. For pass-through entities that qualify for the new section 199A provision (which is a 20 percent deduction from qualifying business income), the top tax rate of 39.6 percent falls to 29.6 percent.
Tax rate arbitrage involves planning the timing of income and deductions to benefit from differences in tax rates. There are several tax planning strategies available to take advantage of these substantial rate differences.
A choice of strategies
Depending on a company’s unique situation, strategies that could be implemented by the extended due date of the 2017 tax return include:
- Timing of advance payments: allows limited deferral for certain items
- Last in, first out inventory: requires book conformity
- Prepaid items: accelerates deductions for certain prepaid expenses
- Contributions to qualified retirement plans: includes 401(k) or pension
- Cost segregation study: reclassifies 39-year property to shorter depreciable lives
In most cases, these planning strategies involve filing IRS automatic method changes. For automatic method changes affecting 2017 tax returns, there is still time to file by the extended due date (Sept. 17, 2018, for calendar-year pass-through entities; Oct. 15, 2018, for calendar-year corporations). If a calendar-year company has already filed its 2017 return, it is still able to file for an automatic method change by the extended due date and then amend the 2017 return. This applies even if the company did not originally request an extension of time to file.
How tax rate arbitrage works
Let’s use an example of a prepaid insurance premium for a profitable, calendar-year corporation at the top 35 percent tax bracket in 2017. Assume a $1 million annual premium was paid on Dec. 31, 2017. For GAAP purposes, the cost of the prepaid insurance is capitalized on the balance sheet when paid. This cost is amortized evenly over the 12 months the policy covers. The cash outlay has occurred in 2017, but the book expense will be recognized throughout the 2018 year. Absent a different method used for tax purposes, the tax deduction for the $1 million would be taken on the 2018 tax return at a 21 percent tax rate ($210,000 tax savings). But what if the same $1 million could be deducted on the 2017 tax return instead? At a 35 percent tax rate, the company would save $350,000 in tax on the 2017 return; this would be additional, permanent savings of $140,000.
Time is almost up
Automotive OEMs and suppliers should consult their tax advisors immediately regarding tax rate arbitrage planning that can be implemented with the filing of their 2017 tax returns. Tax rate changes between 2017 and 2018 offer a tremendous opportunity for tax savings, but the window is closing fast and soon it will be too late.
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