Year-end tax considerations for businesses
INSIGHT ARTICLE |
As 2015 draws to a close, many businesses find themselves looking back at a disappointing year of less-than-expected growth and looking forward to an increasingly uncertain economic climate. From a tax perspective, the high expectations for significant tax reform held by many at the beginning of the year did not, once again, come to pass. Although some minor federal tax legislation was enacted during the year, the tax provisions that expired at the end of 2014 (like the research and development tax credit) have been left to the end of 2015 for Congressional consideration, making tax planning more uncertain than most businesses would like. At the same time, states and local governments continued to change the tax rules around the country and the international tax environment continued to get more complex.
Following is a list of tax considerations designed to help companies make informed decisions related to year-end tax planning. In an increasingly complex world, proper planning becomes all the more important. Should you need additional information related to any of these matters, please contact your tax advisor.
Deduction and revenue planning
For companies looking to reduce taxable income (e.g., minimize current taxes payable) or accelerate income (e.g., in order to use expiring net operating losses), there are several accounting method approaches that may help accomplish those goals. A few of these include:
- Changing from the cash basis to the accrual basis of accounting, or vice versa
- Conducting inventory planning (for example, performing a UNICAP review, electing new last-in, first-out (LIFO) sub-methods, etc.)
- Accelerating certain deductions or electing to capitalize for the current year under the 12-month rule for prepaid expenses
- Electing to recover over 36 months or currently deduct self-developed software costs
- Deferring amounts received from advanced payments for goods or services
- Properly using the recurring-item exception for taxes, rebates and refunds
New accounting method procedures
The IRS has issued new procedures for applying to change an accounting method, and these procedures are fully effective for tax years beginning on or after Jan. 1, 2015. While in some cases the new procedures allow more taxpayers to qualify under the automatic consent procedures for applying for accounting method changes, such an approach may be accompanied by reduced audit protection and more administrative requirements. Highlights from the new procedures include:
- The ability to accelerate the recognition of income associated with an unfavorable section 481(a) adjustment into one year if you have a qualifying transaction
- The ability to recognize an unfavorable section 481(a) adjustment of up to $50,000 in one tax year under an increased de minimis threshold
- A two-year spread for unfavorable changes where taxpayers are under IRS examination and not filing an application in a window period
- A new 90-day window within which to file accounting method changes while under an IRS examination
- The ability to file under the automatic consent procedures while under an IRS examination (without audit protection)
Affordable Care Act employer information reporting requirements
Starting Jan. 1, 2015, large employers (those with 50 or more full-time equivalent employees) will need to begin filing an annual return (Form 1095) that reports with respect to each full-time employee what health coverage the employer offered the employee each month of the year. For 2015, employers must file Forms 1095 with the IRS by Feb. 28, 2016 (or March 31, 2016, if filed electronically). In addition, employers are required to send employees their copy of form 1095 by Jan. 31, 2016. The IRS has released the final reporting forms and instructions, and large employers need to plan now for how they will meet this new reporting obligation. Penalties for unfiled or inaccurate information returns, including Affordable Care Act reporting returns such as Forms 1095-C and 1094-C, were doubled for returns due after Dec. 31, 2015. In general, the maximum penalty charge per calendar year will be $3 million for failure to file such information returns with the IRS and $3 million for failure to furnish all required information to recipients, for a potential total maximum penalty of $6 million. Taxpayers that make a good faith effort to comply can expect a certain degree of leniency from the IRS with respect to errors related to the first-year filings. However, there is no reason to expect leniency for those employers that do not make the proper effort to comply with this new reporting obligation.
Potential extension of expired tax provisions
Several important tax credits and incentives expired after Dec. 31, 2014, and once again, we are waiting to see if Congress will pass legislation to extend these provisions. The historic pattern has been to pass an extenders package just before the end of the year (retroactive to the beginning of the year). However, no one can predict what will be included in the final package or when it will become law. Among the expired tax provisions pending extension are the following popular tax breaks:
- Research and development tax credit
- Work opportunity tax credit
- Section 179 expensing limit of $500,000 (without retroactive extension, the limit is only $25,000 for 2014)
- 50 percent additional first-year (bonus) depreciation
- 15-year straight-line depreciation for qualified leasehold improvements, qualified restaurant buildings and qualified retail improvements
- Section 179D energy efficient commercial building deduction
- Five-year recognition period for built-in gains of S corporations (without retroactive extension, the recognition period is 10 years)
- Look-through treatment of payments between related controlled foreign corporations
- Subpart F exception for active financing income
- New markets tax credit
- Several renewable energy credits
The uncertainty surrounding expired tax provisions has implications for:
- Fourth quarter estimated tax payments
- Fourth quarter tax provisions (Under ASC 740, the benefit of an expired tax credit or deduction cannot be recorded in 2015 unless extenders legislation is enacted by Dec. 31, 2015.)
- Information needed for 2015 tax return preparation
- Tax planning
Executive compensation plan review
The IRS has a current audit initiative focused on how the very largest employers are managing their executive compensation programs. Specifically, the IRS is focused on whether employers are satisfying the strict requirements of section 409A with respect to when an employee may elect to defer compensation, the general prohibition against accelerating income that was previously deferred, and when (if at all) an employee can elect to re-defer compensation that he or she or has already deferred. Typically, such IRS initiatives are precursors to larger audit initiatives. Now is the time for employers to review their deferred compensation plans and, when possible, correct errors before the onset of an IRS examination.
IRS account transcripts
A company’s IRS account transcript contains useful information, including the information necessary to confirm estimated payments or credit elects for the 2014 tax year before preparing an extension or filing the return. For prior years, the account transcript can identify items of which the company may be unaware, such as penalty or interest assessments, math error adjustments, or examination indicators. Thus, companies should consider ordering an IRS account transcript in January.
Tax return due dates to change
Legislation was enacted on July 31, 2015, that changes the tax return filing deadlines for many taxpayers, generally effective for tax years beginning after Dec. 31, 2015. Returns of calendar-year C corporations will be due April 15 (rather than March 15), and returns of calendar-year partnerships will be due March 15 (rather than April 15). Calendar-year S corporation returns will continue to be due March 15. The due dates for fiscal-year filers also are changing, with most C corporation returns due on the fifteenth day of the fourth month following the end of the fiscal year, and S corporation and partnership returns due on the fifteenth day of the third month following the end of the fiscal year. Interestingly, there is an exception for C corporations with a fiscal year ending on June 30. In those cases, the effective date of these changes is delayed until the first tax year beginning after Dec. 31, 2025.
Corporate and transactional considerations
Due date for carryback claims of 2014 losses
Net operating losses must be carried back first before being carried forward unless a timely election to forego the carryback period is made under section 172(b)(3). The net operating loss carryback claim can be filed via Form 1120X, Amended U.S. Corporation Income Tax Return, within three years of the date the loss year return was filed. The refund resulting from the carryback claim filed via Form 1120X is generally subject to examination (including Joint Committee on Taxation review, if applicable) before it is paid. However, a carryback claim filed via Form 1139, Corporation Application for Tentative Refund, must be paid by the IRS within 90 days of filing and any examination (or Joint Committee on Taxation review) of the claim is performed after the refund has been paid. The Form 1139 must be filed within one year of the last day of the loss year. For calendar-year 2014 losses, the Form 1139 must be filed on or before Dec. 31, 2015.
File Form 4466 in January to obtain a quick refund
Corporations can receive a quick refund (generally in less than 45 days) of federal estimated tax payments in excess of the company’s estimate of its tax liability for the year. The company must file IRS Form 4466 after the close of its tax year but before the unextended due date of its Form 1120 to receive this quick refund. The company can designate that the excess amount be credited to another IRS liability. Penalties may apply if the requested refund leaves the corporation underpaid for estimated tax purposes.
Consider filing an automatic extension even if the return will be filed on time
The timely filing of a Form 7004 will provide an automatic six-month extension of time to file a corporate income tax return. Because the extension is automatic, it does not matter whether the corporation files the return the next day—a valid automatic extension request extends the time for the corporation to file its return for six months from the original due date of the return. A return filed before the extended due date can be superseded by the last return filed before the expiration of the extended due date. The extension period allows companies time to make corrections to the return, up to the extended due date, without penalty or to make timely elections or automatic method changes that were omitted from the initial filing. The superseding return becomes the official return, and the statute of limitations on assessment will expire (under normal circumstances) three years from the date that return is filed.
Accelerating subsidiary stock losses
For consolidated taxpayers, two planning opportunities may be available to accelerate and recognize losses in the current year. Consolidated groups with an insolvent subsidiary should evaluate whether it makes sense to take a worthless stock deduction. One of the easiest ways to accomplish this is to convert the insolvent subsidiary into a limited liability company. In addition, consolidated groups can in certain instances recognize losses associated with an insolvent or solvent subsidiary by planning into a section 331 liquidation.
Accelerate section 481 adjustments in the year of an M&A transaction
Under new rules provided by the IRS, taxpayers have the ability to accelerate income into the year of certain M&A transactions and possibly the year prior. These rules allow for the acceleration of income into the period prior to an acquisition and can provide tax advantages in situations where section 382 limitations would limit the ability to offset such income post-transaction. Certain accounting method changes must be filed prior to the end of the tax year in order to obtain this treatment.
Identifying unamortized debt issuance costs
Companies that have refinanced debt or taken out new debt should evaluate whether any unamortized debt issuance costs are eligible for write-off during the current tax year.
Federal income tax do-over
While not a new ruling, Rev. Rul. 80-58 allows taxpayers to rescind a transaction. While this is difficult to accomplish and little guidance exists in this area, this ruling does provide an avenue for rescission. However, in order to successfully complete a rescission, it must occur within the same tax year as the transaction. As a result, this is an item that warrants discussion during year-end planning.
Section 382 closing of the books election
Corporations should carefully monitor changes in stock holdings and stock issuances that occur during the year in order to identify whether the company has undergone a section 382 change in control. If so, planning around a “closing of the books” election may be an opportunity. This election allows a taxpayer to close its books at the date of change for section 382 purposes, thereby specifically allocating income and deductions pre- and post-change. Alternatively, the general rule requires daily proration of the entire year’s items of income and deductions. Understanding whether a closing of the books election will be made before the end of the year can help a company decide if it needs to accelerate items of income or deduction and whether the closing of the books or the default ratable proration is more advantageous. However, the election must be made on a timely filed tax return and is therefore an important year-end planning item.
Projecting earnings and profits
During year-end planning, it is important to project current-year earnings and expected 2016 earnings along with current earnings and profits. This can aid companies in deciding whether or not to accelerate a distribution.
Schedule UTP filing threshold dropped for 2014 and all subsequent tax years
A corporate taxpayer that reports at least $10 million in assets on the balance sheet in its income tax return as of the beginning or the end of its 2014 or subsequent tax year, files one of the forms in the 1120 series, and issues (or a related party issues) audited financial statements reporting all or a portion of its operations for the tax year in which a reserve is reported for at least one uncertain U.S. income tax position must file Schedule UTP, Uncertain Tax Position Statement, for the 2014 or subsequent tax year.
Form 8937, Report of Organizational Actions Affecting Basis of Securities
C and S corporations that take organizational actions that affect the basis of securities in the hands of stockholders generally must file Form 8937 within 45 days of the transaction date, or by January 15 of the year following any such actions that take place in December. Organizational actions include stock splits, stock dividends and distributions that are fully or partially non-taxable, and some reorganizations. S corporations may report the required Form 8937 information on their Schedules K-1 instead of Form 8937, and a company may also meet Form 8937 filing requirements through appropriate postings on the company’s website.
International Tax Considerations
Review cost sharing agreements
The Tax Court recently held that a regulation that required taxpayers to take into account stock-based compensation in their cost-sharing arrangements was invalid. As a result, taxpayers with appropriate facts should consider filing protective amended returns for prior open years to preserve potential refund claims and assess the potentially significant financial statement implications of this decision. In addition, taxpayers should determine whether to apply the decision to management fees and other analogous costs. For further information, see our article, The Altera U.S. Tax Court Decision.
Planning for payments between foreign subsidiaries
U.S. taxpayers generally pay tax on foreign income earned by a non-U.S. subsidiary when the subsidiary makes a distribution of income to the U.S. shareholder. However, payments made between offshore subsidiaries often trigger income inclusions to a U.S. shareholder even if the U.S. shareholder receives no money. A prior law exception that allowed a foreign subsidiary to pay another foreign subsidiary without triggering income to U.S. shareholders expired. Recently, this exception has become part of various tax extender proposals that have emerged in Congress, but whether Congress will include this exception in a final tax extender bill is unclear. In the absence of this exception, taxpayers should consider treating foreign subsidiaries as flow-through or disregarded entities, which may help mitigate income inclusions arising from payments between foreign subsidiaries.
Intercompany loan planning
Under current law, a loan or equity investment in a U.S. company by a related foreign subsidiary can result in an income inclusion to a U.S. shareholder of the foreign subsidiary. Even a guarantee by a foreign subsidiary can trigger an income inclusion. Many taxpayers are unaware of this rule and may have such U.S. investments in place at any given time. However, taxpayers can minimize the adverse impact of this rule by reducing or eliminating U.S. investments or guarantees by foreign subsidiaries before the end of the year.
Exporters should consider a DISC
The United States provides incentives to boost exports of some domestic goods. Taxpayers may exclude tax commissions paid to a domestic international sales corporation (DISC) for supporting overseas sales. When ultimately paid to individual DISC shareholders, DISC commissions are taxable at a 20 percent rate instead of the much higher corporate or individual rates that apply to ordinary business income. DISCs involve little cost, but a new legal entity must be established and all shareholders must elect DISC status before the tax year begins. Thus, interested taxpayers should make a DISC election for 2016 before Jan. 1, 2016.
Under the Foreign Account Tax Compliance Act (FATCA), U.S. persons that make certain payments to non-U.S. entities must collect a tax equal to 30 percent of the gross amount of any amounts paid to so-called foreign financial institutions (FFIs) or to any foreign entity unless an exception applies. Payees that register with the IRS as a “participating FFI” or that otherwise qualify are exempt from withholding, which applies beginning on Jan. 1, 2015 to new accounts opened after July 1, 2014. The FATCA tax could even apply to cross-border intercompany payments made by members of nonfinancial groups. Since significant penalties apply for failure to withhold, payors and payees should consider whether FATCA registration will provide relief.
Pass-through entity considerations
Passive loss/net investment income tax planning
Taxpayers are generally restricted in their ability to deduct losses from “passive activities.” These are losses from rental activities and other business activities in which the taxpayer is not actively involved. However, taxpayers who can demonstrate the necessary level of participation in these activities may be able to deduct these losses and generate significant current income tax savings. The keys to doing so are: 1) understanding how much participation is necessary, and 2) ensuring that the participation can be substantiated. In some cases, a taxpayer may only need to participate for 101 hours in an activity in order to deduct such losses. Thus, taking action now to increase one’s participation can in some instances provide a valuable tax deduction.
In situations where the business activity generates a net profit, participation is also relevant when trying to minimize exposure to the 3.8 percent net investment income tax under section 1411. Owners of pass-through entities usually can avoid the tax on their distributive share of income if they “participate” in the business for more than 100 hours during the year. So again, finding ways for owners to meaningfully participate in the business can have the added benefit of significantly reducing their exposure to this tax.
Reconsidering a subchapter S election
Recent increases in income tax rates have left many S corporation shareholders questioning whether a subchapter S election is still advantageous. In most cases, a company’s annual tax cost will be higher as an S corporation than it would be as a C corporation, disregarding the potential “double tax” imposed on C corporation dividends or the sale of C corporation stock. Taking the second level of tax into account, S corporations (or other pass-through entities) generally still have the advantage. With potential tax changes on the horizon, such as possible reductions to the C corporation tax rate, this may be a good time to reassess medium- and long-term tax planning considerations that affect the decision to maintain S corporation status.
Planning for partner basis limitations
Partners without “at-risk basis” will generally be limited in their ability to deduct losses passing through from a partnership. There are times, however, when partners and the partnership can take steps to generate at-risk basis for a partner to help that partner take advantage of those losses. There has been significant activity in this area, including recently proposed liability-allocation rules that would affect this analysis. Because those rules have not yet been approved, partners and partnerships still have considerable flexibility when determining how liabilities are shares among partners. In many cases, steps would need to be taken prior to year end to ensure that liabilities can be allocated in a way that will give partners the basis necessary to deduct their share of losses that ultimately pass through to them.
State and local tax considerations
Nexus is most often addressed in the context of analyzing what a company does and determining where the company could arguably have established sufficient contacts to be required to file state income and franchise tax returns. However, the question of where a company has to file only scratches the surface of the importance of nexus, and other nexus issues, such as whether the company has the right to apportion or has to throw back or throw out sales from its sales factor, may have more bearing on the amount of total state income and franchise tax actually paid. Additionally, it is important to understand whether a company has any opportunities to restructure legal entities or business operations to generate benefits from establishing or cutting off nexus. For example, a company in a loss year with an expectation of generating income in future years may be well-advised to establish nexus now in states it has targeted for expansion in order to protect a net operating loss. In some cases, this can be as easy as hiring or moving an employee a little bit earlier than originally planned; however, regardless of the necessary steps, any nexus-establishing activities must be done by year end.
Before year end, it is important to extrapolate estimated apportionment data from the first through third quarters of the current year and the fourth quarter of the prior year to identify key positions for which the company will need specific, highly detailed data for its returns. Additionally, by analyzing this data, the company can determine whether more favorable apportionment can be obtained via restructuring of its legal entity structure or business operations or through requesting to use an alternative apportionment formula.
State attribute regimes, such as state net operating loss calculation and usage rules, can vary significantly from federal, and opportunities exist in relation to attributes generated before establishing nexus, becoming a member of a combined or consolidated group, and acquiring, merging or liquidating an entity. If a company has substantial tax attributes trapped in a perennially underperforming or newly acquired entity and has another entity that could fully utilize those attributes, it may be beneficial to merge those entities or, in some cases, to elect or request to file on a combined or consolidated basis.
Current-year deduction maximization
If a company has multiple entities in its structure, it may be beneficial to examine projections of current-year income and deductions to identify isolated current-year loss entities. It may be possible to fully utilize the deductions creating those projected losses through expense allocation, transferring payroll or property, restructuring, or electing or requesting to file on a combined or consolidated basis.
Depending on the circumstances, filing state income tax returns on a mandatory combined basis can provide substantial benefits or detriments to taxpayers. It is important to determine whether the business has the requisite control, integration and flow of value to establish unity and to model state income taxes on a separate and combined basis. Where sufficient value exists, it may be advisable to take steps to break or create unity. This analysis is particularly important if the company has completed, or is going to complete, a major acquisition or disposition of entities or assets during the tax year.
Shared services consolidation
Many businesses have duplicative functions, such as payroll and billing, within legal entities or business units. By consolidating these functions in a single entity and setting up intercompany charges, it may be possible to create operational savings and tax benefits via nexus isolation and shifting taxable income to states with favorable tax base computations, apportionment rules or rates.
Sales tax exemption review
Many exemptions are subject to sunset provisions or have been substantively modified or repealed by legislation that will take effect next year. It is important to review exemptions the company has historically utilized to determine whether any of them will cease to be effective next year or will change in a manner that will take the company or its purchases out of the qualifying class. By identifying these soon-to-be lost exemptions, the company may be able to find room in the budget now to make planned purchases before time runs out.
Credits and incentives compliance
Many state tax credit programs and incentive packages have ongoing annual compliance requirements that must be met in order to retain benefits and avoid claw-backs. It is important for a company benefitting from state credits and incentives to understand its continuing compliance responsibilities, ensure that it meets commitments (such as those associated with new hiring, job retention and investment) by agreed-upon deadlines, and file all required forms and data in a timely manner. By reviewing active state credit and incentive agreements and applicable statutory and regulatory requirements and taking the right steps now to keep in compliance for this year, a company can avoid having to go through the arduous process of renegotiating deals or the outright loss of prior, current and future benefits.