Creating Permanent Tax Savings with Temporary Items
Tabitha Lamontagne, Tax Principal
In light of possible rate reductions from the tax reform bills underway in various stages on Capitol Hill, it is worth considering whether some of your temporary tax differences can become permanent.
- A temporary adjustment for tax purposes is merely a difference in timing between when an item of income or expense is recognized for financial statement reporting and the tax return.
- A permanent adjustment is an item that is either deductible or included in net income of either the financial statements or taxable income, i.e. it will not reverse in the future.
Taxpayers intent on reducing their effective tax rates have traditionally focused on tax planning involving only permanent items, since ordinarily temporary differences will not impact effective rate.
However if the currently proposed tax legislation is enacted, we can expect corporate tax rates to decrease, thereby creating a one-time opportunity to create some permanent savings by focusing on the temporary adjustments that could generate permanent tax savings. The name of the game is almost always to accelerate deductions and defer income. In a year where you could receive a 34%-35% tax benefit from a deduction which could reverse and potentially create future income at a 20% tax rate, traditional “temporary” differences could become both temporary AND permanent. I encourage you to look at your balance sheets and consider whether you may be able to take advantage of a few opportunities identified in this article.
Prepaid Expenses – If you have prepaid expenses related to health insurance premiums, service contracts or maintenance, there may be an opportunity to take advantage of an automatic change in accounting method to accelerate the deduction of these expenses in the year paid if you are not already doing so.
Accrued Bonuses – If your policy is to pay out bonuses within 2 ½ months after year end, there is an opportunity to deduct the accrued balance on your current year tax return if you make a few small one- time changes to your policy. For a liability to be deductible for tax purposes, among the requirements is that the expense must be fixed and determinable. Many bonus policies do not meet this definition even though they are paid out within 2 ½ months after year end because they are payable only if the employee is employed on the day of payout. To make your accrued bonus deductible in 2017, a board may approve an addendum to the policy which is only applicable to the current year’s accrual for the bonus to either
- be payable to employees who are employed on 12/31, or
- be allocated to all employees who are employed on the payout date (i.e. any of the bonus attributable to employees no longer employed on the payout date must be re-allocated to the remaining employees; however none of the accrual can revert back to the Bank).
Pensions – Taxpayers have until the due date including extensions to make pension contributions; this allows taxpayers to contribute additional funds into their pension plans (subject to a maximum limitation) and assign the contribution to the prior tax year for tax purposes to accelerate the deduction. Taxpayers should consult with their advisors to ensure the entire contribution they plan to make does not exceed the plan’s eligible deductible contributions.
Conformity election – Large banks (total assets over $500M) are eligible to make an automatic change of accounting method to exclude nonaccrual loan interest from taxable income, conforming with the book treatment of this interest. This has the effect of deferring income, so banks not already using the conformity election may want to discuss the implications of this with their tax advisors.
Installment sales – By structuring the sale of an asset to receive payments in future tax years, it may be possible to defer gains into lower tax rate years. Note however that some assets may not be eligible for installment sale treatment or may be subject to recapture which may reduce the amount of gain that can be deferred; therefore it would be advisable to consult with your tax advisor concerning the possible tax benefits of an installment sale.
Vehicle Trade-Ins – If your business regularly trades in vehicles for newer models it likely has large deferred losses built up because of the limited tax deduction for passenger vehicles. Consider selling the vehicle to the dealer and then purchasing the new vehicle in a separate transaction to recognize the loss accumulated from previous trade-ins.
Fixed Assets & Repairs – Many banks have historically chosen not to utilize cost segregation studies because of low borrowing costs and the lack of a financial statement benefit. However, by performing studies before the lower rates are enacted, permanent financial statement benefits can be achieved because a deferred tax liability is created in a year with a higher tax rate and then reduced when the lower rates are enacted. Studies do not have to be confined to newly constructed buildings – it may be possible for recently acquired properties or existing facilities to also provide additional tax deductions through a change of accounting method.
I encourage banks to talk to their tax advisors today - some of the changes discussed require action before year end while others have flexibility for decisions to be made up until the filing of the tax return. You do not want to be caught in a situation where you no longer have time on your side to take advantage of these permanent savings on temporary items, some of which reverse as quickly as the next tax year.
(In a previous article we discussed the impact of lower tax rates on deferred taxes; while the rate used in the example may be different from the ultimate rate, the basic principles are still applicable.)
If you would like to discuss these matters further, contact Tabitha Lamontagne or your BNN advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.