How the Right Tax Accounting Methods Can Help Taxpayers Save Cash

Welcome to the latest issue of Talking Tax, where each month I explore a major trend or topic in corporate taxation and offer insights on its implications for taxpayers. Be sure to subscribe so you’ll receive Talking Tax directly in your inbox.

U.S. businesses are struggling with inflation, ongoing supply chain issues and rising interest rates. Recession fears are high, and businesses are doing what they can to save cash and cut costs ahead of an economic downturn. The tax department can play a key role in making their business resilient in the face of a possible recession using accounting methods planning. In this month’s issue, we’ll explore how to build the right tax accounting methods strategy to help your business conserve cash, as interest rates rise and the prospect of a recession looms. Insights from this month’s issue were contributed by Peter Pentland , Accounting Methods National Practice Co-Leader at BDO USA.

Have a question about your business’s tax strategy? Get in touch with me at?[email protected] .

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Types of tax accounting methods to consider

Income tax accounting methods allow taxpayers to time the recognition of items of income and expense, which determines when tax liabilities become due. Accounting methods do not alter the total amount of income or expense that is recognized but allow taxpayers to accelerate or defer items of income or deductible expense.

Some of the more common accounting methods to consider center around the following:

• Advance payments.?Taxpayers may be able to defer recognizing advance payments as taxable income for one year (longer in certain instances involving custom manufacturing).
• Prepaid and accrued expenses. Some prepaid expenses can be deducted when paid instead of being capitalized. Some accrued expenses that are tied to payment can be deducted in the year of accrual if they are paid within a certain period after year-end.
• Costs incurred to acquire or build certain tangible property.?Qualifying costs may be deducted in full in the current year instead of being capitalized and amortized over an extended period. Absent an extension, under current law, the 100% deduction is scheduled to decrease by 20% per year beginning in 2023.?
• Inventory capitalization. Taxpayers can optimize uniform capitalization methods for direct and indirect costs of inventory, including using simplified and non-simplified methods and making certain elections to reduce administrative burden.
• Inventory valuation.?Taxpayers can optimize inventory valuation methods. For example, adopting to (or making changes within) the last-in, first-out (LIFO) method of valuing inventory generally will result in higher cost of goods sold deductions, as costs are increasing.
• Structured lease arrangements.?For taxpayers with certain lease arrangements, such as a lease arrangement structured with deferred or advance rents, there are options to maximize tax cash flow.

Optimizing tax accounting methods can help businesses gain access to cash to make investments in property, people and technology. And many of these investments can in turn benefit from further accounting methods planning – such as accelerating deductions of investments in property via bonus depreciation where applicable. Revisiting your tax accounting methods now could free up cash for a period of years, helping to stabilize your business during a high inflationary economy.

How to select the optimal tax accounting method?

To select the optimal accounting method, start by measuring the potential impact. Multiplying the deferred or accelerated amount of income or expenses by the marginal tax rate of the business or its investors will help determine which tax accounting methods are best for your business. See below for an example of how a business can defer payments in successive years. In this example, assume a business is subject to a 30% marginal tax rate and receives $10 million of advance payments per year. Also assume the business qualifies and elects for tax purposes to defer recognition of the advance payments for one year, instead of paying tax on the advance payments in the year received.

2021 Tax Year

Advance payments received in 2021 but deferred to 2022 for tax purposes?????????? $10 million Resulting tax deferred to 2022 ($10 million * 30%)????????????????????????????????????????????????$ 3 million

2022 Tax Year

Advance payments received in 2022 but deferred to 2023 for tax purposes??????????$10 million Resulting tax deferred to 2023 ($10 million * 30%)???????????????????????????????????????????????$ 3 million Payment in 2022 of tax deferred from 2021????????????????????????????????????????????????????????????$ 3 million

Although the $3 million of tax deferred in 2021 becomes payable in 2022, the business can defer another $3 million of tax in 2022 related to its 2022 advance payments. Continuing this pattern of deferral from one year to the next would preserve cash and potentially generate savings due to the time value of money. By preserving cash, the business could forgo interest expense on debt by not borrowing or by paying down debt using the freed-up cash. As interest rates rise, this opportunity becomes more valuable.

Engaging in discussions now is key to successful planning for the current taxable year and beyond. Start the planning process by reviewing your existing accounting methods. By planning in advance, taxpayers can ensure a holistic roadmap is in place to deploy accounting methods for cash savings.

BDO’s Accounting Methods specialists help businesses identify and implement accounting methods strategies and opportunities. Learn more .?