The tumultuous 2020 tax year, combined with expected tax increases in the future, make 2021 a key year for tax planning. Ryan Vaughan and Andrew Kosoy of Mazars outline common accounting methods and considerations for business taxpayers regarding such methods.
As businesses wrap up their 2020 tax returns and compliance, it’s never too early to begin tax planning for 2021. Taxpayers can be incentivized in several ways to evaluate and change accounting methods. With most changes, taxpayers receive audit protection such that the IRS could not challenge prior years on an impermissible method and could not impose interest and penalties for treating an item incorrectly.
Taxpayers can also benefit from current-year adjustments that would reduce taxable income, and accounting methods provide an opportunity for tax planning around optimal methods for revenue and expense recognition.
A notable item to consider for 2021 tax planning—the likelihood of tax rates increasing. Since accounting methods are simply the timing of when to recognize revenue or an expense into taxable income, they are considered a timing, or temporary, item. There are numerous accounting methods and planning items that can shift the recognition of revenue or an expense into an alternate taxable year.
Although, if the recognition only moves from one year to the next, many taxpayers may not want the administrative burden of maintaining separate wallpapers for book and tax for a specific item when the timing does not result in a significant benefit.
However, when tax rates change, there is an opportunity for quasi-permanent tax savings to recognize an expense in a higher tax rate year or to recognize revenue in a lower tax rate year. Check out the examples below, which demonstrate how a $1,000 deduction for a prepaid expense is not equal when tax rates change