In today's evolving U.S. and global tax environment, the tax implications of business decisions are not always intuitive. Integrating tax considerations throughout the decision-making process can help businesses unlock potential tax savings and efficiencies as well as identify and mitigate tax risks. Whether shifting supply chains, pursuing mergers and acquisitions, implementing sustainability initiatives, or adjusting workforce strategy — embracing a total tax mindset while modeling the tax impact of these decisions can lead to better outcomes that add value to your organization.
Strategic long-term tax planning remains vital for businesses aiming to reduce their overall tax liabilities and optimize cash flow. With 2024 being an election year and with some of the changes enacted under the Tax Cuts and Jobs Act scheduled to expire at the end of 2025, keeping up with tax developments is critical to maintaining an effective, comprehensive tax strategy. The 2024 Year-End Tax Planning Guide identifies key tax strategies and other tax developments businesses should consider as they close out the year and revisit tax planning strategies for 2024 and beyond.
Unless otherwise noted, the information contained in this guide is based on enacted tax laws and policies as of the publication date and is subject to change based on future legislative or tax policy changes.
Corporations and pass-through entities may have opportunities to effectively improve their federal income tax positions and, in turn, enhance their cash tax savings by strategically adopting or changing tax accounting methods. Companies that want to reduce their current year tax liability (or create or increase a current year net operating loss (NOL)) should consider accounting method changes that accelerate deductions and defer income recognition. On the other hand, for various reasons (for example, to utilize an NOL), companies may choose to undertake accounting methods planning to accelerate income recognition and defer deductions. Importantly, when undertaking any future tax planning, companies should also keep in mind current tax proposals as well as changes that could result based on the outcomes of the 2024 presidential and congressional elections.
The rules covering the ability to use or change certain accounting methods are often complex, and the procedure for changing a particular method depends on the mechanism for receiving IRS consent — i.e., whether the change is automatic or non-automatic. Many method changes require an application to be filed with the IRS prior to the end of the tax year for which the change is requested.
The following are some of the many important issues and developments for companies to consider when reviewing their tax accounting methods in 2024:
- December 31 Deadline for Non-automatic Method Changes
- Tax Rules for Calculating Percentage of Completion Revenue
- Year-end Opportunities to Accelerate Common Deductions and Losses
December 31 Deadline For Non-Automatic Method Changes
Although the IRS allows many types of accounting method changes to be made using the automatic change procedures, some common method changes must still be filed under the non-automatic change procedures. A calendar year-end taxpayer that has identified a non-automatic accounting method change that it needs or desires to make effective for the 2024 tax year must file the application on Form 3115 during 2024 (i.e., the year of change).
Notably, Rev. Proc. 2024-23, released on April 30, 2024, removed from the IRS list of permissible automatic method changes any change made to comply with the Section 451 all-events test applicable for accrual method taxpayers. Effective for Forms 3115 filed on or after April 30, 2024, for a year of change ending on or after September 30, 2023, this method change may only be made using the non-automatic change procedures.
Among the other method changes that must be filed under the non-automatic change procedures are many changes to correct an impermissible method of recognizing liabilities under an accrual method (for example, using a reserve-type accrual), deferred compensation accruals, and long-term contract changes under Section 460. Additionally, taxpayers that do not qualify to use the automatic change procedures because they have made a change with respect to the same item within the past five tax years will need to file under the non-automatic change procedures to request their method change.
Planning Considerations
Generally, more information needs to be provided on Form 3115 for a nonautomatic accounting method change, and the complexity of the issue and the
taxpayer’s facts may increase the time needed to gather data and prepare the
application. Therefore, taxpayers that wish to file non-automatic accounting
method changes effective for 2024 should begin gathering the necessary
information and prepare the application as soon as possible.
Tax Rules For Calculating Percentage Of Completion Revenue
The percentage of completion method (PCM) for long-term contracts, governed by Section 460 of the Internal Revenue Code, is often misapplied by taxpayers as a method of tax accounting. Taxpayers with qualifying construction or manufacturing contracts frequently follow their book methodologies with minimal, if any, adjustments for tax purposes; however, the rules governing PCM under Section 460 differ significantly from those governing over-time recognition under GAAP. Further, PCM method changes are typically non-automatic; thus, calendar-year taxpayers seeking to change their method for long-term contracts must file a Form 3115 by December 31, 2024, in order to implement the change for their 2024 tax year.
Defining Long-term Contracts — Eligibility for PCM
Qualification as a PCM-eligible long-term contract is determined on a contract-by-contract basis and has two broad requirements: (i) the contract must be for a qualifying activity (either construction or manufacturing), and (ii) the contract must qualify as long-term.
Construction is considered a qualifying activity if one of the following must occur to satisfy the taxpayer’s contractual obligations:
- The building, construction, reconstruction, or rehabilitation of real property (i.e., land, buildings, and inherently permanent structures as defined in Treas. Reg. §1.263A-8(c)(3))
- The installation of an integral component to real property (property not produced at the site of the real property but intended to be permanently affixed to the real property)
- The improvement of real property
To be considered long-term under the PCM rules, a contract must begin and end in two different taxable years. Therefore, in theory, even a two-day contract from December 31 to January 1 could qualify as a long-term contract.
PCM Calculation
For tax purposes, the taxpayer’s inception-to-date contract revenue corresponds to the ratio of inception-to-date contract costs incurred to total estimated contract costs. With respect to expense recognition, Section 460 mandates the accrual method for contract costs, such that deduction generally occurs in the same year the costs are taken into account in the PCM ratio’s numerator. As previously noted, the tax rules governing PCM likely deviate from the book treatment of income/ expenses in several aspects. For instance, under Section 460, taxpayers must follow how to determine the types and amounts of costs that are considered in the project completion rule. Further, there are specific rules pertaining to the treatment of pre-contracting costs (e.g., bidding and proposal costs), as well as look-back rules, which require a taxpayer, after the completion of a long-term contract, to perform a hypothetical recalculation of its prior years’ income using the actual total contract price and actual total contract costs, rather than the estimated total contract price and estimated total contract costs used for its prior year returns.
Year-End Opportunities To Accelerate Common Deductions and Losses
Heading into year-end tax planning season, companies may be able to take some relatively easy steps to accelerate certain deductions into 2024 or, if more advantageous, defer certain deductions to one or more later years. The key reminder for all of the following year-end “clean-up” items is that the taxpayer must make the necessary revisions or take the necessary actions before the end of the 2024 taxable year. (Unless otherwise indicated, the following items discuss planning relevant to an accrual basis taxpayer.)
Deduction of Accrued Bonuses
In most circumstances, a taxpayer will want to deduct bonuses in the year they are earned (the service year), rather than the year the amounts are paid to the recipient employees. To accomplish this, taxpayers may wish to:
- Review bonus plans before year end and consider changing the terms to eliminate any contingencies that can cause the bonus liability not to meet the Section 461 “all events test” as of the last day of the taxable year. Taxpayers may be able to implement strategies that allow for an accelerated deduction for tax purposes while retaining the employment requirement on the bonus payment date. These may include using (i) a “bonus pool” with a mechanism for reallocating forfeited bonuses back into the pool; or (ii) a “minimum bonus” strategy that allows some flexibility for the employer to retain a specified amount of forfeited bonuses.
It is important that the bonus pool amount is fixed through a binding corporate action (e.g., board resolution) taken prior to year end that specifies the pool amount, or through a formula that is fixed before the end of the tax year, taking into account financial data as of the end of the tax year. A change in the bonus plan would be considered a change in underlying facts, which would allow the taxpayer to prospectively adopt a new method of accounting without filing a Form 3115. - Schedule bonus payments to recipients to be made no later than 2.5 months after the tax year end to meet the requirements of Section 404 for deduction in the service year.
Deductions of Prepaid Expenses
For federal income tax purposes, companies may have an opportunity to take a current deduction for some of the expenses they prepay, rather than capitalizing and amortizing the amounts over the term of the underlying agreement or taking a deduction at the time services are rendered. Under the so-called “12-month rule,” taxpayers can deduct prepaid expenses in the year the amounts are paid (rather than having to capitalize and amortize the amounts over a future period) if the right/benefit associated with the prepayment does not extend beyond the earlier of i) 12 months after the first date on which the taxpayer realizes the right/benefit, or ii) the end of the taxable year following the year of payment. Note that accrual method taxpayers must first have an incurred liability under Section 461 in order to accelerate a prepayment under the 12-month rule.
The rule provides some valuable options for accelerated deduction of prepaids for accrual basis companies — for example, insurance, taxes, government licensing fees, software maintenance contracts, and warranty-type service contracts. Identifying prepaids eligible for accelerated deduction under the tax rules can prove a worthwhile exercise by helping companies strategize whether to make prepayments before year end, which may require a change in accounting method for the eligible prepaids.
These are a few tax planning tips. Click here to see the entire planning guide.
For more information about the above article or other business tax services, contact Lesley L. Price, CPA, by calling (334) 887-7022 or by leaving us a message below.
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