With all eyes on tax reform and a final bill that now seems imminent, businesses should begin focusing their attention on 2017 tax returns. With so many sweeping changes ahead, several strategies exist to realize the maximum tax benefit from the current system and its likely evolution.
First, let’s look at what we know.
Under both the House and Senate bills, Corporate tax rates would drop to 20%, and initial reports are that the Corporate rate will be 21% in a reconciled bill. Additionally, pass through rates will drop, but potentially not as dramatically. As of December 13th reports are that there will be a top marginal tax rate of 37% with a deduction on a pass-through income of 20%. There is still a question as to when these changes will be implemented.
If any of these changes are passed it is obvious to most that rates for many businesses will be lower for 2018 (under the Senate Bill Corporate tax rates would not drop until 2019). Knowing this potential rate drop it is key for taxpayers to look at ways to accelerate deductions into 2017 to take advantage of the potential rate drop. A taxpayer that can accelerate $1,000,000 of deductions into 2017 can realize a permanent tax savings of $10,000 for every 1% rate drop.
The question remains, how does a taxpayer take advantage of this change. Taxpayers should be looking at their depreciation schedules closely. Cost segregation or depreciation analysis can be done on a retroactive basis and the IRS allows for a “catch up” adjustment to make up for any missed depreciation. For example, a taxpayer that placed in service a $10 million building in 2007 can complete a cost segregation study and recapture any missed depreciation. If 20% of the $10 million could have been classified as 5-year property, the taxpayer could realize a 481(a) or “catch up” adjustment of approximately $1.5 million. Obviously, there is a benefit for taking this on a 2017 tax return prior to any changes to the tax code.
Taxpayers with significant equipment should also do a thorough review of associated asset life. Typically the difference between a 5-year equipment life and a 7-year equipment life is nominal. However, if a taxpayer has mistakenly claimed assets in a 7-year category that could be in a 5-year asset class, a catch-up adjustment could be filed accelerating deductions into 2017. While this would typically lead to minimal net present value savings the difference in rates could make this more significant.
Finally, even taxpayers looking to sell their assets have options to consider. Typically a taxpayer that has a building that they plan on selling relatively quickly will not want to complete cost segregation due to recapture penalties on some of the short life property (1245 recapture). While this recapture penalty will most likely still exist in a final bill, the potential of a rate drop may make accelerating deductions into 2017 valuable even on a property that may be sold in 2018.
As with many areas of tax law these analyses can be complicated. However, rarely do taxpayers get a chance to plan for a rate change such as this. It is critical that taxpayers, and tax providers, look at these issues for 2017. Strategic moves now could lead to major benefits in the future. Additionally due to the dollars involved hiring a specialist that understands these areas is crucial.
Please contact your McGuire Sponsel representative if you have any questions about this topic.