By: David McGuire—
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 dropped to 20 percent, with the latest reports signaling a corporate rate of 21 percent in the reconciled bill.
Pass-through rates will also drop, but the decrease will likely not be as dramatic. Recent news accounts indicate a top marginal tax rate of 37 percent with a deduction on pass-through income of 20 percent.
Regardless of the final figures, if a bill is passed, most tax rates for businesses will be significantly lower in the near future. The more important question is what to do now to best maximize the benefit.
The answer: accelerate deductions.
Given a lower rate in the future, businesses should look at ways to accelerate deductions into 2017 to take full advantage of the potential rate drop. For example, if a business were to accelerate $1 million of deductions into 2017, the permanent tax savings would be $10,000 for every percentage point decrease in the new tax rate.
The next step is figuring out how to accelerate deductions, which is a complicated process.
Business owners and executives should first conduct a thorough review of depreciation schedules. Consider a cost segregation and deprecation analysis, which can be done retroactively. The Internal Revenue Service allows for a “catch-up” adjustment to make up for any missed depreciation.
As an example, if a business placed in service a $10 million building in 2007, that business can complete a cost segregation study and recapture any missed depreciation. If 20 percent of the $10 million could have been classified as 5-year property, the business could realize a “catch-up” adjustment of approximately $1.5 million and take the deduction in 2017.
Businesses 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 business mistakenly claimed assets in a 7-year category that could be classified in a 5-year asset class, a “catch-up” adjustment would accelerate deductions into 2017.
Finally, businesses looking to sell assets have options to consider. Traditionally, a building owner planning to sell quickly will choose against a cost segregation and depreciation analysis to avoid recapture penalties on short-life property. While the recapture penalty will most likely still exist in a final bill, the potential of a future rate drop adds a wrinkle to the process. Even with the penalty, the lower rate may position an accelerated 2017 deduction as the right move, even on a property sold in 2018.
As with many areas of tax law, these analyses present difficult choices and are often very complicated. However, businesses rarely get the opportunity to plan for a rate change this dramatic. Strategic moves now could lead to major benefits in the future.
David McGuire is a leading national expert on cost segregation, fixed assets and depreciation law and co-founder of Indianapolis-based McGuire Sponsel.
As always, contact your own tax advisor of choice for individual recommendations for your business.