United States: Tax Planning For Tax Reform: What You Should Be Doing Now

Republican control of both the White House and Congress has created a historic opportunity for sweeping tax reform. Republican lawmakers are proposing structural changes to the tax code that would have a dramatic impact on all businesses.

Although there are many steps left in the legislative process, businesses don't have time to wait and see what happens.

Your planning should begin now for several reasons:

  • Immediate opportunities: Many planning opportunities will only be relevant if implemented before tax reform is effective. You don't want to miss potential permanent tax savings from things like accelerating deductions or repatriating income early.
  • Long-term business decisions: No company should be making a long-term business decision without understanding the potential future impact of tax reform. The inability to deduct interest or the cost of imports could drastically change the economics of many current strategic business decisions.
  • New tax planning: Sweeping legislative changes would force companies to rethink every aspect of their current tax planning strategy. Long-standing supply chain processes, financing arrangements, transfer pricing agreements, capital structures, and legal entity status can't be changed overnight. Planning should start now even if changes wouldn't be implemented until after reform is effective.
  • Financial statements: It's past time to begin assessing the potential financial statement impact of the proposed changes. Tax reform may pose significant risks, like devaluation of deferred tax assets, potential liability on unremitted foreign earnings, and even whether certain taxes still fit the definition of income tax under generally accepted accounting principles. Companies identifying risks should already be considering whether the risk merits discussion in the Management Discussion and Analysis (MD&A).

The changes being proposed

Your planning should start with an understanding of what is being proposed, and how it would affect your company. House Republicans have released a blueprint for a tax reform that would shift the U.S. tax system toward a destination-based, border-adjustable cash-flow tax that mimics the economic impact of a consumption tax in many ways. The Trump administration has released an outline for tax reform with its own sweeping proposals.

Republicans are working on combining these proposals, which should be considered the starting point for tax reform. Many of the proposed changes would have a profound impact on business taxation, including:

Cutting the top corporate rate from 35% to 20% (House blueprint) or 15% (Administration plan) and creating a lower rate for certain pass-through income

  • Eliminating most credits and special deductions
  • Allowing immediate expensing of business property
  • Ending deductions for net interest expense (with certain exceptions)
  • Disallowing deductions for imports and excluding export revenue from taxable income
  • Enacting a territorial regime exempting most foreign source income from U.S. corporate tax
  • Imposing a one-time tax at reduced rate on previously unrepatriated earnings

Your first step should be modeling the impact of the proposed changes, which will allow you to identify and plan for actions needed before and after reform is effective. You will also be able to gauge tax reform's potential impact on current business decisions and the risk to your financial statements.

Acting early

Some of the most effective planning opportunities created by tax reform will require action before reform is actually effective. The potential for a significant rate cut in a future year means deferring income and accelerating deductions may be even more powerful than usual.

You will want to use deductions against today's higher rates and recognize income when rates are potentially lower. Consider how much value your deductions and tax attributes could lose against a rate of just 20%. Many companies are reluctant to pursue timing changes if the change doesn't provide a financial statement benefit. But acting before a rate cut can turn timing plays into permanent benefits. In a few instances, such as with foreign earnings, acting now can mean paying tax currently to save in the future. Key opportunities include:

Accounting methods review – Businesses employ dozens of separate accounting methods on everything from inventory and rebates, to software development and advanced payments. Identifying a method that accelerates deductions or defers income often results in a favorable adjustment that can be recognized fully in the year the change is made.

Fixed assets and repairs – Building assets represent a very large expense for most businesses, and not all costs associated with these assets must be capitalized and depreciated over a 39-year schedule. Many building assets can be reclassified and depreciated using shorter lives, while other costs may qualify for immediate deduction as repairs or maintenance.

Compensation and benefits – Making minor changes to bonus pools, other compensation arrangements, and even benefit plans may present opportunities to accelerate deductions against today's higher rates.

Repatriating foreign earnings – Any company with offshore earnings should assess whether it would pay less in tax if earnings are repatriated before tax reform and foreign tax credit are available or after when the rate may be reduced. You may not want to act until you know whether tax reform will actually be enacted and how the one-time tax will apply, but you should be preparing to support the amount and location of unrepatriated earnings so you can make an informed decision.

Your business should carefully consider its entire tax and financial situation before making major decisions. It's possible that rate cuts are made effective early, or don't happen at all. The good news is that deferring tax is typically a good strategy, if only for the cash flow benefits and the time value of money. The value of other planning strategies, such as repatriating earnings early, will be heavily dependent on the outcome of tax reform. Either way, your business may need to take action before the effective date of tax reform.

Assessing risk

Even if you don't make any actual tax planning moves before tax reform is effective, it's critical to understand the impact tax reform would have on current business decisions with long-term economic affects. Key questions include:

  • Does it make sense to postpone large capital projects until full expensing is available through tax reform?
  • How would the loss of the interest deduction affect financing plans, particularly with assets that wouldn't benefit from full expensing, such as land, stock acquisitions, or assets placed in service before tax reform is effective?
  • Has due diligence been performed on how changes like the loss of import or interest deductions would affect acquisitions or investments in business lines?
  • Will long-term global contracts or service agreements still make economic sense if reform is enacted?

Planning for the new tomorrow

The biggest tax planning shifts may be made after tax reform is actually effective. But such wholesale changes in tax structuring need to be considered well in advance of enactment. Key considerations include the following:

  • Entity choice Global supply chain
  • Target markets Debt versus equity financing
  • Intellectual property development and jurisdiction
  • Cost-sharing and transfer-pricing arrangements International capital structure
  • Cross-border debt placement
  • Treasury and cash management activities

Assessing financial statement impact

The type of fundamental tax reform lawmakers are discussing raises several important financial statement issues. The principles of ASC 740, Accounting for Income Taxes, apply to "taxes based on income." Proposals meant to shift to a destination-based cash-flow tax raises the question of whether they should be accounted for under ASC 740 or considered a non-income based tax. Many other proposed changes, like full expensing may create or change existing temporary differences between tax and financial statement accounting.

If tax reform is ultimately enacted, the impact must be recorded in the financial statements in the period of enactment, regardless of the effective date. Deferred tax assets and liabilities must be measured at the enacted tax rate expected to apply when temporary differences are settled or realized, meaning that companies may encounter increased complexity if rule and rate changes phase in over several years.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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