Accounting Methods Year-End Planning
Businesses contemplating year-end tax planning should consider accounting methods planning to help achieve their business objectives. Specifically, accounting methods actions can help mitigate tax compliance risks and reduce taxable income, potentially resulting in cash tax savings.
Action Items Prior to Tax Year-End
Advance Consent Accounting Method Changes
Consider the need for non-automatic method changes, i.e., method changes that require pre-approval from the IRS. Such changes must be filed during the tax year for which the change is requested, i.e., must be filed by the last day of the tax year of the change.
Fix Accrued Liabilities
Explore and evaluate opportunities to fix the fact and amount of liabilities, such as accrued bonuses. Actions required to fix or establish a liability are often internal company/organizational policy changes that may require action prior to year-end. By fixing accruals, businesses may claim a tax deduction that otherwise may have been deferred.
Overall Cash Method of Accounting for Businesses – Cash Flow Management
Businesses currently using an accrual method that is qualified, i.e., eligible to adopt the cash method (or vice versa), should model the impact of a change in the overall accounting method to explore taxable income advantages that may be achieved. Businesses using the cash method should consider the timing of cash collections and expenditures relative to the end of the year.
Additional Year-End Planning Considerations
Defer Revenue
Accounting methods are available for accrual basis businesses that will defer the timing of revenue recognition. Contact us to help identify opportunities for adopting these methods.
Accelerate Deductions
Go over accrued liabilities to help identify accelerated deduction opportunities, such as the recurring item exception and other exceptions that allow for the acceleration of deductions for accrued and prepaid expenses.
Capital Expenditure Planning
Look over capital spending projects to help identify assets ready and available to be placed into service and claim accelerated depreciation, including bonus depreciation if eligible.
For additional discussion of these items and how they can impact your business, please contact one of our accounting method professionals at Forvis Mazars.
Updates to Form 6765
Introduction
In June 2024, the IRS released a revised draft Form 6765, Credit for Increasing Research Activities (research and development (R&D) tax credit), including changes to Form 6765, which is applicable for tax years 2024 and beyond.
Summary of Form 6765 Changes
Beginning with tax year 2024, a new Section E, “Other Information,” requires all taxpayers to report additional disclosures, including:
- The number of business components (projects) generating claimed qualified research expenses (QREs);
- The amount of officers’ wages included in QREs;
- Whether there were any acquisitions or dispositions in the tax year;
- Whether any new categories or expenditures were claimed; and
- Whether Accounting Standards Codification (ASC) 730 guidance was used in computing QREs.
The new Section G, the “Business Component Information” reporting section, is optional for taxpayers for tax year 2024. Section G requires extensive information to be reported on Form 6765. Taxpayers will be required to report the following on business components for 80% of the total QREs, but not more than 50 business components:
- Qualitative information:
- Business component name and type;
- Software identifier (not yet defined); and
- Information sought to be discovered.
- Quantitative information:
- QREs by direct research, direct supervision, or support; and
- Qualified costs by cost type and business component.
While the changes will be applicable for tax years 2024 and beyond, Section G will be optional for taxpayers who claim the research credit on an original filed return and:
- Meet the definition of a qualified small business (QSB) (see draft form) and (2) claim a reduced payroll tax credit; or
- Taxpayers with less than $1.5 million in QREs and less than $50 million of gross receipts.
Action Item Recommendations
Begin preparing for future R&D tax credit claims by capturing the information needed to complete the draft Form 6765. Prudent action items for taxpayers can include the following:
- Maintain a detailed project list throughout the year and/or adopt a time- and cost-tracking system.
- Begin the R&D analysis earlier to allow time to gather the newly required qualitative information.
- Adopt an R&D methodology in tax year 2024 that complies with newly requested information in Section G to prepare for tax year 2025 requirements.
- Have the R&D credit team at Forvis Mazars in client tax planning conversations for the upcoming year.
If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.
Repairs & Maintenance & Cost Segregation Studies on Renovated Spaces
As a normal course of business, many businesses will renovate their existing spaces to create more appealing, newer, and cleaner facilities for brand consistency, or just simply for aesthetic purposes. Often, these businesses will simply capitalize these expenditures as improvements. What these businesses may overlook, however, are the additional benefits of tax savings that can be reaped through the performance of repair and maintenance (R&M) and cost segregation studies on these renovated spaces.
In 2013, the IRS issued the final tangible property regulations, aka the “Repair Regs.” These regulations sought to clarify the existing rules to determine whether certain costs are currently deductible (written off in the year the expenditure was made) or must be capitalized (depreciated over the class life of the property as defined by the IRS). Even though these regulations were supposed to clarify the definitions, the rules remain very complicated. Further complicating matters is the revised definition of qualified improvement property (QIP), which is no longer limited to certain leased, retail, and restaurant spaces.
With good record-keeping and thoughtful analysis, owners can start to potentially see some tax savings. The Repair Regs included a de minimis safe harbor rule whereby the taxpayer can classify as expenses amounts up to $5,000 per unit, provided the taxpayer has an audited financial statement ($2,500 without one) and written accounting procedures thereon. The de minimis rule is particularly beneficial when the taxpayer purchases large quantities of fixtures, such as computers. The total invoice may be well more than $5,000, but each unit cost—with all indirect costs included—can be well under and, therefore, written off as a currently deductible repair.
After carving out costs that meet the safe harbor rule, the next step is to determine if the remaining expenditures are a betterment, an adaption, or a restoration, aka the “BAR test”; if so, they must be capitalized. These tests must be applied to the unit of property (UOP) to which these expenditures relate. In general, a betterment will correct a material defect that existed prior to placing the UOP in service, create a material addition to the UOP, or create a material increase in strength, capacity, production, efficiency, quality, or output; an adaptation will adapt the UOP to a new or different use; and a restoration will rebuild the UOP to a like-new state or it replaces a part that comprises a major component or a substantial structural part of the UOP. It is important to note that renovations will only be considered a restoration if they replace a significant portion of a component’s UOP or physical structure. Where owners are only replacing a small percentage of the building and/or systems, it is likely that these improvements do not meet the restoration test. The exception will be for all other tangible property and any manufacturing equipment.
Furniture, fixtures, and equipment are considered other tangible personal property; therefore, if the owner is replacing these items, unless they meet the safe harbor rules, these items will need to be capitalized. The good news is these items typically will qualify for a shorter class life and bonus depreciation. Bonus depreciation in 2024 is still significant at 60%. (It phases out by 20% every year until it expires in 2027.) For any other costs that will be required to be capitalized, a cost segregation study will help identify any costs that can be reclassed to a shorter class life, such as special electrical, plumbing, and mechanical systems; QIP; or land improvements that also will qualify for bonus depreciation.
In addition, not only do R&M and cost segregation studies provide undiscovered tax savings that can help a business retain cash in the year the expenditures are made, but they also can be performed on a look-back basis to provide catch-up benefits in the current tax year for past expenditures. They can be an effective way to obtain non-cash deductions to help offset expected or unexpected income.
If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.
The Rise in Aircraft Audits & How to Prepare
On February 21, 2024, the IRS announced a new examination campaign focused on business aircraft. IRS Commissioner Danny Werfel stated, “These aircraft audits will help ensure high-income groups aren’t flying under the radar with their tax responsibilities.” Proper reporting and structuring of private aviation involve complex rules that connect with multiple agencies focused on safety and taxation. The taxes involved include federal income, payroll, excise and state/local sales, use, and property. Businesses utilizing private aviation in any form should familiarize themselves with the reporting and record-keeping rules to prepare for an examination.
Internal Revenue Code (IRC) Section 274 outlines the pertinent substantiation requirements. Taxpayers must maintain adequate records and/or provide sufficient evidence to support the amount of expenses incurred, the time and place of travel, and the business purpose of the flight.1 Upon exam, businesses will be required to provide this information. The IRS will request flight logs containing the flight date, departure and arrival locations, flight time, passenger count, and names for each leg of every flight flown during the tax year. These logs will be a starting point for the IRS’ review, but the logs alone will not be enough.
The IRS will request a list of passengers who are 5% owners of the company or related entities, control employees, and specified individuals. Any passenger with a familial relationship to these categories must be identified. A description of the flight purpose will be required, with additional documentation requested to support the business purpose for these flights. The company will be expected to provide general ledger details for flight expenses, information concerning the aircraft, and legal documents such as leases, charter agreements, and management contracts, as well as aircraft use policies and meeting minutes describing the business need for the aircraft.
Companies deducting expenses related to private aviation should consider acting in a timely manner to execute policies to capture flight activity and document flight purposes. This information is critical for accurate reporting on the business’ tax return(s) and can help prepare the company for a favorable result upon examination.
If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.
Taking Advantage of Energy Credits in the IRA
The Inflation Reduction Act (IRA) offers several benefits to businesses (including nonprofits) in the form of tax credits and incentives for investing in renewable energy, such as solar panels, geothermal heating systems, energy storage, and other clean energy projects. Some credits only require investment in qualified energy property to be eligible, while others must be applied for before the energy property is placed in service. One significant change in the IRA is the ability for nonprofit organizations and governmental agencies to claim these tax credits and elect direct payment or refund of the credits. Many credits also allow for-profit taxpayers to transfer or sell tax credits if they cannot utilize them.
Key Investments to Consider in Year-End Planning
Investment Tax Credit (ITC)
Businesses can claim a tax credit for installing renewable energy technologies, e.g., solar panels, wind turbines, energy storage, etc. While the base ITC is 6% of the basis of the energy property, the credit percentage can increase to 30% if the project’s maximum output is less than one megawatt, construction begins prior to January 29, 2023, or it meets the prevailing wage and apprenticeship requirements. There also are additional bonus credits to consider, such as whether the project is located within an energy community or low-income community (applicable to solar and wind projects only) or if it meets the domestic content requirements. While an energy project is generally unlikely to meet all bonus credit criteria, the ITC can be as high as 500% for most energy projects (60% for solar projects and 70% for wind projects) if all bonus credits are met.
Electric Vehicle-Related Credits
Businesses can claim a tax credit for investing in electric or hybrid vehicles for commercial use through the commercial clean vehicles credit (Internal Revenue Code (IRC) Section 45W). This credit provides up to $7,500 for light-duty electric vehicles and up to $40,000 for heavier electric vehicles, and there is no limit to the number of vehicles the business can claim. For businesses in low-income communities or non-urban areas, the IRA also provides a tax credit for alternative fuel charging stations (IRC §30C), limited to a maximum $100,000 credit per item of qualified property.
Energy Efficiency Deduction
The IRA significantly expanded the energy-efficient commercial buildings property deduction under §179D, increasing the base deduction to $0.50 per square foot, with a maximum deduction of $5 per square foot if the “five-times” bonus credit requirements and certain energy efficiency requirements are met.
Production Tax Credit (PTC)
IRC §45 provides a tax credit for electricity produced from renewable sources. The credit, which can be claimed during a 10-year period, is based on the amount of electricity produced and sold to an unrelated party, multiplied by a set monetary amount. For 2024, the credit ranges from 0.3 cents per kilowatt hour to 3 cents per kilowatt hour depending on what type of energy property is producing the electricity and if the same requirements for qualifying for the five-times multiplier that apply for the ITC are met.
IRA incentives can help businesses improve their return on investment in renewable energy projects while also lowering energy costs and reducing emissions. When tax planning conversations take place for 2024, it’s also important to discuss future potential IRA credit eligible projects to make sure any application-based bonus credits are timely filed. If you have any IRA energy credit questions or need assistance, please reach out to a professional at Forvis Mazars.
Significant Changes to State Income Tax Filings on the Horizon
Public Law 86-272 (P.L. 86-272)2 is seminal in state income tax and protects sellers of tangible personal property (TPP) from a state income tax filing requirement if their only activity in a jurisdiction is solicitation of orders. Now, certain states are reinterpreting P.L. 86-272’s protections to exclude common activities conducted on a company’s webpage.
In 1959, Congress enacted P.L. 86-272, which limits states’ ability to tax out-of-state persons. P.L. 86-272 generally provides that a state cannot impose a net income tax on a person that limits in-state activity to the solicitation of orders for sales of TPP, provided the order is approved and fulfilled by shipment from outside the state. Through numerous court rulings and interpretations, states, taxpayers, and intergovernmental groups such as the Multistate Tax Commission (MTC) generally agree upon a list of protected and unprotected activities. Activities protected from triggering a state income tax filing requirement include, but are not limited to, carrying samples and promotional material, coordinating shipment, checking (but not replacing) inventory, owning cars for sales representatives, and the presence of home offices of sales representatives. Activities not protected from triggering a state income tax filing requirement include, but are not limited to, making repairs to property sold, installations, in-person technical assistance, approving or accepting orders in-state, and consigning inventory.3 Importantly, P.L. 86-272 only protects sellers of TPP and does not apply to service providers.
In 2021, the MTC released an updated Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272 (the Updated Statement).4 In addition to enumerating generally the same protected and unprotected activities set forth in previously issued MTC PL 86-272 Statements, the Updated Statement includes a third section entitled “Activities Conducted via the Internet.”5 This new section includes the following as examples of activities that are not protected by P.L. 86-272:
- The business regularly provides post-sale assistance to in-state customers via either electronic chat or email that customers initiate by clicking on an icon on the business’s website.
- The business solicits and receives online applications for its branded credit card via the business’s website.
- The business’s website invites viewers in a customer’s state to apply for non-sales positions with the business.
- The business places internet “cookies” onto the computers or other electronic devices of in-state customers that are used for non-sales activities.
- The business offers and sells extended warranty plans via its website to in-state customers who purchase the business’s products.6
As of this article’s publication date, a handful of states have formally or informally adopted the MTC’s Updated Statement, including California, New Jersey, New York, and Ohio. In addition, Minnesota and Oregon considered its adoption, but have not to date. California’s initial guidance was struck down in court on procedural grounds.7 However, California, along with Ohio and other states, is applying provisions from the Updated Guidance retroactively under audit. New Jersey applied its guidance prospectively via a tax bulletin and included additional unprotected activities related to cryptocurrency activity.8 As of the writing of this article, New Jersey’s guidance is unchallenged in court. New York State issued guidance via regulations that are currently being challenged on both procedural and substantive grounds.9 Such a challenge may produce a landmark U.S. Supreme Court case or force congressional action.
On April 16, 2024, U.S. Rep. Scott Fitzgerald (R-WI) introduced H.R. 8021, which defines solicitation of orders for the purposes of P.L. 86-272 to mean “any business activity that facilitates the solicitation of orders even if that activity may also serve some independently valuable business function apart from solicitation.”10 The bill is currently before the House Judiciary Committee. Ultimately, the fate of P.L. 86-272 and the Updated Guidance will likely remain uncertain heading in to 2025.
Absent intervention by the courts or federal legislation, more states are likely to adopt language provided by the Updated Guidance in 2025 and thereafter. Sellers of tangible personal property must remain abreast of these developments. If your business is concerned about the MTC’s Updated Statement and how it may affect your state income tax filing footprint, Forvis Mazars can help. Our team of state and local tax professionals are monitoring developments nationwide as they relate to P.L. 86-272 and can assist your business in helping mitigate the risks that may arise from reinterpretations of this long-standing state income tax law.
California Microsoft Case Overturned After OTA Fails to Defer to FTB
On July 27, 2023, the California Office of Tax Appeals ruled in favor of Microsoft for a refund of approximately $94 million based on the inclusion of approximately $109 billion of qualifying dividends in the sales factor denominator.11 The main issue on appeal was whether qualifying dividends deducted from income should be included or excluded from the sales factor.12 Microsoft argued that dividends from its foreign affiliate should be included in the sales factor denominator as gross receipts while being deducted from its taxable income.13 The Franchise Tax Board (FTB) argued that 75% of the dividends (based on the dividends received deduction on the tax base) should be excluded from the sales factor.14
To support its position, the FTB argued that the qualifying dividend deduction should be treated like eliminated intercompany dividends, which are not included in the sales factor.15 However, the Office of Tax Appeals (OTA) distinguished deducted dividends from eliminated dividends and noted that eliminated dividends are expressly excluded from the sales factor by statute and regulation.16 The OTA looked to the plain language of the statute to determine that qualified dividends are not excluded or eliminated from income but are deducted from it.17
The FTB further argued that Revenue and Taxation Code (R&TC) Section 25120(f)(2)(A)-(L) provides a non-exhaustive list of exclusions from gross receipts, including several that are excluded because they do not contribute to the tax base, indicating a “matching principle” should be applied to exclude the deducted dividends. The OTA disagreed, stating that R&TC §25120(f)(2) provides that dividends qualify as gross receipts and there is no applicable exclusion in the plain language of the statute.
The OTA looked to the legislative history of R&TC §25120(f)(2), which the OTA stated was based upon exclusions and exemptions from income rather than deductions. The FTB pointed to its opinion in FTB Legal Ruling 2006-01, in which the FTB stated that a domestic corporation that received dividends from a unitary controlled foreign corporation (CFC) excluded from the water’s-edge group must include in the sales factor denominator only the net dividends after applying the qualifying dividend deduction because the deducted amount relates to an activity excluded from the tax base apportioned by the Uniform Division of Income for Tax Purposes Act (UDITPA).18 Despite acknowledging the FTB’s knowledge on the tax at issue, the OTA refused to defer to the FTB’s interpretation in Ruling 2006-01 and asserted that the FTB was interpreting a statute promulgated by the legislature as opposed to the FTB’s own regulation.19 The OTA ruled that the FTB’s interpretation was inconsistent with the law and the plain language of the statute.20 Accordingly, the OTA determined that the gross receipts from the dividends should not be reduced to account for dividends deducted under the tax base.21
The OTA also denied the FTB’s argument that Microsoft’s receipt of dividends should be treated as an occasional sale of a fixed asset or other property under Regulation §25137(c)(1)(A) because the dividends were not a sale of property.22 In addition, the OTA denied the use of an alternative apportionment methodology, pursuant to R&T §25137, because the FTB failed to prove the inclusion of the dividends in the sales factor denominator was distortive.23 The OTA affirmed its ruling by denying the FTB’s petition for rehearing on February 14, 2024.24
On June 27, 2024, California enacted Senate Bill No. 167 (S.B. 167) to overturn the OTA’s Microsoft decision.25 The bill states it is the California General Assembly’s intent that the FTB’s Legal Ruling 2006-1 shall apply with respect to apportionment factors attributable to the income of taxpayers subject to tax under the Corporation Tax Law. Further, the new law provides that it does not constitute a change in—but is declaratory of—existing law.26 As a result, S.B. 167 also operates retroactively. Lastly, the bill also states that the California Administrative Procedure Act shall not apply to any regulation or other guidance issued by the FTB pursuant to S.B. 167.27
In response to the recently enacted legislation, two lawsuits have been filed in different California superior (trial) courts arguing that the new law is unconstitutional as it violates the due process clause of the U.S. Constitution and the California Constitution.28
Depending on how the pending lawsuits challenging S.B. 167 unfold, there still may be a possibility of refunds for taxpayers receiving foreign dividends who originally had excluded the dividends from their California sales factor. Importantly, on June 28, 2024, a day after S.B. 167 was passed, the U.S. Supreme Court overturned the “Chevron doctrine,” which had required courts to defer to an agency’s interpretation of an ambiguous statute as long as the agency’s interpretation was reasonable.29 Some commentators have suggested that S.B. 167 could be susceptible to challenge under the reasoning of Loper Bright Enterprises v. Raimondo. Further, other states may define sales or gross receipts included in their sales factors by statutes similar or identical to California’s statute at issue in Microsoft. Similar positions for taxpayers may be available in those states.
If you have any questions or need assistance, please reach out to a professional at Forvis Mazars. Be sure to check out our Legislative Year-End Tax Guide where we look at some significant legislative tax developments in 2024 to help you prepare for next year.
- 1IRC §274(d)(3).
- 2Public Law 86-272, 15 U.S.C. §§381-384.
- 3Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272, Multistate Tax Commission, (July 27, 2001).
- 4Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272, Multistate Tax Commission, (August 4, 2021).
- 5Id.
- 6Id.
- 7Technical Advice Memorandum 2022-01 (Feb. 14, 2022); American Catalog Mailers Association, Plaintiff, v. Franchise Tax Board, Defendant., CGC-22-601363, December 13, 2023.
- 8New Jersey Tax Bulletin TB-108(R), January 18, 2024.
- 9N.Y. Comp. Codes R. & Regs. 1-2.10; American Catalog Mailers Association, Plaintiff, v. Department of Taxation and Finance, Defendants. Albany County Clerk, 903320-24 04/05/2024.
- 10H.R.8021 — 118th Congress (2023-2024).
- 11Appeal of Microsoft Corporation and Subsidiaries (07/27/2023, Cal. Off. Tax. App.) OTA Case No. 21037336.
- 12Id.
- 13Id.
- 14Id.
- 15Id.
- 16Id.
- 17Id.
- 18Id.; FTB Legal Ruling 2006-01.
- 19Appeal of Microsoft
- 20Id.
- 21Id.
- 22Id.
- 23Id.
- 24Appeal of Microsoft Corporation and Subsidiaries Opinion on Petition for Rehearing (02/14/2024, Cal. Off. Tax. App.) OTA Case No. 21037336.
- 25California Senate Bill No. 167, Chapter 34, Statutes of 2024 (approved June 27, 2024).
- 26Id.
- 27Id.
- 28See, California Taxpayers Association v. California Franchise Tax Board (Fresno County Superior Court, Aug. 15, 2024); National Taxpayers Union v. California Franchise Tax Board (Sacramento County Superior Court, Aug. 14, 2024).
- 29Loper Bright Enterprises v. Raimondo, 603 U.S. __(2024).