Businesses typically seek to delay recognizing taxable income into future years and accelerate deductions into the current year to minimize their current tax liabilities. However, there are instances where the opposite strategy may be advisable, particularly in anticipation of tax law changes that could increase tax rates.
One such scenario is the proposed increase in corporate federal income tax rates by the Biden administration, potentially raising the flat rate from 21% to 28%. Similarly, discussions about raising individual federal income tax rates could affect noncorporate pass-through entities, where income is taxed on personal returns.
If there’s a belief that income could be subject to higher tax rates in the future, accelerating income recognition into the current tax year can capitalize on the current lower rates. Conversely, postponing deductions to a later tax year, when rates are expected to be higher, can maximize their tax-saving impact.
To accelerate income recognition:
- Consider selling appreciated assets with capital gains in the current year instead of waiting.
- Review depreciable assets and sell fully depreciated ones to trigger taxable gains now.
- Elect out of installment sale treatment for gains to be recognized in the year of sale.
- Opt for taxable transactions instead of tax-deferred exchanges like Section 1031 for real property.
To postpone deductions:
- Delay purchasing capital equipment and fixed assets that would lead to depreciation deductions.
- Avoid claiming large first-year Section 179 or bonus depreciation deductions and spread out asset depreciation over time.
- Capitalize professional fees and salaries associated with long-term projects to spread out costs.
- Purchase bonds at a discount to increase interest income in future years.
- Delay inventory shrinkage write-downs and other deductions to years with higher tax rates.
These strategies can be complex and tailored to your specific business circumstances. It’s recommended to consult with a tax advisor to determine the best approach for optimizing your tax planning amidst potential tax rate changes.
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