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A Check Under the Hood: Now Is the Time for a Methods “Tune Up”
While the US is currently recovering from a recession, now is an opportune time to take a closer look at accounting methods. By strategically using accounting method changes, taxpayers can consider ways to cut spending and free up liquid resources without the continued growth businesses they have relied on in the past. Taxand US reviews ways in which a taxpayer might identify more favourable accounting methods.
These opportunities to change accounting methods serve not only as a means for generating cash flow by reducing taxes for current, future or prior tax years (through an NOL carryback) but also as a means of reducing tax exposure for prior years. The Internal Revenue Service ("IRS") also offers an attractive incentive for taxpayers to voluntarily correct impermissible methods before they are potentially discovered under audit. Specifically, a taxpayer that voluntarily requests a change in a method is often afforded audit protection on the issue for earlier years. This would enable a taxpayer to reduce its exposure for interest and penalties that could otherwise apply if the IRS were to discover the use of an impermissible method.
Some of the ways in which a taxpayer might identify a more favourable accounting method include:
- advance payments received
- disputed income
- unbilled receivables
- wholly or partially worthless bad debts
- prepaid expenses
- liability reserves (e.g., "incurred but not reported" liabilities for self-insured medical claims, workers compensation, retiree medical benefits)
- depreciation cost recovery for fixed assets
- software development costs
- repairs and maintenance expenditures
- transaction costs
- compensation accruals (e.g., salaries, bonuses and payroll taxes)
- inventory costing (e.g., uniform capitalisation (UNICAP), lower of cost or market, and subnormal goods)
Taxpayers looking to improve cash flow by reducing income taxes payable or maximising refund opportunities should seriously take into consideration method planning opportunities. Although method planning may not always yield the recurring tax benefits associated with other sophisticated tax planning opportunities (e.g., intellectual property shifting, shared services company, foreign finance company), method planning generally does not entail an intrusive restructuring of business operations. Therefore, taxpayers can often capitalise on such opportunities with minimal disruption to business operations.
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