Whether you choose to accelerate taxable income into 2016 or defer it until 2017 depends, in part, on the marginal tax rate for each year projected for your business. Generally, unless your 2016 marginal tax rate will be significantly lower than your 2017 marginal tax rate, you should defer taxable income to 2017.
The marginal tax rate is the rate applied to your next dollar of income or deduction. Projections of your business’s 2016 and 2017 income and deductions are necessary to determine the marginal tax rate for each year.
Your client service professional can be consulted to recommend how your business can shift income and deductions between these years to minimize your tax liability. (Also see our 2016 Year-End Tax Planning Letter for Individuals.)
In addition, the circumstances of an individual taxpayer may cause the marginal or effective tax rate to be higher in one year than in the other year. While the maximum marginal federal tax rate is 35% for C corporations, the maximum marginal federal tax rate for individuals is nominally 39.6%. Moreover, the combined effect of certain phase-out provisions for high-income individuals and the additional 3.8% tax on net investment income could push the effective marginal tax rate on high-income individuals to levels approaching 45%. If the relevant tax rate is expected to be approximately the same for each of 2016 and 2017, consider taking advantage of various tax rules that allow taxable income or gain to be deferred, such as sales of stock to an employee stock ownership plan, like-kind exchanges, involuntary conversions, and tax-free merger and acquisition transactions.
Except for farming businesses and certain qualified personal service corporations, taxable (C) corporations and partnerships that have a C corporation as a partner must use an accrual method of accounting if their average annual gross receipts for the three prior taxable years are more than $5 million, regardless of the type of business in which they are engaged. If their average annual gross receipts are $5 million or less, C corporations and partnerships that have a C corporation as a partner can use the cash method of accounting unless they have inventories, in which case they must use an accrual method of accounting.
All other taxpayers, including S corporations and C corporations that are qualified personal service corporations, can use the cash method of accounting regardless of their average annual gross receipts. However, if they have inventories, they must use an accrual method for purchases and sales, with the exception of certain qualifying small business taxpayers having average annual gross receipts for the prior three taxable years of not more than $10 million. Supplies consumed in the rendering of services are not inventory. In addition, some taxpayers in certain businesses have been successful in persuading courts that certain types of tangible property transferred to customers in connection with the provision of services are not inventory if the property is incidental to the performance of services.
The Internal Revenue Service has provided a de minimis exception with regard to the use of an accrual method of accounting. Under this exception, a taxpayer can use the cash method of accounting if it has average annual gross receipts of $1 million or less. If the taxpayer has inventories, it can deduct the cost of the inventory only when sold.
We have only discussed a few items here to assist you in your annual tax obligation. Click Download Article for the full Tax Alert.