As year end approaches, C corporations, like individuals, should decide when and how to shift income and deductions between 2017 and 2018. Although C corporations will generally benefit from the deferral of income and the acceleration of deductions in the same way as individuals, particularly in light of likely tax reform legislation, there are a number of special rules that should be taken into account.
In spite of uncertainty inherent in tax reform proposals—nobody knows when such legislation might be enacted and what the new rules may be—the best year-end tax planning strategy for many taxpayers will be to follow the time-honored approach of deferring income and accelerating deductions to minimize 2017 taxes. This approach may turn out to be even more valuable if Congress succeeds in enacting broad tax reform that reduces tax rates beginning next year in exchange for slimmed-down deductions. Under the framework for tax reform now being considered, the corporate tax rate would be reduced to 20% (down from the current top rate of 35%). The corporate AMT would also be eliminated, and a reduction in the double taxation of corporate earnings is a possibility.
Regardless of whether tax reform is enacted, deferring income also may help a taxpayer minimize or avoid adjusted gross income (AGI)-based phaseouts of various tax breaks that apply for 2017.
Year-end tax planning doesn’t occur in a vacuum. It must take account of each taxpayer’s particular business and financial situation, and planning goals, with the aim of minimizing taxes to the greatest extent possible. Thus, while most taxpayers will come out ahead by following the traditional approach described above, others with special circumstances may do better by accelerating income and deferring deductions.
Take, for example, a corporation that is currently subject to the 39% “bubble”. Corporate taxable income between $100,000 and $335,000 is taxed at the rate of 39% to phase out the benefits of the 15% and 25% brackets that apply to a corporation’s first $75,000 of taxable income.
Taxable income between $75,000 and $100,000, and between $335,000 and $10 million, is taxed at 34%. Taxable income over $10 million is taxed at 35%, except that there is also a 38% “bubble” that applies to corporate taxable income between $15 million and $18,333,333 to eliminate the benefit of the 34% rate.
Assume a C corporation expects taxable income of about $90,000 for 2017, but expects its income to go well over $100,000 in 2018. Accelerating $10,000 in income from 2018 to 2017, assuming that the current rates and brackets remain in effect, will save about $500 in taxes since the $10,000 will be taxed at only 34% instead of 39% ($10,000 × 5% = $500). This represents a return of 14.7% on the $3,400 used to make the early tax payment ($500 divided by $3,400).
Similar considerations apply to situations where the acceleration of income from 2018 into 2017 will prevent the corporation from moving into other higher tax brackets next year, say from the 15% bracket into the 25% bracket, or from the 35% bracket into the 38% “bubble” that applies to corporate taxable income between $15 million and $18,333,333, and might similarly apply if new legislation uses bubble rates to create a flat-rate for higher income corporations.
Corporations in industries that tend to pay effective tax rates at or near or the current corporate maximum (e.g., domestic retailers) should benefit more from a deep rate reduction than multinationals (e.g., large tech and pharmaceutical companies), even after the possible loss of some deductions and credits. These companies are likely to benefit most from using traditional year-end income and deduction timing strategies. However, the possibility that a corporate rate cut might be phased in over a few years to reduce it’s overall cost would reduce their benefit.
Qualifying for the small corporation AMT exception. In the event that broad tax reform turns out to be legislatively unachievable in the short term, and a simpler rate-reduction package ends up being passed, year-end AMT strategies could still generate some savings for small corporations. The tentative minimum tax of a corporation is zero for any tax year that it qualifies as a small corporation meeting a “gross receipts test”.
A corporation qualifies if:
Its average annual gross receipts for all three-tax-year periods beginning after Dec. 31, ’93 and ending before the tax year do not exceed $7.5 million; and
The corporation’s average gross receipts do not exceed $5 million for its firstthree-tax-year period taken into account in (i).
A calendar-year corporation was created on Jan. 1, 2009. To qualify as a small corporation for 2017:
The corporation’s average gross receipts for the three-tax-year period 2009 through 2011 must be $5 million or less, and
The corporation’s average gross receipts for the 2010 through 2012 period, the 2011 through 2013 period, the 2012 through 2014 period, the 2013 through 2015 period, and the 2014 through 2016 period must be $7.5 million or less.
If the corporation qualifies for 2017, the corporation will qualify for 2018 if its average gross receipts for the three-tax-year period 2015 through 2017 is also $7.5 million or less. If the corporation does not qualify for 2017, it can’t qualify for 2018 or any later year.
Thus, a corporation such as the one in the illustration might consider deferring income to 2018 if necessary to keep average annual gross receipts for the three-tax-year period 2015 through 2017 at $7.5 million or less. This would preserve the AMT exemption if needed for 2018.
Accelerating or deferring income can save estimated tax break
Corporations (other than certain “large” corporations, see below) can avoid being penalized for underpaying estimated taxes if they pay installments based on 100% of the tax shown on the return for the preceding year. Otherwise, they must pay estimated taxes based on 100% of the current year’s tax. However, this 100%-of-last-year’s-tax safe harbor isn’t available unless the corporation filed a return for the preceding year that showed a liability for tax (i.e., a return showing a zero tax liability doesn’t satisfy this requirement). Only a return that shows a positive tax liability for the preceding year makes the safe harbor available.
A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2017 and substantial net income in 2018 may find it worthwhile to accelerate just enough of its 2018 income (or to defer just enough of its 2017 deductions) to create a small amount of net income, and thus a small positive tax liability, for 2017.
This will permit the corporation to base its 2018 estimated tax installments on the relatively small amount of tax shown on its 2017 return, rather than having to pay estimated taxes based on 100% of its much larger 2018 taxable income. Also, by accelerating a small amount of income from 2018 to 2017, the corporation might be able to pay tax on that income at a lower rate—e.g., 15% instead of 25% or 34%—if doing so converts its 2017 NOL to a small amount of taxable income.
However, where a 2017 NOL would result in a carryback that would eliminate tax in an earlier year, this income acceleration strategy should be employed only if the value of the carryback is less than the value of having to pay only a small amount of estimated tax for 2018.
Generally speaking, a taxpayer will be treated as a “large” corporation (and won’t be eligible for the safe harbor) only if it had taxable income of $1 million or more in any one of the three preceding tax years. As a result, a corporation that didn’t reach that threshold in 2014 or 2015 but expects net income of $1 million or more in 2018 and later tax years will have an additional incentive for deferring income into (or accelerating deductions from) 2018. If such a shifting of income or deductions lets the corporation avoid reaching the $1 million threshold in 2017, it will be able to use the 100%-of-last-year’s-tax safe harbor in 2018.