The long-term impact of tax reform is highly uncertain, but with last year’s passage of the Tax Cuts and Jobs Act, business leaders can be sure of one thing: Your 2017 tax return is likely the most important you’ve ever filed.
With so many sweeping changes ahead – from rate differentials to rule changes to property life cycles – 2017 tax returns present a tremendous opportunity to maximize the full benefits of this evolution.
Now that new tax rates are locked in, many of which are lower for businesses, the most important question is how to best maximize the benefit.
The answer: accelerate deductions.
With much lower future rates, businesses should look at ways to accelerate deductions into 2017 to take full advantage. For example, if a business were to accelerate $1 million of deductions into 2017, the permanent tax savings would be $140,000 given the rate change from 35 to 21 percent.
And while the strategy is fairly simple, figuring out how to accelerate deductions is a complicated process.
Business owners and executives should first conduct a thorough review of depreciation schedules. Consider a cost segregation and deprecation analysis, which can be done retroactively. The IRS allows for a “catch-up” adjustment to make up for any missed depreciation.
As an example, if a business placed in service a $10 million building in 2007, that business can complete a cost segregation study and recapture any missed depreciation. If 20 percent of the $10 million could have been classified as 5-year property, the business could realize a "catch-up" adjustment of approximately $1.5 million and take the deduction in 2017.
Businesses with significant equipment should also do a thorough review of associated asset life. Typically, the difference between a 5-year equipment life and a 7-year equipment life is nominal. However, if a business mistakenly claimed assets in a 7-year category that could be classified in a 5-year asset class, a "catch-up" adjustment would accelerate deductions into 2017.
Finally, businesses looking to sell assets have options to consider. Traditionally, a building owner planning to sell quickly will choose against a cost segregation and depreciation analysis to avoid recapture penalties on short-life property. While the recapture penalty still exists, the rate drop for 2018 adds a wrinkle to the process. Even with the penalty, the lower rate may position an accelerated 2017 deduction as the right move, even on a property sold in 2018.
As with many areas of tax law, these analyses present difficult choices and are often very complicated. However, businesses rarely get the opportunity to plan for a rate change this dramatic. Strategic moves now could lead to major benefits in the future.
Dave McGuire is co-founder of Indianapolis-based McGuire Sponsel.