If your business involves the production, purchase or sale of merchandise, your inventory accounting method can significantly affect your tax liability. In some cases, using the last-in, first-out (LIFO) inventory accounting method, rather than first-in, first-out (FIFO), can reduce taxable income, giving cash flow a boost. Tax savings, however, aren’t the only factor to consider.
FIFO vs. LIFO
FIFO assumes that merchandise is sold in the order it was acquired or produced. Thus, the cost of goods sold is based on older — and often lower — prices. The LIFO method operates under the opposite assumption: It allocates the most recent costs to the cost of sales.
If your inventory costs generally rise over time, LIFO offers a definite tax advantage. By allocating the most recent — and, therefore, higher — costs first, it maximizes your cost of goods sold, which minimizes your taxable income. But LIFO involves more sophisticated record keeping and more complex calculations, so it’s more time-consuming and expensive than FIFO.
Other considerations
LIFO can create a problem if your inventory levels begin to decline. As higher inventory costs are used up, you’ll need to start dipping into lower-cost “layers” of inventory, triggering taxes on “phantom income” that the LIFO method previously has allowed you to defer. If you use LIFO and this phantom income becomes significant, consider switching to FIFO. It will allow you to spread out the tax on phantom income.
If you currently use FIFO and are contemplating a switch to LIFO, beware of the IRS’s LIFO conformity rule. It generally requires you to use the same inventory accounting method for tax and financial statement purposes. Switching to LIFO may reduce your tax bill, but it will also depress your earnings and reduce the value of inventories on your balance sheet, which may place you at a disadvantage in comparison to competitors that don’t use LIFO. There are various issues to address and forms to complete, so be fully informed and consult your tax advisor before making a switch.
The method you use to account for inventory can have a big impact on your tax bill and financial statements. These are only a few of the factors to consider when choosing an inventory accounting method. Contact us for help assessing which method will provide the best fit with your current financial situation. ©2016
The IRS recently issued its 2017 cost-of-living adjustments. Because inflation remains relatively in check, many amounts increase only slightly, and some stay at 2016 levels. As you implement 2016 year-end tax planning strategies, be sure to take these 2017 adjustments into account.
Individual income taxes
Tax-bracket thresholds increase for each filing status but, because they’re based on percentages, they increase more significantly for the higher brackets. For example, the top of the 10% bracket increases by $50 to $100, depending on filing status, but the top of the 35% bracket increases by $1,875 to $3,750, again depending on filing status.
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2017 ordinary-income tax brackets
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Tax rate
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Single
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Head of household
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Married filing jointly or surviving spouse
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Married filing separately
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10%
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$0 – $9,325
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$0 – $13,350
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$0 – $18,650
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$0 – $9,325
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15%
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$9,326 – $37,950
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$13,351 – $50,800
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$18,651 – $75,900
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$9,326 – $37,950
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25%
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$37,951 – $91,900
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$50,801 – $131,200
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$75,901 – $153,100
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$37,951 – $76,550
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28%
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$91,901 – $191,650
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$131,201 – $212,500
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$153,101 – $233,350
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$76,551 – $116,675
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33%
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$191,651 – $416,700
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$212,501 – $416,700
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$233,351 – $416,700
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$116,676 – $208,350
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35%
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$416,701 – $418,400
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$416,701 – $444,550
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$416,701 – $470,700
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$208,351 – $235,350
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39.6%
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Over $418,400
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Over $444,550
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Over $470,700
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Over $235,350
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The personal and dependency exemption remains unchanged at $4,050 for 2017. The exemption is subject to a phaseout, which reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s adjusted gross income (AGI) exceeds the applicable threshold (2% of each $1,250 for separate filers).
For 2017, the phaseout starting points increase by $1,250 to $2,500, to AGI of $261,500 (singles), $287,650 (heads of households), $313,800 (joint filers), and $156,900 (separate filers). The exemption phases out completely at $384,000 (singles), $410,150 (heads of households), $436,300 (joint filers), and $218,150 (separate filers).
Your AGI also may affect some of your itemized deductions. An AGI-based limit reduces certain otherwise allowable deductions by 3% of the amount by which a taxpayer’s AGI exceeds the applicable threshold (not to exceed 80% of otherwise allowable deductions). The thresholds are the same as for the personal and dependency exemption phaseout.
AMT
The alternative minimum tax (AMT) is a separate tax system that limits some deductions, doesn’t permit others and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.
Like the regular tax brackets, the AMT brackets are annually indexed for inflation. For 2017, the threshold for the 28% bracket increased by $1,500 for all filing statuses except married filing separately, which increased by half that amount.
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2017 AMT brackets
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Tax rate
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Single
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Head of household
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Married filing jointly or surviving spouse
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Married filing separately
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26%
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$0 – $187,800
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$0 – $187,800
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$0 – $187,800
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$0 – $93,900
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28%
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Over $187,800
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Over $187,800
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Over $187,800
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Over $93,900
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The AMT exemptions and exemption phaseouts are also indexed. The exemption amounts for 2017 are $54,300 for singles and heads of households and $84,500 for joint filers, increasing by $400 and $700, respectively, over 2016 amounts. The inflation-adjusted phaseout ranges for 2017 are $120,700–$337,900 (singles and heads of households) and $160,900–$498,900 (joint filers). (Amounts for separate filers are half of those for joint filers.)
Education- and child-related breaks
The maximum benefits of various education- and child-related breaks generally remain the same for 2017. But most of these breaks are also limited based on the taxpayer’s modified adjusted gross income (MAGI). Taxpayers whose MAGIs are within the applicable phaseout range are eligible for a partial break — breaks are eliminated for those whose MAGIs exceed the top of the range.
The MAGI phaseout ranges generally remain the same or increase modestly for 2017, depending on the break. For example:
The American Opportunity credit. The MAGI phaseout ranges for this education credit (maximum $2,500 per eligible student) remain the same for 2017: $160,000–$180,000 for joint filers and $80,000–$90,000 for other filers.
The Lifetime Learning credit. The MAGI phaseout ranges for this education credit (maximum $2,000 per tax return) increase for 2017; they’re $112,000–$132,000 for joint filers and $56,000–$66,000 for other filers — up $2,000 for joint filers and $1,000 for others.
The adoption credit. The MAGI phaseout ranges for this credit also increase for 2017 — by $1,620, to $203,540–$243,540 for joint, head-of-household and single filers. The maximum credit increases by $110, to $13,570 for 2017.
(Note: Married couples filing separately generally aren’t eligible for these credits.)
These are only some of the education- and child-related breaks that may benefit you. Keep in mind that, if your MAGI is too high for you to qualify for a break for your child’s education, your child might be eligible.
Retirement plans
Only a few retirement-plan-related limits increase for 2017, and even those increases are only slight. Thus, you have limited, if any, opportunities to increase your retirement savings if you’ve already been contributing the maximum amount allowed:
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Type of limitation
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2016 limit
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2017 limit
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Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans
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$18,000
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$18,000
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Annual benefit for defined benefit plans
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$210,000
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$215,000
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Contributions to defined contribution plans
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$53,000
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$54,000
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Contributions to SIMPLEs
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$12,500
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$12,500
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Contributions to IRAs
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$5,500
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$5,500
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Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans
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$6,000
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$6,000
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Catch-up contributions to SIMPLEs
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$3,000
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$3,000
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Catch-up contributions to IRAs
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$1,000
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$1,000
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Compensation for benefit purposes for qualified plans and SEPs
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$265,000
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$270,000
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Minimum compensation for SEP coverage
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$600
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$600
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Highly compensated employee threshold
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$120,000
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$120,000
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Your MAGI may reduce or even eliminate your ability to take advantage of IRAs. Fortunately, IRA-related MAGI phaseout range limits all will increase for 2017:
Traditional IRAs. MAGI phaseout ranges apply to the deductibility of contributions if the taxpayer (or his or her spouse) participates in an employer-sponsored retirement plan:
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For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
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For a spouse who participates, the 2017 phaseout range limits increase by $1,000, to $99,000–$119,000.
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For a spouse who doesn’t participate, the 2017 phaseout range limits increase by $2,000, to $186,000–$196,000.
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For single and head-of-household taxpayers participating in an employer-sponsored plan, the 2017 phaseout range limits increase by $1,000, to $62,000–$72,000.
Taxpayers with MAGIs within the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.
But a taxpayer whose deduction is reduced or eliminated can make nondeductible traditional IRA contributions. The $5,500 contribution limit (plus $1,000 catch-up if applicable and reduced by any Roth IRA contributions) still applies. Nondeductible traditional IRA contributions may be beneficial if your MAGI is also too high for you to contribute (or fully contribute) to a Roth IRA.
Roth IRAs. Whether you participate in an employer-sponsored plan doesn’t affect your ability to contribute to a Roth IRA, but MAGI limits may reduce or eliminate your ability to contribute:
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For married taxpayers filing jointly, the 2017 phaseout range limits increase by $2,000, to $186,000–$196,000.
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For single and head-of-household taxpayers, the 2017 phaseout range limits increase by $1,000, to $118,000–$133,000.
You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.
(Note: Married taxpayers filing separately are subject to much lower phaseout ranges for both traditional and Roth IRAs.)
Gift and estate taxes
The unified gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption are both adjusted annually for inflation. For 2017 the amount is $5.49 million (up from $5.45 million for 2016).
The annual gift tax exclusion remains at $14,000 for 2017. It’s adjusted only in $1,000 increments, so it typically increases only every few years. It increased to $14,000 in 2013, so it might go up again for 2018.
Impact on your year-end tax planning and retirement planning
The 2017 cost-of-living adjustment amounts are trending higher than 2016 amounts, but only slightly. Regarding retirement-plan-related limits, only a few increased, and they increased minimally. How might these amounts affect your year-end tax planning or retirement planning? Contact us for answers. We’d be pleased to help.
One important consideration when starting your business is determining the best legal organizational structure. Why? Because it will affect operating efficiency, transferability, control, the way you report income, the taxes you pay and your personal liability.
Four basic structure types are available:
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Sole proprietorship
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Partnership — general and limited
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Corporation — S corporation, C corporation
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Limited liability company (LLC)
The choices can be complicated — and errors can be costly. Business legal structures are regulated by state governments, but your county or municipality also may have license requirements. What’s more, current tax laws make it difficult to change your legal structure after you begin operating. Making the right decision before you open for business is very important. How do you decide which legal structure is best for you and avoid potential problems? Consult with a certified public accountant (CPA). A CPA can help you make well-informed choices, explain how business structure affects your organization’s bottom line and file the necessary paperwork to start your business, if you’d like.
We have included the basic pros and cons of each structure in the chart below.
This is a complicated subject. To learn more about each structure and how to compare and determine which one is right for your business, read or download our Guide to Selecting Your Small Business Legal Structure or contact your SKR+Co tax advisor. We are happy to answer your questions and help you make the best choice for your specific situation.
New Filing Requirements for Business by Tax Year 2014
In September of 2013, the IRS issued regulations, required to be employed on tax year 2014 returns, that created guidelines for treatment of tangible property expenditures, whether tangible personal or real property. These new tangible property regulations (TPRs) provide guidance on the capitalization and depreciation of capital expenditures, the treatment of materials and supplies, and the opportunity to write off all or a portion of an asset when disposed of. They present new risks and opportunities that affect taxpayers in every industry that owns depreciable capital assets, spends funds on repairs and maintenance, and/or material and supplies. Below is a summary of the new regulations and how they will impact your business.
Required Tax Filings
The good news of the TPRs is that taxpayers who have significant fixed assets with remaining depreciation or real property will typically have large current and future tax deductions. In order to obtain these tax deductions, a significant amount of “one time” work and related IRS tax filings need to occur, and occur by tax year 2014. This work relates to accounting method change forms. On the other hand, taxpayers who have been able to write their asset acquisitions off under bonus or Section 179 deductions will see minimal tax deductions but are still subject to the “one time” new tax filing requirements for 2014.
It is unfortunate that the IRS has required the majority of the TPRs to be implemented: (a) retroactively, and (b) via the filings of numerous additional required special tax forms for tax year 2014. Retroactive application of the TPRs requires taxpayers to revisit every asset on its depreciation schedule to see if it should have been capitalized under the new capitalization rules or criteria (see below). If a prior asset/expenditure does not qualify as an asset under the new principals, it must be written off by 2014, or the opportunity to write off that item by tax year 2014 will be lost. The scary part of the TPRs is the threat of the IRS to disallow any future depreciation for prior items that do not pass the new capitalization criteria.
Example, ABC, Inc. capitalized a $40,000 roof expenditure ten years ago. After applying the new criteria, it is determined that the remaining tax depreciation of $30,000 should be written off in 2014. If ABC does not properly complete the “one time” tax filings in their 2014 return, ABC will permanently lose $30,000 as a tax deduction. It is not allowed to continue to take annual depreciation for this item. Even if ABC did not have a tax deduction to take for tax 2014, ABC still has to file those numerous “one time” tax forms. Additionally, the IRS requires that the accounting method change forms not all be filed together. This could require several different sets of these forms to be filed.
The word “required” used above is very important to us as your tax return preparers. As CPAs and as your tax preparer, we are required to follow the rules and restrictions of our state and federal licensing parameters. Those parameters subject us to very large preparer’s penalties and sanctions, should we not follow them. One of those rules and regulations prohibits us from preparing and/or signing your 2014 return unless that return includes the new TPR implementation and form submissions.
Capital expenditures
Taxpayers and their accountants have always faced the challenge of differentiating between what are capital improvements or repair and maintenance expenses as they sought the balance between accurately reflecting business profits verses maximizing tax deductions. The new TPRs dictate that expenditures must be written off as repairs if they are not required to be capitalized. That is, repairs and maintenance are the opposite of what is required to be capitalized. Consequently, an understanding of the capitalization rules is imperative. Rule: a taxpayer must capitalize any amounts that are paid to improve a unit of property or assets purchased. One makes an improvement to a unit of property if it is deemed to be betterment, a restoration, or adaption to a new or different use. The employment of this guidance is heavily fact specific. While there are no bright line tests, there are now known specific criteria that need to be applied to the expenditures. The new criteria also require a thorough review of the past and future expenditures on improvements. That review will determine if prior capitalized expenditures should now be written off and will determine whether future ones will be capitalized.
Unit of Property
The foundation of the capitalization rules is in the comparison of the expenditure to the unit of property. A unit of property consists of a group of functionally interdependent components. In other words, if placing one component in service is dependent on placing another component in service, then they are functionally interdependent and considered one unit of property.
For example, a truck and its components (engine, tires, etc.) are one unit of property because each of those components needs to be placed in service at the same time in order for the truck to function. The regulations have special rules for buildings. In general, a building and its structural components are one unit of property.
Examples of the structural components would be roofs, walls, floors, ceilings and other items that relate to the operation of a building. There are also certain “building systems” that the regulations have defined as separate units of property. These building systems include HVAC system, plumbing, electrical, escalators, elevators, fire protection, alarm/security and gas distribution. Even though a building is one unit of property, the capitalization criteria must be applied at the building structure or system level, and then even smaller comparisons for any item that performs a material and specific function.
New Capitalization Criteria
Once a unit of property is defined, a taxpayer then needs to determine if the amounts paid result in a betterment, restoration or adaption to new/different use, as follows:
Betterment: Funds spent to correct a material defect/condition that existed prior to the acquisition of a unit of property; result in a material addition to the unit of property (i.e. enlargement, expansion or extension); and/or result in a material increase in capacity, productivity, efficiency, strength, quality or output of the unit of property.
Restoration: Funds spent to return the unit of property to its ordinarily efficient operating condition if the property was in disrepair and no longer functional; replacement of a component of a unit of property where a gain/loss is recognized on the component; rebuilding the unit of property to a like-new condition after the end of its class life; or the replacement of part(s) that comprise a major component, large physical portion, or substantial structural part of the unit of property.
New/Different Use: Funds spent to adapt a unit of property to a new or different use if the adaption is not consistent with the taxpayer’s original intended use of the unit of property when acquired.
Example: Able Contractors LLC purchased a bulldozer tractor in 2008. In 2014, it paid $20,000 to have the engine and transmission rebuilt and everything repainted. Under the new regulations, this cost would fall under the restoration category discussed above and would be required to be capitalized. The applicable class life for a contractor is 6 years and in this example the item was rebuilt to a like-new condition after the end of its class life. Let’s assume the same facts but the bulldozer was purchased in 2010. As the class life of the tractor (6 years) does not end until 2015, the expenditures could be deducted.
Routine Maintenance Safe Harbor
The IRS offered some opportunities in the regulations by acknowledging that taxpayers do incur expenditures that assist in keeping a unit of property in its efficient operating condition. As a result, the IRS created the Routine Maintenance Safe Harbor (RMSH) rule that allows taxpayers to expense certain costs that are routine and reoccur at specific times during the use of unit of property. For personal property, an activity is reoccurring if you expect to do it more than once during the applicable class life of the unit of property. The RMSH has special rules for buildings and their structural components. In the case of a building and/or its components, an expenditure can be treated as a repair & maintenance if one reasonably expect to perform it more than once over a 10 year period of time.
De Minimis Safe Harbor to acquire property
When a taxpayer purchases a unit of property, generally capitalization is required; however, the IRS provided some relief under the TPRs by creating a De Minimis Safe Harbor (DMSH) exception. This exception allows taxpayers to immediately deduct amounts they pay to acquire or improve property, if the taxpayer complies with all of the DMSH rules. The DMSH rules can be applied by all taxpayers if the rules are met. First, one must have a capitalization policy in place before the tax year starts. This policy must specify that expenditures under a certain dollar amount (i.e. like $1,000 and under) are allowed to be expensed. Additionally, the taxpayer must have an invoice, and deduct the expenditure on its books. Under the regulations, taxpayers who have an applicable financial statement (AFS) are granted safe harbor to be able deduct up to $5,000 of the cost of an item of property (per invoice) or expenditure. For those who do not have an AFS, the $5,000 safe harbor is reduced to $500 per item. Although the regulations state the $5,000/$500 as safe harbor limits, the capitalization policy should be set to an appropriate level for your business. During an IRS audit, the taxpayer has the burden of proving to the IRS that the amount paid in excess of the safe harbor was reasonable. The DMSH is a safe harbor and not a restricted ceiling limitation.
Example: XYZ, Inc. does not have an AFS, has a written policy in place before tax year begins that states they will expense property that costs $500 or less. XYZ purchases 25 items that cost $400 each on a total invoice of $10,000. Since XYZ has a written policy in place and each item (unit of property) is $500 or less, XYZ must expense the full $10,000 paid if it writes these items off on its books.
Disposals
As another positive aspect of the TPRs, it also allows taxpayers the opportunity to partially dispose of duplicate portions of property, including buildings and their structural components. Historically, for example, if one replaced a roof on a building and capitalized the replacement costs the taxpayer was not allowed to dispose of the prior roof. Under the TPRs, a taxpayer can elect to dispose of the prior roof. These partial asset dispositions provide an opportunity to write
off duplicable assets for tax years prior to 2014 and are only available through the filing of the 2014 tax returns.
Materials and Supplies
Materials and supplies (M & S) are defined as tangible property, excluding inventory, which is used or consumed in operations and is: either (a) A component acquired to maintain, repair or improve a unit of tangible property, (b) bulk, such as fuel, water, lubricants and similar items that are reasonably expected to be used in 12 months or less, (c) temporary or emergency spare parts, (d) units of property whose useful life is 12 months or less, or (e) a unit of property with a cost less than $200. Once an item is determined to be M & S, the regulations require a taxpayer to classify these M & S as either incidental or nonincidental. Incidental materials and supplies can be deducted when they are purchased. On the other hand, nonincidental materials and supplies are required to be deferred and deducted in the year they are used or consumed. No later than tax year 2014, taxpayers are required to defer and keep a physical inventory or a record of consumption for its nonincidental M & S. This rule is trumped, up to the taxpayer’s DMSH. Taxpayers must review and adapt its accounting by tax year 2014 to conform its treatment of M & S to the TPRs.
Example, Bob’s Wood Shop has temporary machine parts and bulk wood treatment on hand at tax year end 2014, that are above its DMSH. Bob’s has to defer, and not take as tax deduction in 2014, these items.
Conclusion
While the new regulations are complex, understanding how they impact your business is critical to maximizing tax deductions while maintaining tax compliance. Past decisions regarding the Maintenance & Supplies expenditures, as well as the capitalization or write off of R & M must be reviewed to determine what changes are necessary under the new regulations. These changes will require the filing of certain IRS tax forms no later than tax year 2014 while other changes are either new annual elections or choices. Stockman Kast Ryan and Company has the resources and expertise to assist you in determining how these new regulations will affect your business.
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SKR+Co Alert: Revised capitalization policy and updated IRS final tangible property (“repair”) regulations
To say that this issue is complicated is an understatement. In our ongoing analysis of this issue, we discovered some inconsistencies. We recommend you use this information and the linked capitalization policy sample in place of earlier information and samples.
Take action now! Final tangible property ("repair") regulations require written policy by January 1, 2014
As we shared in an October Tax Alert and in our recent tax seminar, the IRS has issued final regulations which govern the capitalization of materials and supplies, amounts paid to acquire or produce tangible property, and expenditures relating to the betterment, adaptation, and restoration of tangible property. One part of the regulations – the De Minimis Expensing Rule – requires taxpayers to have a written policy in place at the beginning of the taxable year to be able to expense amounts paid for:
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Property costing $5,000 or less per item/invoice, if there is an applicable financial statement, or
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Property costing $500 or less per item/invoice, if there is no applicable financial statement.
Taxpayers may also expense amounts paid for property with an economic useful life of 12 months or less provided the amount per item/invoice does not exceed $5,000 (with an applicable financial statement) or $500 (without an applicable financial statement).
Additionally, the taxpayer must treat the amount paid for the property as an expense on its books and records in accordance with the company’s written book capitalization policy.
To help you take advantage of the new rules, we recommend you prepare a written Book Capitalization Policy before January 1, 2014. A sample written policy can be accessed here.
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SKR+Co Tax Alert: Big changes for businesses owning tangible property 
The IRS has released its final regulations on the tax treatment of expenditures related to tangible property. The regulations provide guidance on how to comply with Sections 162 and 263 of the Internal Revenue Code, which require the capitalization of amounts paid to acquire, produce or improve tangible property but allow amounts for incidental repairs and maintenance of property to be deducted.
This article examines the final regulations, which primarily focus on how taxpayers determine whether expenditures are for deductible repairs or capital improvements.
If you have expenditures related to tangible property, the final regulations apply to you. Compliance may require changes to your current capitalization procedures and the filing of Form 3115, “Application for Change in Accounting Method.”
This is a complicated topic. If after reading the article you have questions about how this applies to you, please contact us.
Read the Full Article Here.
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What is tangible property?
These regulations affect all businesses that own or lease tangible property, which includes buildings, machinery, equipment, office furniture, tools, and vehicles.
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Next Tax Seminar: 
