Last March we heard a lot about the healthcare act of 2010. What we didn’t hear so much about were the “revenue raisers” that followed in its wake.
One thing to watch out for is the Economic Substance Doctrine. Section 7701(o) of the Internal Revenue Code, which states that when any transaction occurs “to which the economic substance doctrine is relevant” (ignoring federal income tax effects), it will be considered to have economic substance only if:
The transaction changes in a meaningful way the taxpayer’s economic position, and The taxpayer has a substantial purpose for entering into this transaction.
In other words, you need a good business reason for having made that transaction, other than saving yourself some income tax. This IRS test is one you’ll want to pass. Failure means the transaction will likely not be allowed as a deduction, and you may be subject to a potential 20 to 40 percent penalty. IRS Notice 2010-62 contains more details.
Does your company have independent audits or financial statements prepared? Read on.
The IRS has been demanding to see accountants’ work papers under the Work Product Doctrine. These work papers are used to document income tax accruals for the financial statements – primarily for book-to-tax differences. They also can include issues to support contingent tax liabilities if certain tax return positions are disallowed.
Historically protected as privileged information, it’s no longer clear whether these files can be kept private. The Supreme Court declined to review the Textron case, which has been the most prominent case on this controversy.
General business credits extended
Most general business incentives were extended for 2012, but the temporary HIRE Act expired in December. The highly touted Small Business Health Care Tax Credit is available from 2010 through 2013, but only a few small businesses will meet the criteria to benefit from it.
Qualified small business stock
If you were fortunate enough to acquire qualified small business stock (between Sept. 27 and Dec. 31, 2010) that gained in value, and if you hold it at least five years, in 2015 you’ll be able to take advantage of the 100 percent exemption for capital gains (including for AMT) under the Small Business Jobs Act of 2010.
More good news: The 2010 tax relief act extends that exemption for acquisitions through 2011.
Startup expense deduction
If you started a business in 2010, you’ll be glad of the change in the rules related to capitalizing startup expenses. Through 2009, there was an allowance of $5,000 for this deduction with a phaseout when total expenses exceeded $50,000. For 2010 only, this threshold was doubled to $10,000. Of course, the excess amounts are amortizable over 15 years.
Change in inventory methods
There were no substantial changes in the tax impact of altering the method of inventory accounting, but some economic pressures may make the timing more advantageous than in recent years.
The last-in, first-out (LIFO) method has been a boon to income tax savings in inflationary times, allowing companies to deduct the cost of sales at the highest amount possible and maintain their inventory at a much lower valuation using the low cost of purchases from years past.
Inflation’s relatively flat rate for the past few years has diminished the difference in that deferral.
Simultaneously, with the move toward conforming US GAAP to the International Financial Reporting Standards (IFRS), LIFO will not be an acceptable method for financial reporting. IRC Section 472c requires that, if LIFO is used for tax reporting, then book accounting must use that method also. Thus, companies moving toward the IFRS will have to abandon the LIFO method for tax reporting as well.
With the convergence of those two realities, the next couple of years will be a good time to consider making the change toward the first-in, first-out (FIFO) or some other more appropriate inventory method.
You’ll need IRS Form 3115 to report the inventory accounting change with the tax year to which it applies. In most cases, the income tax impact can be spread over four years, beginning in the tax year of the change. Consult your tax adviser if you are considering this change to discuss the tax impact, accounting impact and timing to see if it is appropriate for your situation.