Tax & Assurance Alert: Intersection of Tax Reform under the Tax Cuts and Jobs Act and IRC Section 15 for Fiscal Year Taxpayers

One of the biggest corporate tax reforms under the Tax Cuts and Jobs Act is the reduction of the corporate tax rate from the highest marginal rate of 35% to a flat 21% rate. The Act indicates that this change shall apply to taxable years beginning after December 31, 2017; however, there is an intersection with existing IRC Section 15 that impacts the effective date of the rate change for fiscal-year corporations.

IRC §15

IRC Section 15 indicates that “if any rate of tax imposed…changes, and if the taxable year includes the effective date of the change…, then

Tentative taxes shall be computed by applying the rate for the period before the effective date of the change, and the rate for the period on and after such date, to the taxable income for the entire taxable year, and

The tax for such taxable year shall be the sum of that proportion of each tentative tax which the number of days in each period bears to the number of days in the entire taxable year.” (§15(a)).

This means that for fiscal year corporate taxpayers that have a fiscal year straddling the January 1, 2018, effective date of the rate change, a blended tax rate will be applied to taxable income for the full fiscal year based on the tax rates in effect for the proportional number of days included in the fiscal year before and after the effective date of the rate change. The result is that fiscal year corporations will receive a benefit of the reduced corporate rates prior to its first fiscal year that occurs after December 31, 2017.  Accordingly, because implementing IRC Section 15 is mandatory, there is no benefit for transitioning a fiscal year corporation into a calendar year-end taxpayer – the benefits of the reduced tax rate will occur on January 1, 2018, regardless of a taxpayer’s year-end. 

Example

If a corporation has a September 30 fiscal year end and was previously subjected to the 35% tax rate, their statutory tax rate for the year ending September 30, 2018, will be computed as follows:

  • Number of days of fiscal year occurring in 2017 at 35% rate: October 1, 2017 – December 31, 2017: 92 days
  • Number of days of fiscal year occurring in 2018 at 21% rate: January 1, 2018 – September 30, 2017: 273 days
  • Proportion of days in 2017: 92/365 = 25.2%
  • Proportion of days in 2018: 273/365 = 74.8%
  • Blended rate for fiscal year ending September 30, 2018: (35% x 25.2%) + (21% x 74.8%) = 24.52%

Please note that IRC §15 is applicable only to statutory tax rate changes. It does not impact the effective date for the implementation or repeal of other provisions contained in the Tax Cuts and Jobs Act, which will be effective pursuant to the dates provided in the Act (generally for tax years beginning after December 31, 2017).

Planning Opportunity

Fiscal year taxpayers should evaluate whether there is any opportunity accelerate tax deductions into the fiscal year that straddles the effective date of the tax rate change. Because taxable income during this straddle year will be based partially on the legacy statutory tax rates, tax deductions will be more valuable in the straddle year than when a corporation is subject to the flat 21% rate for its full fiscal year. Even for items that are generally temporary in nature, there will be a permanent element to tax savings as result of the blended rate.

As an example, one of the provisions of the Act is to permit 100% bonus for fixed assets placed in service after September 27, 2017. Assume that a September 30 fiscal year taxpayer normally purchases $1,000,000 of depreciable property during its fiscal year. Under the Act, this taxpayer will now be entitled to claim 100% bonus depreciation on its qualifying fixed assets placed in service from October 1, 2017 – September 30, 2018. Based on the blended rate computed in the above example, this $1,000,000 deduction would be valued at $245,200 ($1,000,000 deduction x 24.52% blended rate) for the fiscal year ending September 30, 2018. For the next fiscal year (the year ending September 30, 2019), the taxpayer will be subject to a flat 21% tax rate, and accordingly that same pre-tax deduction will be valued at only $210,000 ($1,000,000 deduction x 21% rate). This means that the deduction’s value was permanently impaired by $35,200, simply as a reduction in the corporate tax rate.

Accordingly, to maximize the value of the deduction, corporations may want to consider revisiting their budgeting and planning to determine if it makes sense to accelerate purchases or deductions (to the extent permissible) into the fiscal year in which the blended tax rate will be applied..

We Can Help

Please contact your Elliott Davis advisor if you have any questions about this alert.