Posted by Amy Henretty, CPA
Under the newly enacted Tax Cuts and Jobs Act, the corporate tax rate decreased from a maximum of 35 percent to a flat 21 percent rate beginning in 2018. The Internal Revenue Service recently released a notice to corporate taxpayers which provides more guidance about the tax rates that corporations will be paying with the transition to the new tax law.
Many U.S. corporations choose to use the fiscal year reporting method instead of calendar year reporting. The current change in the tax rates was effective January 1, 2018. In the case of a fiscal year corporation, it needs to be determined what tax rate should be used when a tax year begins in 2017 but ends in 2018. According to the recent guidance from the IRS corporations who report on a fiscal year should use a “blended” 2017-2018 tax rate and not the flat 21 percent tax rate.
Corporations can determine their federal income tax for fiscal years which end on or after January 1, 2018 by first calculating their tax for the entire taxable year using the tax rates in effect prior to the new tax law and then calculate the total tax with the new 21 percent rate. After the tax is calculated using both the prior tax rate and new tax rate, it can then be proportioned by multiplying each tax amount based on the number of days in the calendar year when the different rates were in effect. Finally, adding the results of the two calculations will determine the tax due for the 2017-2018 fiscal year.
To illustrate, a fiscal year corporation with a year end March 31, 2018 has taxable income of $10 million. To compute its tax, the corporation first determines the tax using the pre-2018 rate. The total tax pre-2018 tax would equal $3.5 million, based on the prior law 35% maximum rate. This amount would then be proportioned for the number of days in the fiscal year in 2017, which results in a tax liability of approximately $2.67 million ($3.5 million x (275 days in 2017 divided by 365 total days)). Next, the total tax on the taxable income based on the 2018 rate would equal $2.1 million. This amount would then be proportioned for the number of applicable days in 2018, which results in a tax liability of approximately $525,000 ($2.1 million x (90 days in 2018 divided by 365 total days)). The corporation then adds $2.67 million and $525,000 for a total tax due of roughly $3.2 million. The blended rate results in a statutory rate of 32%.
Depending on the fiscal year end of a corporation, the 2017-2018 blended statutory rate will vary and drops by about 1.17% per month. Therefore, a corporation with an April year end would have a blended rate about 1.17% lower than the above example.
In addition, in another recent IRS notice, similar blended 2017-2018 rules apply for fiscal year corporations that were subject to alternative minimum tax (AMT) prior to the Tax Cuts and Jobs Act. The new law repealed the application of the AMT beginning January 1, 2018 so a zero rate is to be used for 2018 when calculating the blended rate.
Although the blended rate is only applicable for the 2017-2018 tax year, it applies to all corporations reporting on a fiscal year which include January 1, 2018 in its year-end. Due to the blended rate, all fiscal year corporations will be in a higher tax bracket in 2017-2018 then they will be in future years when they will be taxed at the flat 21% rate. Therefore, deductions in the 2017-2018 tax year will have greater value than in later years. This can be used as a tax planning opportunity to move deductions to the current fiscal year. Additionally, corporations that have already filed their federal income taxes that did not reflect the blended rate will want to consider filing an amended return. Please contact us with any questions or for assistance in planning for a corporation filing under a fiscal year ending in 2018.