As a result of the fact that the Tax Cuts and Jobs Act (the Act) reduced the corporate income tax rate from a maximum of 35% to a flat 21%, and that change’s interaction with Code Sec. 15(a) which covers changes in rates during a tax year, fiscal year corporations have a “blended” 2017-2018 tax rate. The one-year existence of that blended rate has planning implications.
The blended rate. Before enactment of the Act, corporations were taxed at graduated rates that ranged from 15% to 35% (Code Sec. 11(b) before amended by the Act) Act Sec. 13001(a) changed the corporation tax rate to a flat 21%. (Code Sec. 11(b)) Act Sec. 13001(c)(1) provides that the lowered corporate income tax rate is effective for tax years that begin after December 31, 2017.
However, Code Sec. 15(a) provides that, when tax rates change during a taxpayer’s tax year (straddle year), the taxpayer’s tax for the straddle year is computed using a blended tax rate. That is, the taxpayer
- Calculates two tentative taxes for the straddle year by applying each tax rate to the taxpayer’s income for the year,
- Multiplies each tentative tax by the proportion of the straddle year to which each tax rate applies, and
- Adds the results of the two calculations.
So, the Act’s changes to the corporate tax rate result in a blended rate for the 2017-2018 tax year of fiscal year corporations.
Illustration Jay Company’s tax year ends Sept. 30, 2018, and its taxable income is $10 million. To compute its tax, Jay first determines the tax on the taxable income of $10 million based on the pre-2018 rates. That tax, $3.5 million, is multiplied by the ratio of 92 days in Jay’s 2017-2018 tax year (i.e., the number of days in the 2017 calendar year) over 365 to arrive at approximately $875,000. Next, the tax on the taxable income of $10 million based on the 2018 rates is determined. The tax of $2.1 million is multiplied by the ratio of 273 days in Jay’s 2017-2018 tax year (i.e., the number of days in the 2018 calendar year) over 365 to arrive at approximately $1,575,000. Jay then adds $875,000 and $1,575,000 to determine total tax due of $2,450,000. Dividing the total tax of $2,450,000 by taxable income of $10 million yields a blended statutory rate of 24.5% for a fiscal year ending on Sept. 30, 2018.
Observation: The blended statutory rate drops by 1.17% per month ((35%-21%)/12)). For example, a corporation with an October year end will have a blended rate roughly 1.17% lower than Jay Company’s.
Planning considerations. As a consequence of having a 2017-2018 blended tax 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 21%. Thus, deductions in their 2017-2018 tax years will have greater value than in later years, and income will be taxed at a higher rate in their 2017-2018 tax years then it will be in later years.
Fiscal year corporations can benefit from actions that move deductions away from future years into the current year and move income from the current year to future years.
Source: Thomson Reuters Checkpoint Newsstand 2/26/18