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Read this if you are interested in learning about ESG. 

Although tax credits as subsidies have been a cornerstone catalyst for advancing many environmental, social, and governance (ESG) policies and technologies over the last several years, tax is often forgotten or minimized in the process of creating and implementing corporate ESG and value creation strategies. Ignoring the symbiotic relationship between tax and ESG is a losing strategy, given increased awareness of the importance of tax transparency among shareholders and other stakeholders as a mechanism for holding companies accountable to their stated ESG commitments. A rise in media and rating agency reports on the topic indicate tax will continue to be under scrutiny in the future and may increasingly have significant corporate reputational impacts as well.

As leaders of an organization’s tax function, including as vice presidents of tax, tax directors, or CFOs among others, you are the stewards charged with ensuring tax strategy and operations appropriately intersect with the corporate ESG vision and meaningfully advance ESG commitments. However, the 2022 BDO Tax Outlook Survey found that while an overwhelming majority of senior tax executives expressed an understanding of the value of ESG, three quarters of those responsible for tax were not currently involved in the organization’s ESG strategy. The findings indicate that tax leaders will need to insert the tax function into the ESG planning and execution process and take ownership of tax’s role in ESG. Insights from the survey outline how tax fits into ESG, the core principles of an ESG-focused tax strategy and key considerations for transparent reporting.

How does tax overlap with ESG?

Because there is some misunderstanding about how tax relates to environmental, social, and governance issues, there is a high probability that tax may not be incorporated in responsible business strategy and planning. While not reflected in the ESG acronym, there is an element of tax that is central to each of these principles. For example, environmental behavioral taxes and incentives, such as carbon taxes on greenhouse gas emissions and tax incentives for green energy adoption, are crucial to driving behavior change toward more sustainable practices in the near term while many impacts of climate change are still experienced in indirect ways. In terms of the social element, taxes are a key mechanism for companies to contribute to the societies in which they operate and to build trust among members of the public as a responsible corporate actor. Finally, proper tax governance can ensure that there is appropriate oversight over an organization’s tax strategy and decisions, ensuring they align with overarching business objectives and stakeholder communications around tax reporting.

Using the tax ESG cipher to unlock a successful ESG-driven tax strategy

Aligning the tax function with an overarching ESG strategy across the business is a heavy lift. To build and implement a responsible tax program will take time and requires careful consideration of an organization’s overall approach to tax, tax governance and total tax contribution. Each company will have a unique tax strategy based on its business and stakeholder considerations and may be at varying points along its responsible tax journey. Whether you are just beginning or at the stage of reassessing your approach based on changing market conditions, updates to your ESG strategy, or regulations, the cypher below can be used to guide these critical considerations and help ensure tax is meaningfully incorporated in ESG strategy. The process should be iterative over time and when implemented successfully, will drive improved decision-making on risk mitigation, strengthen risk awareness and increase transparency and accountability.

Core principle one: Approach to tax

The first step to meaningfully incorporating tax in ESG strategy is understanding and articulating the purpose and values that guide the tax function. This process includes defining the organization’s approach to regulatory compliance and the interaction with tax authorities. Writing a tax policy and strategy is an important way to articulate the company’s tax priorities and educate all team members across the organization about the function’s principles. The statement may include commitments to communicate transparently with regulators and disclose more information than required by law in some cases, for example.

As the organization evolves due to changes in the industry, overall ESG commitments and sustainability strategies, the tax strategy statement should be updated accordingly. Regulatory changes will also necessitate continuous assessment and consideration of whether the strategy meets the current understandings of transparency, risk mitigation and accountability based on new information. Through this set of guiding principles, the tax function can help improve decision-making and reporting actions to align with changes in the broader corporate ESG strategy, purpose, and values. 

Core principle two: Tax governance and risk management

Establishing a robust governance, control, and risk management framework provides comfort and assurance that the reported approach to tax and tax strategy is well embedded in an organization’s substantiable business strategy and that there are mechanisms in place to effectively monitor its compliance obligations.

However, it’s important to remember that tax governance and risk management have broad considerations that go beyond the traditional frameworks governing internal controls over financial reporting (ICFR). A common pitfall for many is a narrow focus on governance strategies. Generally, ICFR focuses on accurate and complete reporting in financial statements. While this is an important area of governance, it does not account for or represent the many objectives included in a tax ESG control framework, which is typically broader as it focuses on how and why decisions regarding tax approaches and positions are made.

The objective of this core principle is to demonstrate to stakeholders how the organization’s tax governance, control and risk management function are in alignment with the values and principles outlined in the Approach to Tax statement. This can include establishing a risk advisory council, guidelines for including tax in ESG reporting deliverables and any corresponding regulatory requirements, and communications to relevant stakeholders on executive oversight activities related to the tax strategy.  

However, many organizations have not taken the time to document and define their risk mitigation and executive oversight strategy. Often this is left merely to control procedures that are mechanical and regulatory in nature. Instead, a tax governance and risk management strategy should aim to establish a framework focused on strengthening risk awareness and transparently communicating governance activities to both internal and external audiences when appropriate.

Core principle three: Total tax contribution

While quantifying and providing necessary qualitative context around an organization’s total tax contribution is not an easy task, today, stakeholders from employees and customers to investors and regulators expect transparency around tax strategies, tax-related risks, total tax contribution and country-by-country activities. Recently, tax has received increased scrutiny from these stakeholders because it is a core component of many ESG metrics used to evaluate a business’s tax behaviors and ensure there is accountability across its tax practices. The result is that how a company shares tax information with stakeholders and what it includes in reports has a significant impact on reputation and perceptions of corporate ESG statements.

However, the increased demand for tax transparency is not without its challenges. Nearly two-thirds of respondents in the 2022 BDO Tax Outlook Survey (62%) said data collection and analysis (the quantitative component of ESG-focused tax) is the greatest challenge of tax transparency reporting efforts, pointing to an underlying issue of tax data governance and fragmented systems. Often this is an area where tax leaders require outside assistance to establish automated processes that can collect tax data on a periodic basis for regular analysis. The importance of ESG and attention around the topic will only continue to increase over the next several years, so it is critical to begin thinking about adequate data collection and analytic capabilities for tax leaders looking to incorporate tax in ESG practices and strategy. For those just beginning the process, our advice is to partner with in-house IT functions or external consultants for assistance and support.

Collecting relevant tax data on a regular basis is a critical early step because it affords tax leaders the opportunity to determine which information will be disclosed to various stakeholders and which information can help shape and support broader ESG narratives being developed by corporate leadership. While determining data collection processes, it is also important to consider and seek counsel on communication and information delivery strategies that will best reach and address the concerns of priority stakeholder groups.   

Although this task can be a heavy lift, it may also result in significant business advantages. A key benefit is that the data and information gathered will help tax leaders further define and evolve ESG-driven tax strategies through tax monetization structures and company core value items, among others. Ultimately, organizations that better understand their total tax contribution across various taxing jurisdictions and country-by-country activities are best equipped to make data-driven tax strategy decisions that are aligned with broader ESG and sustainability objectives, while also avoiding value creation hinderances. 

Key reporting considerations

Once the quantitative data have been collected, the next step is to consider how you report the information. Communicating the numbers themselves is not enough. Communicating the narrative behind the numbers – the qualitative component of reporting – is extremely important. The narrative should always aim to communicate the company’s approach to tax, values guiding decision-making and the impact of the tax strategy to key stakeholders in a straightforward and transparent manner. However, qualitative reporting can vary by organization depending on several factors, from choice of standards to company philosophy.

The 2022 BDO Tax Outlook Survey also found that challenges and variance in tax transparency reporting are driven by a lack of universal reporting standards and clarity around which ESG frameworks to follow. In the meantime, the best reporting framework for any company is one that drives a deep understanding of the organization’s ESG philosophy and vision, which may require more investment in terms of time and effort. When determining a reporting approach, it is important to consider the goal of the report or disclosure and which data best demonstrate ESG progress and strategy. Because the ESG-related tax reporting is not a mandated process and is currently a voluntary disclosure in the U.S., it can often be helpful to review tax reports related to ESG from other companies already making these disclosures as a baseline.

Keep in mind that one of the main reasons businesses are electing to publish comprehensive ESG and Sustainability Tax Reports and Global Tax Footprints is to articulate their broader total tax contribution to ensure that the tax narrative speaks to the needs and demands of their stakeholders. Each report must be unique and relevant to the company in terms of content and method of disclosure.

Currently, there is a relatively small number of companies electing to make such disclosures, based on the findings of the 2022 BDO Tax Outlook Survey outlined below. Of the 150 senior tax executives polled, less than a quarter (23%) are implementing both qualitative and quantitative disclosures:

Tax transparency reporting disclosures

Today, tax is an essential component of the ESG metrics that determine how stakeholders perceive an organization. Despite this fact, the movement to incorporate tax in ESG planning and strategies is still in its infancy. This means leaders of tax functions still have time to begin the process of implementing ESG-driven tax strategies and operations to ensure the function evolves with the importance of ESG. While there is no simple one-size-fits-all solution, given the nuances and complications of the tax function for each organization, the general framework in the Tax ESG Cipher can help guide tax leaders at any point on the journey. The cipher outlines key considerations to ensure an organization’s ESG vision is well-structured and appropriately includes tax strategies. While the process requires long-term effort and dedication, it generates high returns in terms of accountability, transparency, and reputational and sustainable value.

As ESG takes center stage in a rapidly changing business landscape, how is your organization advancing toward true sustainability?

Written by Daniel Fuller and Jonathon Geisen. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com  

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Navigating the intersection of tax and ESG

Read this if you file taxes with the IRS for yourself or other individuals.

To protect yourself from identity thieves filing fraudulent tax returns in your name, the IRS recommends using Identity Protection PINs. Available to anyone who can verify their identity online, by phone, or in person, these PINs provide extra security against tax fraud related to stolen social security numbers of Tax ID numbers.

According to the Security Summit—a group of experts from the IRS, state tax agencies, and the US tax industry—the IP PIN is the number one security tool currently available to taxpayers from the IRS.

The simplest way to obtain a PIN is on the IRS website’s Get an IP PIN page. There, you can create an account or log in to your existing IRS account and verify your identity by uploading an identity document such as a driver’s license, state ID, or passport. Then, you must take a “selfie” with your phone or your computer’s webcam as the final step in the verification process.

Important things to know about the IRS IP PIN:

  • You must set up the IP PIN yourself; your tax professional cannot set one up on your behalf.
  • Once set up, you should only share the PIN with your trusted tax prep provider.
  • The IP PIN is valid for one calendar year; you must obtain a new IP PIN each year.
  • The IRS will never call, email or text a request for the IP PIN.
  • The 6-digit IP PIN should be entered onto your electronic tax return when prompted by the software product or onto a paper return next to the signature line.

If you cannot verify your identity online, you have options:

  • Taxpayers with an income of $72,000 or less who are unable to verify their identity online can obtain an IP PIN for the next filing season by filing Form 15227. The IRS will validate the taxpayer’s identity through a phone call.
  • Those with an income more than $72,000, or any taxpayer who cannot verify their identity online or by phone, can make an appointment at a Taxpayer Assistance Center and bring a photo ID and an additional identity document to validate their identity. They’ll then receive the IP PIN by US mail within three weeks.
  • For more information about IRS Identity Protection PINs and to get your IP PIN online, visit the IRS website.

If you have questions about your specific situation, please contact our Tax Consulting and Compliance team. We’re here to help.

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The IRS Identity Protection PIN: What is it and why do you need one?

The Centers for Medicare & Medicaid Services (CMS) has issued the final rule for FY 2023 SNF PPS which was published in the Federal Register on August 3, 2022. The rule:

  • Updates the PPS rates for SNFs for FY 2023 using the market basket update and budget neutrality factors effective October 1, 2022;
  • Recalibrates the Patient Driven Payment Model (PDPM) parity adjustment;
  • Establishes a permanent 5% cap on annual wage index decreases;
  • Finalizes proposed changes in PDPM International Classification of Diseases, Version 10 (ICD-10) code mappings;
  • Updates the SNF Quality Reporting Program (SNF QRP); and
  • Updates the SNF Value-Based Purchasing (SNF VBP) Program.

2023 PPS rate calculations

The final rule provides a net market basket increase for SNFs of 5.1 percent beginning October 1, 2022 which reflects:

  • An unadjusted market basket increase of 3.9 percent adjusted upward by 1.5 percent associated with a forecast error adjustment;
  • A reduction of 0.3 percentage points in accordance with the multifactor productivity adjustment required by Section 3401(b) of the Affordable Care Act (ACA).

In addition, as discussed in the Recalibration of the PDPM parity adjustment section below, the net market basket increase of 5.1 percent is further reduced by 2.3 percent related to accounting for year one of a two-year PDPM parity adjustment phase-in.

CMS projects an overall increase in Medicare Part A SNF payments of approximately 2.7 percent or $904 million in FY 2023 related to the payment rate updates. The final rule also estimates an increase in costs to SNFs of $31 million related to the FY 2023 SNF QRP changes and an estimated reduction of $186 million in aggregate payments to SNFs during FY 2023 as a result of the changes to the SNF VBP program.

The projected overall impact to providers in urban and rural areas is an average increase of 2.7% and 2.5%, respectively, with a low of 1.4% for urban outlying providers and a high of 3.6% for urban Pacific providers―actual impact will vary. 

The applicable wage index continues to be based on the hospital wage data, unadjusted for occupational mix, rural floor, or outmigration adjustment (from FY 2019) in the absence of SNF specific data.

Recalibration of the PDPM parity adjustment

When CMS finalized PDPM in October 2019 it also finalized that this new case-mix classification model would be implemented in a budget neutral manner. However, since PDPM implementation, CMS has closely monitored SNF utilization data which has indicated an unintended increase in payments to providers. In order to achieve budget neutrality under PDPM, CMS is finalizing their proposal to recalibrate the PDPM parity adjustment using a factor of 4.6 percent (an impact of $1.5 billion) using the combined methodology of a subset population that excludes patients whose stay utilized a coronavirus (COVID-19) public health emergency (PHE)-related waiver or who were diagnosed with COVID-19 and control period data using months with low COVID-19. CMS is finalizing the implementation of the parity adjustment with a two-year phase-in period (2.3 percent applied in FY 2023, and 2.3 percent in FY 2024), which means that, for each of the PDPM case-mix adjusted components, CMS will lower the PDPM parity adjustment factor from 46 percent to 42 percent in FY 2023 and would further lower the PDPM parity adjustment factor from 42 percent to 38 percent in FY 2024. CMS applied the parity adjustment equally across all components.

Permanent cap on wage index decreases

To mitigate instability in SNF PPS payments due to significant wage index decreases that may affect providers in any given year, CMS is finalizing a permanent 5% cap on annual wage index decreases to smooth year-to-year changes in providers’ wage index payments.

Changes in PDPM ICD-10 code mappings

Beginning with the updates for FY 2020 nonsubstantive changes to the ICD-10 codes included on the PDPM code mappings and lists are applied through a subregulatory process consisting of posting updated code mappings and lists on the PDPM website. Substantive changes will be proposed through notice and comment rulemaking. The final rule finalized several proposed changes to the PDPM ICD-10 mappings.

SNF QRP update

CMS is finalizing the adoption of a new process measure, the Centers for Disease Control and Prevention (CDC)-developed Influenza Vaccination Coverage Among Healthcare Personnel (HCP) (NQF#0431) measure, beginning with the FY 2024 SNF QRP. The measure is intended to increase influenza vaccination coverage in SNFs, promote patient safety, and increase the transparency of quality of care in the SNF setting. Residents of long-term care facilities have greater susceptibility for acquiring influenza. Therefore, monitoring and reporting influenza vaccination rates among HCP is important as HCP are at risk for acquiring influenza from residents and exposing residents to influenza. The measure reports the percentage of HCP who receive an influenza vaccine. SNFs will submit the measure data through the CDC National Healthcare Safety Network.

CMS is also revising the compliance date for certain SNF QRP reporting requirements, including the Transfer of Health Information measures and certain standardized patient assessment data elements to October 1, 2023. This will align the collection of data with the Inpatient Rehabilitation Facilities and Long-Term Care Hospitals and Home Health Agencies.

SNF VBP program

The rule finalizes a proposal to suppress the SNF 30-Day All-Cause Readmission Measure (SNFRM) as part of the performance scoring for the FY 2023 SNF VBP program year due to the combination of fewer admissions to SNFs, regional differences in the prevalence of COVID-19 throughout the PHE and changes in hospitalization patterns in FY 2021 which has impacted the ability to use the SNFRM to calculate payments for the FY 2023 program year. For FY 2023, CMS will assign a performance score of zero to all participating SNFs and will reduce the otherwise applicable adjusted Federal per diem rate for each SNF by 2% and award SNFs 60% of that withhold, resulting in a 1.2% payback. Any SNFs that do not report a minimum of 25 stays for the SNFRM will be excluded from the VBP program for FY 2023.

In addition, Section 111(a)(2) of the Consolidated Appropriations Act, 2021 allows the secretary to add up to an additional nine new measures with respect to payments beginning in FY 2023 to the VBP program, which may include measures of functional status, patient safety, care coordination, or patient experience. CMS is using this authority to finalize the adoption of three new measures into the VBP program—two measures in FY 2026 and one measure in FY 2027.

CMS is also finalizing a number of updates to its scoring methodology:

  • Updating the policy for scoring SNFs that do not have sufficient baseline period data beginning with the FY 2026 VBP Program year.
  • Adoption of a measure minimum policy beginning with the FY 2026 SNF VBP program year which will require a two-measure minimum for a SNF to receive a SNF performance score for FY 2026 and a three-measure minimum for FY 2027.
  • Adoption of a case minimum policy for the SNFRM that replaces the Low-Volume Adjustment policy beginning with the FY 2023 program year. 
  • Adoption of a case minimum policy for the SNF HAI, Total Nurse Staffing, and DTS PAC SNF Measures beginning between FY 2026 and FY 2027.

Our experts at BerryDunn have created an interactive rate calculator to assist you with the calculation of your PPS rates for FY 2023. You can access the PPS rate calculator now:

Click to download SNF PPS Rate Calculator

Please note: The rates per our calculator are prior to any FY 2023 VBP adjustment based on the final rule which includes special scoring and payment policies for FY 2023. When CMS releases the final VBP incentive payment multipliers for FY 2023 by facility, we will update the interactive rate calculator as necessary.

If you have any specific questions about the final rule or how it might impact your facility, please contact Ashley Tkowski or Melissa Baez.

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Fiscal Year (FY) 2023 Skilled Nursing Facility (SNF) Prospective Payment System (PPS) final rule

Release Date: August 1, 2022
Federal Register Publication Date: Scheduled for August 10, 2022
Effective Date: October 1, 2022 

The Centers for Medicare & Medicaid Services (CMS) issued a final rule that updates Medicare payment rates and policies for inpatient hospitals and long-term care hospitals for the fiscal year 2023, as well as other provisions. Following is a summary of the major provisions of this final rule.

IPPS payment rates:

CMS finalized a net increase in FY 2023 Medicare IPPS rates of 4.3% for hospitals that are meaningful users of electronic health records and submit required quality data, up 1.1 percentage points from the 3.2% increase initially proposed. The increase is broken down as follows:

CMS estimates the following impact of the proposed rule on hospital payments, including the impact of reductions to DSH and other payments:


 

LTCH PPS Payment Rates:

CMS finalized a net increase in FY 2023 Medicare LTCH PPS rates of 2.3% for long-term care hospitals, up 1.6 percentage points from the 0.7% increase initially proposed. The payment rate update includes the productivity-adjusted market basket increase of 3.8% for FY 2023 and a projected decrease in high-cost outlier payments. CMS estimates that LTCH PPS payments will increase approximately $71 million as a result of the FY 2023 payment update.

Other major provisions:

  • Rate setting will be based on FY 2021 MedPAR claims data and FY 2020 cost report data, consistent with historical practice, but with modifications to account for the COVID-19 pandemic, including:
    • Calculating MS-DRG relative weights based on the average of two set of weights, one including and one excluding COVID-19 claims
    • Determining outlier fixed-loss amount using charge inflation and Cost to Charge Ratio (CCR) adjustment factors to approximate the increase in costs that will occur from FY 2021 to FY 2023
    • Modifying the outlier fixed-loss amount calculation to factor in certain payment increases for COVID-19
  • 25 technologies are eligible for new technology add-on payments (NTAP) in FY2023, including 8 newly approved technologies, discontinuation of NTAP for those technologies that have been in the market for 3 years, and discontinuation for those technologies that received an extension in FY2022.
  • No new MS-DRGs are established and the implementation of the “three-way split criteria” will be further delayed.
  • Policy modification relating to Medicare Graduate Medical Education (GME) for teaching hospitals that apply for the FTE cap when the Hospital’s weighted FTE count is greater than its FTE cap but would not reduce the weighting factor of residents that are beyond their initial residency period to less than 0.5 for cost reporting periods beginning on or after October 1, 2022.
  • Urban and rural hospitals participating in the same Rural Training Program (RTP) are given the same flexibility as other teaching hospital to share RTP cap slots via an GME affiliation agreement, effective academic year beginning July 1, 2023. 
  • Uncompensated care costs will be distributed based on more than one year of Worksheet S-10 cost report data. Data from the two most recent years of audited data (FY 2018 and FY 2019) will be used to distribute FY 2023 payments and a three-year average would be used for FY 2024 and beyond. 
  • Decreases to a hospital’s wage index from the prior fiscal year will be capped at 5%. This policy will be applied in a budget neutral manner through a national adjustment to the standardized amount.
  • Wage index rural floor will be calculated as it was before FY 2020. Wage data of hospitals that have reclassified from urban to rural will be included in the calculation of the rural floor and wage index for rural areas in the state where the hospital’s county is located. 
  • Expected in Fall 2023, CMS will establish a publicly-reported, public-facing hospital designation on the quality and safety of maternity care for hospitals that report “Yes” to both questions in the Maternal Morbidity Structural Measure in the Hospital Inpatient Quality Reporting (IQR) Program. 
  • CMS finalizes a variety of changes for the Hospital IQR Program, some include:
    • Adopting ten measures and refining two current measures
    • Making changes to the existing Electronic Clinical Quality Measures (eCQM) reporting and submission requirements
    • Removing the zero denominator declaration and case threshold exemptions for hybrid measures
    • Updating eCQM validation requirements for medical record requests
    • Establishing reporting and submission requirements for patient-reported outcome-based performance measures.
  • CMS finalizes a variety of changes to the Medicare Promoting Interoperability Program for eligible Hospitals and Critical Access Hospitals (CAHs).
  • CMS will pause or refine certain measures in the Hospital Readmissions Reduction Program (HRRP), Hospital-Acquired Condition (HAC) Reduction Program, and Hospital Value-Based Purchasing (VBP) Program that would be impacted by circumstances caused by the COVID-19 Public Health Emergency.
  • Implement a five-year extension of the Rural Community Hospital and Frontier Community Health Integration project (FCHIP) demonstrations, as authorized by the Consolidated Appropriations Act of 2021.
  • Revise Conditions of Participation (CoP) for Hospitals and CAHs to continue to report COIVD-19 and seasonal influenza data after the conclusion of the COVID-19 PHE and continue until April 30, 2024, unless ended earlier by the Secretary.

Major Proposed Provisions that were NOT finalized:

  • Proposed regulation governing the calculation of the Medicaid fraction of the Medicare disproportionate share hospital (DSH) that would be explicit as to who is “regarded as eligible” for Medicaid. As proposed, it would include only patients who receive health insurance through a Section 1115 demonstration itself, or who purchase such insurance with the use of premium assistance provided by a Section 1115 demonstration that assists with at least 90% of the cost of health insurance. CMS is not moving forward with this proposal currently but expects to revisit it in future rulemaking.
  • CMS has withdrawn its proposal to establish additional data reporting requirements for Hospitals and CAHs during future PHEs related to epidemics and pandemics.

Sources: 
CMS-1771-F Medicare Program; Hospital Inpatient Prospective Payment Systems for Acute Care Hospitals and the Long-Term Care Hospital Prospective Payment System and Policy Changes and Fiscal Year 2023 Rates; Quality Programs and Medicare Promoting Interoperability Program Requirements for Eligible Hospitals and Critical Access Hospitals; Costs Incurred for Qualified and Non-qualified Deferred Compensation Plans; and Changes to Hospital and Critical Access Hospital Conditions of Participation

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Medicare Final Rule for FY 2023 Hospital Inpatient Prospective Payment System (IPPS) and Long Term Care Hospitals (LTCH PPS)

Read this if you are a business owner or responsible for your company’s accounts.

US businesses have been hit by the perfect storm. As the pandemic continues to disrupt supply chains and plague much of the global economy, the war in Europe further complicates the landscape, disrupting major supplies of energy and other commodities. In the US, price inflation has accelerated the Federal Reserve’s plans to raise interest rates and commence quantitative tightening, making debt more expensive. The stock market has declined sharply, and the prospect of a recession is on the rise. Further, US consumer demand may be cooling despite a strong labor market and low unemployment.

As a result of these and other pressures, many businesses are rethinking their supply chains and countries of operation as they also search for opportunities to free up or preserve cash in the face of uncertain headwinds.

Income tax accounting methods

Adopting or changing income tax accounting methods can provide taxpayers opportunities for timing the recognition of items of taxable income and expense, which determines when cash is needed to pay tax liabilities.

In general, accounting methods either result in the acceleration or deferral of an item or items of taxable income or deductible expense, but they don’t alter the total amount of income or expense that is recognized during the lifetime of a business. As interest rates rise and debt becomes more expensive, many businesses want to preserve their cash. One way to do this is to defer their tax liabilities through their choice of accounting methods.

Some of the more common accounting methods to consider center around the following:

  • Advance payments. Taxpayers may be able to defer recognizing advance payments as taxable income for one year instead of paying the tax when the payments are received.
  • Prepaid and accrued expenses. Some prepaid expenses can be deducted when paid instead of being capitalized. Some accrued expenses can be deducted in the year of accrual as long as they are paid within a certain period of time after year end.
  • Costs incurred to acquire or build certain tangible property. Qualifying costs may be deducted in full in the current year instead of being capitalized and amortized over an extended period. Absent an extension, under current law, the 100% deduction is scheduled to decrease by 20% per year beginning in 2023.  
  • Inventory capitalization. Taxpayers can optimize uniform capitalization methods for direct and indirect costs of inventory, including using or changing to various simplified and non-simplified methods and making certain elections to reduce administrative burden.
  • Inventory valuation. Taxpayers can optimize inventory valuation methods. For example, adopting to (or making changes within) the last-in, first-out (LIFO) method of valuing inventory generally will result in higher cost of goods sold deductions when costs are increasing.
  • Structured lease arrangements. Options exist to maximize tax cash flow related to certain lease arrangements, for example, for taxpayers evaluating a sale vs. lease transaction or structuring a lease arrangement with deferred or advance rents.

Improving cash flow: Revisiting your tax accounting methods

Optimizing tax accounting methods can be a great option for businesses that need cash to make investments in property, people, and technology as they address supply chain disruptions, tight labor markets, and evolving business and consumer landscapes. Moreover, many of the investments that businesses make are ripe for accounting methods opportunities—such as full expensing of capital expenditures in new plant and property to reposition supply chains closer to operations or determining the treatment of investments in new technology enhancements.

For prepared businesses looking to weather the storm, revisiting their tax accounting methods could free up cash for a period of years, which would be useful in the event of a recession that might diminish sales and squeeze profit margins before businesses are able to right-size costs.

While an individual accounting method may or may not materially impact the cash flow of a company, the impact can be magnified as more favorable accounting methods are adopted. Taxpayers should consider engaging in accounting methods planning as part of any acquisition due diligence as well as part of their regular cash flow planning activities.  

Impact of deploying an accounting method

The estimated impact of an accounting method is typically measured by multiplying the deferred or accelerated amount of income or expense by the marginal tax rate of the business or its investors.
For example, assume a business is subject to a marginal tax rate of 30%, considering all of the jurisdictions in which it operates. If the business qualifies and elects to defer the recognition of $10 million of advance payments, this will result in the deferral of $3 million of tax. Although that $3 million may become payable in the following taxable year, if another $10 million of advance payments are received in the following year the business would again be able to defer $3 million of tax.

Continuing this pattern of deferral from one year to the next would not only preserve cash but, due to the time value of money, potentially generate savings in the form of forgone interest expense on debt that the business either didn’t need to borrow or was able to pay down with the freed-up cash. This opportunity becomes increasingly more valuable with rising interest rates, as the ability to pay significant portions of the eventual liability from the accumulation of forgone interest expense can materialize over a relatively short period of time, i.e. the time value of money increases as interest rates rise.

Accounting method changes

Generally, taxpayers wanting to change a tax accounting method must file a Form 3115 Application for Change in Accounting Method with the IRS under one of two procedures:

  • The “automatic” change procedure, which requires the taxpayer to file the Form 3115 with the IRS as well as attach the form to the federal tax return for the year of change; or
  • The “nonautomatic” change procedure, which requires advance IRS consent. The Form 3115 for nonautomatic changes must be filed during the year of change.

In addition, certain planning opportunities may be implemented without a Form 3115 by analyzing the underlying facts.

Next steps for businesses

Taxpayers should keep in mind that tax accounting method changes falling under the automatic change procedure can still be made for the 2021 tax year with the 2021 federal return and can be filed currently for the 2022 tax year.

Nonautomatic procedure change requests for the 2022 tax year are recommended to be filed with the IRS as early as possible before year end to give the IRS sufficient time to review and approve the request by the time the federal income tax return is to be filed.

Engaging in discussions now is the key to successful planning for the current taxable year and beyond. Whether a Form 3115 application is necessary or whether the underlying facts can be addressed to unlock the accounting methods opportunity, the options are best addressed in advance to ensure that a quality and holistic roadmap is designed. Analyzing the opportunity to deploy accounting methods for cash savings begins with a discussion and review of a business’s existing accounting methods.

Please contact our Tax Consulting and Compliance team if you have questions or concerns about your specific situation. We’re here to help.

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When interest rates rise, optimizing tax accounting methods can drive cash savings