Article written by:
Michele McKenney, CPA
Manager, Tax & Business Advisory Services
The Tax Cuts & Jobs Act significantly increased the number of taxpayers eligible for simplified methods of accounting. These simpler methods can result in favorable tax deductions in the year of implementation. Optimizing the year of implementation can result in bigger tax savings and result in less time and resources spent on complicated accounting methods going forward.
Certain methods of accounting previously available to taxpayers with gross receipts below $5 or $10 million have become available in 2018 to “small business taxpayers” who have average gross receipts over a three-year period below $25 million. Following is an overview of each of the four new automatic accounting method changes. The IRS has allowed these accounting method changes to be implemented through “automatic” change procedures through the filing of Form 3115. A significant advantage of an “automatic” change is that the required due date for filing Form 3115 is the due date of the taxpayer’s income tax return, including extensions.
Overall Cash Method of Accounting
Many taxpayers with gross receipts over $5 million were previously forced to use the overall accrual method of accounting. Under tax reform, this threshold increased to $25 million, making the overall cash method of accounting available to many more taxpayers.
Under the cash method of accounting revenue is not recorded until payment is received and expenses are deducted when paid. Taxable income is derived from revenue actually received, not just earned. This is simpler than many of the rules under the accrual method, and the use of the cash method better matches up tax liabilities with cash flow. To help determine which is right for your business, click here.
Exemption from Uniform Capitalization (UNICAP) Rules
Another threshold raised to $25 million of gross receipts is UNICAP (previously $10 million). Taxpayers, including both manufacturers and resellers, under the $25 million gross receipts test, are no longer required to calculate UNICAP. UNICAP involves capitalizing costs into inventory and can be a complicated, resource-consuming calculation for taxpayers. The new threshold increase results in less taxpayers being mandated to follow these rules.
Exemption from Requirement to Account for Inventory under Section 471
Taxpayers with gross receipts under $25 million are exempt from the requirement to account for inventory under Section 471. These taxpayers can instead account for inventoriable costs as non-incidental materials and supplies, or follow their book treatment. This may be appealing to taxpayers that presently expense inventoriable costs for book purposes.
Exemption from Percentage-of-Completion Method (PCM)
The exemption from the requirement to use the percentage-of-completion method (PCM) increased from $10 million to $25 million. This allows small business taxpayers who previously adopted the PCM for exempt long-term construction contracts to change to another permissible method, or to stop capitalizing costs under Section 263A for home construction contracts.
Your Unique Business
While simplified methods of accounting can be positive changes for your business, there are always additional factors unique to your company and goals that need to be considered before making a switch. Please contact your GBQ tax team member to discuss your company’s specific situation and we will help you optimize the new opportunities tax reform provides.