Small Businesses: Is It Time to Switch to a Simpler Method of Tax Accounting?
posted Dec 3, 2018 by Henry A. Silva, CPA, CGMA, MBA in the Business Blog
The Tax Cuts and Jobs Act (TCJA) permanently expands the number of small businesses that are eligible for various simpler, more-flexible tax accounting methods. Here are the details.
Cash Method Accounting
The TCJA permanently increases the gross-receipts threshold for businesses that are eligible for the cash method of accounting for federal income tax purposes. Under prior law, businesses with average annual gross receipts of $5 million or less for the previous three tax years generally were allowed to use the cash method.
Under the TCJA, for tax years beginning after 2017, businesses with average annual gross receipts of $25 million or less for the three previous tax years can use the cash method. It’s generally allowed for qualifying businesses that produce income from the purchase, production or sale of merchandise.
The cash method of accounting provides flexibility for the taxpayer to manage the timing of taxable income. That is, they can take proactive measures to defer income or accelerate expenses, assuming a constant (21%) tax rate.
Businesses above the $25 million gross receipts threshold are required to use the accrual method of accounting for federal income tax purposes. The accrual method generally matches income when earned with related expenses recorded (as incurred) in the same tax year, regardless of when cash is received or paid.
Inventory Accounting Rules
Under the TCJA, businesses with average annual gross receipts of $25 million or less for the previous three tax years also may be exempt from the requirement to use inventory accounting for federal income tax purposes. Instead, they can write off inventory costs as inventory is used or consumed as nonincidental materials and supplies. Or they can report them using financial accounting conventions.
In addition, businesses with average annual gross receipts of $25 million or less for the previous three years are exempt from the uniform capitalization (UNICAP) rules. These rules require a business to capitalize many expenses as inventory costs. Under prior law, businesses with average annual gross receipts in excess of $10 million were required to follow the UNICAP rules.
Percentage of Completion Accounting
The gross-receipts threshold for being required to use the so-called “percentage of completion” method of accounting for long-term real estate and construction contracts has also been raised from $10 million or less in average annual gross receipts to $25 million or less in average annual gross receipts. But there’s a hitch: To be eligible for the percentage of completion method, you must expect the contract to be completed within two years.
Small construction companies generally prefer to use the alternative “completed contract” method, whenever possible. Compared to percentage of completion, the completed contract method simplifies tax accounting and defers recognizing income until completion of a project.
Ready to Switch?
Contact our small business tax professionals to discuss whether your business is eligible for the increased gross-receipts thresholds for electing these simplified methods of tax accounting under the TCJA. We can help you weigh the pros and cons of switching accounting methods, implement the changes and discuss other tax planning strategies under the new law that can reduce your small business tax liability for 2018 and beyond.