By: Alyss Carpenter, Manager, Maloney+Novotny
Tax Accounting Methods Relief Provided to Small Business Taxpayers
The Tax Cuts & Jobs Act (TCJA) has provided relief to certain “small business taxpayers” with less than $25 million in average gross receipts (over the past three tax years) to utilize the cash method of accounting, to no longer account for inventories, and to be exempt from the uniform capitalization (UNICAP) provisions which require certain costs relating to inventories to be capitalized. The new provisions for small business taxpayers become effective with tax years beginning after December 31, 2017, and the taxpayer must follow certain procedures to properly elect for the change in accounting methods. Along with being a simpler method of accounting, these changes could provide significant tax savings in the current year and beyond, depending on the taxpayer’s facts and circumstances.
Background and Old Law
The cash method of accounting generally provides that income and expenses are recognized when the cash is received or paid. The accrual method generally recognizes income the earlier of 1) when cash is received, or 2) when the right to receive income is received and the amount of income is determinable. Further, taxpayers using the accrual method generally cannot deduct expenses before 1) all events have occurred that fix the obligation to pay, 2) the amount of expense is determinable, and 3) economic performance has occurred. A taxpayer is permitted to select a method of accounting for tax purposes within the guidelines of the Internal Revenue Code. The cash method of accounting is generally simpler, but under prior law, was only available to a small group of taxpayers.
Under the pre-TCJA law, most C corporations, any partnership with a C corporation partner, and taxpayers who carried inventory were required to use the accrual method for tax purposes. Some exceptions applied based on limited gross receipts thresholds which were applied every year since taxpayer business inception, depending on the taxpayer’s business activities.
In addition, several provisions in the Code have also required the capitalization of certain costs related to inventory such as nonincidental materials and supplies, and certain direct and indirect costs under §263A UNICAP.
Beginning with tax year 2018, all taxpayers who qualify as small business taxpayers (including C corporations and taxpayers who carry inventory) with less than $25 million in average annual gross receipts can elect to change their overall accounting method to utilize the cash method for tax purposes, to no longer account for inventories, and to be exempt from the UNICAP requirements. All three changes are separate accounting method changes which if applicable, should be requested using the automatic change request procedures on a single Form 3115 to be filed with the taxpayer’s tax return. The taxpayer recognizes an overall favorable or unfavorable change based on the taxpayer’s beginning balance sheet for the year, which is known as a 481(a) adjustment.
For more information on this change in accounting methods for small business taxpayers, contact your Maloney + Novotny representative or use this online contact form.