September 4, 2018 | Tax Planning
The Tax Cuts and Jobs Act (TCJA) included many changes, including that many more businesses can now use the simpler and more flexible cash method of accounting for federal income tax purposes. The TCJA also includes some other tax accounting changes that are good news for small businesses. These provisions are permanent, like many TCJA changes that apply to businesses. Here’s what you need to know.
Expanded Use of Cash Method Accounting
Prior to the TCJA, C corporations generally weren’t allowed to use the cash method if they had average annual gross receipts of more than $5 million for the previous three tax years. This was also true for entities with average annual gross receipts of more than $5 million that were:
- Partnerships with C corporation partners, or
- Limited liability companies (LLCs) treated as partnerships for tax purposes with C corporation members.
These taxpayers were instead required to use the accrual method of accounting. That limited the opportunities to manage taxable income across several years by altering the timing of income and deductions to minimize the cumulative federal income tax liability for those years.
For tax years beginning after 2017 and under the TCJA, cash method accounting is allowed for those taxpayers if their average annual gross receipts for the three previous tax years didn’t exceed $25 million. Even if the purchase, production, or sale of merchandise is an income-producing factor for these taxpayers, the cash method is allowed.
This change allows many more C corporations—and partnerships and LLCs with C corporation partners and members—to use the cash method in 2018 and going forward.
Expanded Use of Simplified Inventory Accounting Rules
For tax years beginning after 2017, accounting for inventories will be much easier for many businesses under the TCJA. This provision of the law exempts most businesses with average annual gross receipt of $25 million or less for the three previous tax years from the requirement to use inventory accounting for federal income tax purposes. These taxpayers can instead either account for inventory costs:
- As the cost of non-incidental materials and supplies that are simply written off when they’re used or consumed, or
- In the same manner as the costs are treated for financial accounting purposes.
Businesses with average annual gross receipts of $25 million or less for the three previous tax years are also exempt from the complicated uniform capitalization (UNICAP) rules that mandate capitalizing many expenses as inventory costs. Both producers and resellers are subject to this change. Before the TCJA, many businesses with average annual gross receipts in excess of $10 million were required to follow the UNICAP rules.
Long-Term Real Property Construction Contracts
Before the TCJA, construction companies with average annual gross receipts in excess of $10 million for the previous three tax years were generally required to use the percentage of completion method (PCM) to calculate annual taxable income from long-term contracts for the construction or improvement of real property. Because it requires contractors to recognize taxable income earlier than under the completed contract method, this method of accounting is less favorable.
Under the TCJA, for tax years beginning in 2017 and beyond, businesses with average annual gross receipt of $25 million or less won’t be required to use the PCM for contracts that are expected to be complete within two years.
Accounting for taxes can be very complicated. Fortunately, tax reform legislation has expanded the eligibility requirement for some simplified tax accounting method for small businesses. Contact us to determine whether these alternatives could work for your business in 2018, as well as for other tax planning opportunities under the TCJA.