Jennifer Kloppel, BridgeTower Media Newswires
The Tax Cuts and Jobs Act (TJCA) included several provisions that will allow more taxpayers to take advantage of some tax methods previously unavailable to them. These provisions contain the following changes:
Expanded use of the overall cash method of accounting;
- An increase in the level of income required for exemption from the requirement to keep inventory;
- An increase in the level of income required for exemption from the Uniform Capitalization (UNICAP) rules; and
- An increase in the level of income required for exemption from the requirement to use the percentage of completion method.
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Cash method of accounting
With the cash method, taxpayers recognize sales when the cash is received from the customer instead of when revenue is earned; expenses are recognized when paid instead of when incurred.
Since the cash method is simple to use, it does not require a high level of accounting structure or expertise, which can translate into significantly lower administrative costs to a company. This method also allows for better tracking of available cash that may be needed for tax payments. The cash method often defers the recognition of income to a later period essentially deferring the tax liability. Using this method can result in a tax savings - if future tax rates decrease.
Since the cash method defers the recognition of income to a later period, it is possible to alter reported earnings by not cashing checks until the next year or paying suppliers early to bring expenses into the current year. This is why the Internal Revenue Service is suspicious of its use and puts limitations on it.
Previously the IRS restricted the use of the cash method from the following taxpayers:
- A company that reports inventory on hand at year-end;
- C corporations, tax shelters, or partnerships that have "C" corporation partners;
- Entities with average annual gross receipts above $5 million for the past three tax years; and
- Personal service businesses where activities related to services are not at least 95%
For taxable years beginning after Dec. 31, 2017, the cash method of accounting is now available to C corporations and partnerships that have "C" corporation partners and the average annual gross receipts over the past three years threshold has been increased to $25 million. Taxpayers who are required to use or prefer the accrual method for book purposes can still use this method for tax purposes as long as they meet the new requirements.
Requirement to keep inventory
The IRS requires taxpayers that purchase, produce or sell merchandise as an income-producing activity to use the accrual method of accounting for inventories. Prior to the tax reform, there were exceptions for small businesses with average annual gross receipts of $1 million or less and certain trades or businesses that have average annual gross receipts of $10 million or less.
For taxable years beginning after Dec. 31, 2017, the IRS has increased the level at which taxpayers are allowed to use the cash method for accounting for inventory to $25 million in average annual gross receipts for the last three years.
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Uniform Capitalization Rules (UNICAP ) - Section 263A
The Uniform Capitalization Rules of IRC Section 263A, also known as UNICAP, require taxpayers to capitalize into inventory all direct costs and a portion of indirect costs attributable to property produced or acquired for sale. As with everything else, there are a couple of exceptions. Prior to the tax reform resellers with average annual gross receipts are $10 million or less over the last three years are not required to apply these capitalization rules. However, for taxable years beginning after Dec. 31, 2017, the gross receipts threshold has been increased to $25 million.
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Percentage-of-completion method
Taxpayers with long-term contracts must generally use the percentage-of-completion method to determine income. An exemption from the percentage-of-completion method was available if the contract was expected to be completed within two years of commencement and was performed by a taxpayer whose average annual gross receipts do not exceed $10 million.
The tax reform bill increased the gross receipts threshold from $10 million to $25 million.
Application of this $25 million threshold will be applied on a cutoff basis so taxpayers will not compute a 481(a) adjustment for contract entered into prior to Jan. 1, 2018.
With the increase in gross receipts limits increased so significantly, many more taxpayers are going to be able to simplify their tax reporting, as well as take advantage of tax savings opportunities. In order to change to any of these methods, taxpayers must file a Form 3115 using the appropriate automatic change request number.
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Jenifer Kloppel is tax manager with Mengel, Metzger, Barr & Co. LLP. She may be reached at jkloppel@mmb-co.com.
Published: Mon, Oct 01, 2018
