The Tax Cuts and Jobs Act provides a number of opportunities that may benefit small businesses. Taxpayers with gross receipts at or below the newly established requirements may be eligible for an automatic change to certain accounting methods. These include 1) an overall change in accounting method from accrual (or other hybrid methods, such as the percentage of completion method used by certain contractors) to cash; 2) the opportunity to treat inventory as non-incidental supplies and materials; and 3) an exemption from the UNICAP requirements that require allocation and capitalization of inventory related costs. Please consider the items below if you are contemplating an accounting method change for your business.
Potential benefits to using the cash method of accounting:
- Opportunities to accelerate deductions and decrease taxable income.
- The ability to defer revenue until cash is received, thereby deferring tax.
- Additional tax planning opportunities through timing management of expenses and revenue.
- The ability to include a favorable net adjustment (an overall deduction) from an accounting method change in the year the change is requested; and the ability to allocate an unfavorable net adjustment (an overall increase in income) over a four year period.
- The option to treat inventory as non-incidental supplies and materials which may reduce the administrative burden of tracking inventory and costs of goods sold.
- Exemption from the UNICAP requirements of IRC § 263A that require a portion of overhead be capitalized as inventory. This is available to both qualified producers and resellers of real and personal property.
- Potential reduction in compliance costs if no 263A adjustment needs to be calculated for tax purposes.
- All changes referenced above qualify as automatic method changes and do not need the special permission of the IRS prior to implementation.
Additional items to consider prior to initiating a method change:
- Preparing an accounting change involves analysis and calculation of specific financial information summarizing the tax impact of such a change as well as the filing of specific forms with the taxing authorities. This may be somewhat costly, depending upon the complexity of the business and operations.
- The accounting method changes noted above would alter the timing of deductions and income from one tax period to another, but would not lead to a permanent adjustment to taxable income when evaluated over time.
- The above changes may less accurately reflect the business’s operations and cost allocations if books are kept on a cash basis and no inventory is maintained.
- Income inclusion for tax purposes cannot be later than income inclusion in financial reports. Consequently, businesses that have audited financial statements, or other financial statement reports submitted to reporting or regulatory agencies, must use a method of accounting for the computation of taxable income that is consistent with their financial records.
- If a business does not have audited financials or other financials that are submitted to a regulatory or reporting agency, but financial records are maintained using a method other than that used to compute taxable income, then the business must maintain book to tax reconciliations as part of their permanent accounting records.
- If the business operates in a non-conforming state, then it may be necessary to maintain two sets of financial records — one on a cash basis and the other on an accrual basis.
- If the business operates in a non-conforming state, then compliance work will potentially be more costly since additional federal and state adjustments may be necessary. A 263A UNICAP adjustment calculation would still be required for non-conforming state purposes and year-end planning would be completed separately for federal and state purposes.
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