“Accounting Method Changes May Lead to Tax Savings” by Kathy Davis | Senior Manager – Tax
Tax Reform and Accounting Method Changes May Benefit Businesses with Less Than $25,000,000 in Revenues
The recently enacted Tax Cuts and Jobs Act (TCJA) includes a number of changes to the rules governing the choice of accounting methods for businesses. These changes are very favorable to business in regard to the timing of revenue recognition and the current expensing of costs for income tax purposes.
A brief summary of the accounting method changes, generally effective for years beginning January 1, 2018, are as follows:
The TCJA expands the exception to the percentage-of-completion method for construction contractors. Previously, contractors with average revenues of more than $10,000,000 ($5,000,000 if they were a C Corporation), were required to use the percentage-of-completion method recognizing a portion of revenue during the course of the project based upon achieving milestones. The TCJA raises this limit to $25,000,000 and is applicable to contracts entered into after December 31, 2017.
- Client Benefit – Contractors with less than $25,000,000 in average revenues will be not be required to use percentage-of completion. Contractors will be able to choose from other accrual methods, including completed contract or cash basis reporting, enabling them to defer revenue recognition for tax purposes.
Eligible businesses will be able to use the cash method if their average gross receipts are less than $25,000,000.
Previously, businesses were required to use an accrual method of accounting if their average gross receipts exceeded $10,000,000 for pass-through entities ($5,000,000 for C Corps) or if the business had inventories.
- Client Benefit – Many more business will be eligible for cash basis accounting method permitting them to report income as received and expenses when paid. Businesses where accounts receivable exceed accounts payable would from benefit from deferral of income until payment is received (or made). The reportable net income would match better with the business’s actual cash flow.
Accounting for Inventory
Businesses that have average annual gross receipts of $25,000,000 or less will not be required to account for inventories under normal inventory rules and therefore, not required to use accrual method of accounting. Businesses will be able to use a method of accounting for inventories that either treats inventories as non-incidental materials and supplies (i.e. expense when used), or conforms to the financial accounting treatment of inventories.
- Client Benefit – Businesses unable to use the cash method previously due to inventory, will now be able to account for inventory under different rules, allowing them to use the cash method of accounting. For example, a contractor that previously had to use an accrual method of accounting for tax purposes due to a large supply inventory, may now be able to use the cash method to recognize revenue and expenses, resulting in deferral of income from their prior method.
Uniform Capitalization (UNICAP or 263A)
Businesses with annual gross receipts of less than $25,000,000, will not have to capitalize UNICAP costs. This applies to producers (including manufacturers) and resellers (wholesalers and retailers). Thus, eligible businesses will now be able to expense these UNICAP costs.
Previously, producers had to capitalize UNICAP costs, and resellers with receipts over $10,000,000 had to capitalize UNICAP costs.
- Client Benefit – Applicable businesses will be able to expense their capitalized UNICAP costs in 2018, benefiting from the current expensing of these costs.
These changes to acceptable methods of revenue recognition and current expensing of costs may provide significant tax deferral and savings to many of our clients. In addition to the accounting method changes, the TCJA also changes the taxation of different entity types. To make the proper choices we will need to review the:
- Allowable revenue recognition for the client
- Appropriate inventory method, if applicable
- Entity type
- Potential Alternative Minimum Tax implications
- Required Accounting Method Change with the IRS
- Timing of the method change
- Need to maintain a different basis of accounting for financial statement purposes
We will also explain the tax impact of the cash method when accounts receivable are eventually collected resulting in higher taxable income for the period compared to the accrual basis of accounting.
The choice of accounting methods is potentially transformational for your business. We will be reviewing these opportunities with you not only from a current year perspective but also from a long term strategic perspective. It will be important for us to understand your business plans as we discuss potential changes.
The information contained in this article is current through the published date and may change when regulations and other guidance are issued. Content has been vetted by Apple Growth Partners’ internal tax reform team of licensed CPAs. For more information about this content, or any other matters related to tax reform, please contact your Apple Growth Partners advisor.