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TAX REFORM: Tax Accounting Method Changes Under The Tax Cuts and Jobs Act

February 19, 2018

By Dennis Cancellarich

The Tax Cuts and Jobs Act (“TCJA”) has provided for significant tax reform for businesses. Included among the many changes are some favorable provisions offering relief to small businesses with respect to accounting method reform and simplification.  The common theme of these provisions is to increase outdated gross receipt thresholds.

Once these thresholds were surpassed, affected taxpayers were required to use accrual basis accounting, Section 263A inventory capitalization, percentage of completion method, or account for inventories.  This consistently resulted in an increased administrative burden and compliance costs.

Therefore, the increase in the gross receipts threshold will result in fewer businesses having to comply with costly and onerous tax provisions and accounting method change requests.   The gross receipts threshold refers to the taxpayers’ average annual gross receipts for the three preceding tax years.

Modification of the Limitation on Cash Method of Accounting

Under previous law, limitations applied to corporations and partnerships with corporate partners, whereby these taxpayers were prohibited from using the cash method of accounting for tax purposes unless their average annual gross receipts were $5 million or less. Under the TCJA, for tax years beginning after December 31, 2017, the threshold was increased to $25 million (indexed for inflation), regardless of the type of entity or the industry of the taxpayer.

Any change in accounting method made pursuant to this provision is considered an accounting method change allowing the taxpayer to recognize ratably taxable income resulting from the method change over a four year period.  Losses would be recognized immediately.

Exemption from Uniform Capitalization (UNICAP) Requirements

Previously, a taxpayer was required to either include in inventory or capitalize certain direct costs, and an allocable portion of indirect costs related to real or tangible personal property either produced by the taxpayer or acquired by the taxpayer for resale. Resellers of personal property were exempt from this capitalization requirement if their average annual gross receipts were $10 million or less.

Under the TCJA, for tax years beginning after December 31, 2017, the $10 million threshold is increased to $25 million (indexed for inflation), regardless of entity structure or industry. Any change in accounting method made pursuant to this provision is considered an accounting method change, allowing the taxpayer to recognize ratably the taxable income resulting from the method change over a four year period.  Losses would be recognized immediately.

Exemption from Inventories

Under previous law, generally, taxpayers with inventory were required to use the accrual method of accounting. Some exceptions to this rule were (1) businesses with inventory that had average annual gross receipts of $1 million or less; and (2) certain businesses with average annual gross receipts of $10 million or less that treated the inventory as non-incidental materials and supplies, therefore not being required to follow the accrual method.

Under the TCJA, for the tax years beginning after December 31, 2017, taxpayers with average annual gross receipts of $25 million or less (indexed for inflation) are not required to account for inventory and have the option to either:

  1. Treat the inventory as non-incidental materials and supplies;
  2. Conform to the taxpayer’s method of accounting reflected in the taxpayer’s applicable financial statements; or
  3. If the taxpayer does not have applicable financial statements, the taxpayer conforms to the books and records prepared in accordance with the taxpayer’s accounting procedures.

Any change in accounting method made pursuant to this provision is considered an accounting method change, allowing the taxpayer to recognize ratably the taxable income resulting from the method change over a four year period.  Losses would be recognized immediately.  

Exemption from Percentage Completion for Long-Term Contracts

Under the previous law, taxpayers with average annual gross receipts of $10 million or less and who estimate that the contract will be completed within a two year period (from the time the contract is entered into) were considered “small contractors” and were not required to use the percentage of completion method of accounting.

Under the TCJA, the average gross receipts threshold increased from $10 million to $25 million (indexed for inflation).   Therefore, a taxpayer with $25 million or less in average annual gross receipts is not required to use the percentage of completion method of accounting.

This is effective for contracts entered into after December 31, 2017.  This provision is effected on a cut-off basis and, although it’s considered a change of accounting method, making this change does not result in an income adjustment to be recognized over a four year period.

Mazars Insight:

The above provisions of the TCJA are a welcome change for small businesses. The prior, lower base gross receipts thresholds were never increased or indexed for inflation, which could result in higher taxes, an increased administrative burden, and higher professional fees.

Where a business was subject to the above under the prior law, but below the gross receipts threshold under the TCJA, careful consideration should be given to switching. Taxpayers reporting financial information to third parties, may be required to maintain accrual basis accounting or inventory accounting.  Thus, different financial and tax reporting methods may be problematic for many reasons.

Alternatively, businesses that have already surpassed the gross receipts threshold under the previous law, and are interested in applying the provisions under the TCJA, first need to understand the tax impact. These businesses are required to make a change in their accounting method, along with filing the appropriate forms to reflect the method change. Accordingly, making an accounting method change can be a costly and complicated process and the taxpayer needs to take into consideration many factors before doing so.

Please contact your Mazars USA LLP professional for additional information.

 


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Mazars USA LLP is an independent member firm of Mazars Group.

Legal and privacy policy    Contact us    Terms and Conditions