The Internal Revenue Service recently issued Revenue Procedure 2018-40, which provides guidance to small business taxpayers regarding how to obtain automatic consent to change their method of accounting as a result of certain statutory changes enacted as part of the Tax Cuts and Jobs Act (“TCJA”). The TCJA allows small business taxpayers with average annual gross receipts of $25 million or less (indexed for inflation) in the prior three-year period the option to use certain simplified tax accounting methods.
The simplified tax accounting methods allow eligible taxpayers to:
- Use the overall cash basis method accounting,
- Be exempt from certain accounting rules for inventories,
- Be exempt from capitalizing costs related to real and personal property and
- Be exempt from long-term contract reporting.
Click here to read our February 19, 2018 Tax Alert that further discusses these method changes.
This Revenue Procedure clarifies that taxpayers seeking to change to one or more TCJA permitted accounting method changes for small businesses must, if eligible, use the automatic change procedures in Rev. Procs. 2015-13 and 2018-31 (or any successors), as modified. However, the above method changes are subject to reduced filing requirements where only portions of Form 3115 need be completed, and more than one of the above method changes can be reported in a single filing as long as each change is identified. This is a welcome update, as method change applications can be onerous and costly.
Generally, under prior law, IRC Section 481(a) would require taxpayers to recognize the resulting expense from a method change in the year of the change and to recognize income from a method change over a four year period. Revenue Procedure 2018-40 gives taxpayers some flexibility with respect to Section 481 adjustments originating in a year prior to 2017 if the taxpayer makes a related change in method of accounting under this Revenue Procedure.
For example, a taxpayer that changed from the cash method to an overall accrual method in a prior year and was required to take the relevant § 481(a) adjustment into account over four years could continue to take into account any remaining adjustment or choose to combine or net the remaining portion of the prior § 481(a) adjustment with the § 481(a) adjustment required by the related change in method of accounting made under Revenue procedure 2018-40. Any taxpayer choosing to combine or net the § 481(a) adjustments must indicate this choice in the statement required on Line 26 on the Form 3115, Application for Change in Accounting Method.
The Revenue Procedure is generally effective for tax years beginning after December 31, 2017. However, for method changes involving exempt long-term contracts, it is effective for contracts entered into after December 31, 2017, during tax years ending after December 31, 2017. In addition, the IRS has waived the five year restriction on eligibility for making automatic changes for a taxpayer’s first, second, or third tax year beginning after December 31, 2017. Method change applications may be made with a timely filed return.
While some of the business provisions in the new law created additional complexity and uncertainty, the tax accounting method changes for eligible small business along with Revenue Procedure 2018-40 expand eligibility for the use of cash basis accounting methods as well as simplify the tax compliance burdens on small businesses in making a method change. In addition, one or more of these method changes can provide planning opportunities for acceleration of expenses or income deferral.
For example, where a business has more receivables than payables, the cash method will generally defer income over the accrual method. Conversely, where a business has more payables than receivables, the cash method may accelerate income relative to the accrual method. It is important to project business income over a few years and convert results to the cash basis. Business owners must be mindful of cash management and requirements to pay taxes as well as possibly losing eligibility to use any of the above methods and switching back.
Careful consideration and planning is required before adopting an overall change to cash basis tax reporting. Furthermore, taxpayers that made prior, but related, method changes must consider the transition rules outlined in the Revenue Procedure.
Rev. Proc. 2018-40 also indicates that the Treasury Department and the Internal Revenue Service expect to publish future guidance to implement legislative changes enacted by the TCJA and invite comments for future guidance. We will monitor future developments and report accordingly.
Please contact your Mazars USA LLP professional for additional information.