The Tax Cuts & Jobs Act (TCJA) involves several changes to the rules governing choice of accounting method for businesses.
Specifically the gross receipts threshold for Cash Basis Accounting has been raised. The details and qualifications for this law change are outlined below.
Cash Method of Accounting
In the past most taxpayers were required to use an accrual method of accounting for tax return purposes due to a myriad of restrictions placed on the use of the cash method. Specifically, corporations and partnerships with a corporate partner were previously only allowed to use the cash method if their average gross receipts for the prior three tax years were less than $5,000,000. The TCJA has revised this threshold to $25,000,000 for all partnerships and corporations.
Points to note:
• The gross receipts test is applied at an affiliated group level, including all businesses with more than 50% common ownership with the taxpayer. Foreign corporations are included in the affiliated group if they meet the 50% ownership test.
• The effective date for the new threshold is for tax years ending on or after December 31, 2017. In applying the test for the tax year, the taxpayer only needs to determine if they meet the gross receipts test for that tax year. This is a change from the old law that required taxpayers to meet the test for all prior years before the taxpayer could pass the test.
• The $25,000,000 threshold will be indexed for inflation for tax years beginning after December 31, 2018, rounded to the nearest million.
Accounting for Inventory
The requirement to apply §263A (“UNICAP”) to inventories has also been raised to the $25,000,000 average gross receipts level. The prior small taxpayer exemption from UNICAP only applied to retailers and resellers with gross receipts below $10,000,000 – producers were still required to follow UNICAP. The expansion of the small business exception under tax reform now applies the new $25,000,000 gross receipts test to both retailers and producers of both real and personal property.
Long-Term Contract Accounting
Generally, a “long-term contract” for tax purposes is any contract in which the completion of the contract occurs in a tax year later than the year in which the contract is entered. The percentage-of-completion method in accounting for long-term contracts was generally required for tax purposes. There was an exception, however, for taxpayers with gross receipts below a $10,000,000 threshold and an anticipated completion date of less than two years from commencement of the contract. Tax reform now applies the higher gross receipts threshold of $25,000,000 before requiring the percentage-of completion method to be utilized as long as the two-year rule is still met.
These changes may have an impact on your choice of accounting method. Please contact us to further discuss how these changes affect your specific tax situation and if revised tax planning is necessary.
