Under the Tax Cuts and Jobs Act (TCJA), many more businesses are now eligible to use the cash method of accounting for federal tax purposes. The cash method tax reform expansion offers greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether the cash method would be advantageous and, if so, consider switching methods.

What’s Changed?

Previously, the cash method was unavailable to certain businesses, including:

• C corporations — as well as partnerships (or limited liability companies taxed as partnerships) with C corporation partners. To be applicable, average annual gross receipts for the previous three tax years exceeds $5 million. Be sure to take a look at our previous post: C Corporation Advantages and Disadvantages.
• Businesses that require accounting for inventories. To be applicable, average annual gross receipts for the previous three tax years exceeded $1 million. Additionally, there must be $10 million average annual gross receipts for certain industries.

There’s also a specific requirement for construction companies whose average annual gross receipts for the previous three tax years exceed $10 million. That is, the percentage-of-completion method (PCM) needs to account for taxable income from long-term contracts. However, certain home construction contracts are an exception. Generally, the PCM method is less favorable, from a tax perspective, than the complete-contract method.

The TCJA raised all of these thresholds to $25 million, beginning with the 2018 tax year. In other words, if your business’s average gross receipts for the previous three tax years is $25 million or less, you generally now will be eligible for the cash method tax reform. This is regardless on the structure of your business, your industry or whether you have inventories. And construction firms under the threshold need not use PCM for jobs that are expecting to be complete within two years.

You’re also eligible for streamlined inventory accounting rules. And you’re exempt from the complex uniform capitalization rules, which require certain expenses to be capitalized as inventory costs.

Should You Switch?

Even if you meet eligibility to switch to the cash method tax reform, there are additional factors to consider. It’s important to determine whether it’s the right method for you. Usually, if a business’s receivables exceed its payables, the cash method will allow more income to be deferred than will the accrual method. (Note, however, that the TCJA has a provision with certain limitations. This includes the cash method’s advantages for businesses that prepare audited financial statements or file their financial statements with certain government entities.) It’s also important to consider the costs of switching, which may include maintaining two sets of books.

The IRS has established procedures for obtaining automatic consent to such a change by filing Form 3115 with your tax return. This official change will begin with the 2018 tax year. Contact us to learn more.

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