Small Business Taxpayers Can Choose More Favorable Accounting Methods

Small business owners often work within tight operating margins, so saving time and using resources efficiently is top of mind. Consider how a change in accounting method could bring unexpected benefits:

• Simplify accounting procedures
• Better match income and expenses
• Help reduce taxable income in the current year
• Comply with new tax laws or regulations
• Improve insight into financial performance

Background

The Tax Cuts and Jobs Act (TCJA) took effect in 2018 and still provides benefits for small business taxpayers (SBT). Notably, it expanded their options to choose potentially more favorable accounting methods that could bring tax advantages and ease administrative burdens when filing.

Accounting method options for small businesses

Learn more about each option and how the benefits could outweigh the time and effort it takes to make a switch.

Cash method

If your accounts receivable exceeds accounts payable and accrued expenses, the cash method may provide an opportunity to lower taxable income by deferring recognition of income until the cash is received.

Uniform capitalization (UNICAP)

Normally, taxpayers subject to UNICAP must capitalize certain direct and indirect costs allocable to property produced or acquired for resale to the basis of that property — and relieve that cost once the inventory item is ultimately sold.

However, if you meet the SBT gross receipts test as noted above, you do not need to capitalize those additional costs over what is currently capitalized for your books.

If you are currently applying UNICAP, you could start deducting those costs in the current year, providing an immediate cash flow increase.

Inventory

Generally, taxpayers must account for inventories whenever the production, purchase, or sale of goods produces income. However, if you meet the SBT gross receipts test, you have two options on how to treat inventories (rather than following the rules of Section 471).

1. Follow the method conforming to your financial accounting treatment, which can ease administrative burden.
2. Treat inventory as non-incidental materials and supplies (NIMS). Keep track of the inventory on the balance sheet and relieve the costs of the inventory when it’s used or consumed in your trade or business.

The NIMS option could help you keep better track of inventory from a tax perspective and does not require additional costs to be allocated to inventory items.

Long-term construction contracts and PCM

Taxpayers with long-term contracts generally determine taxable income using the percentage-of-completion method (PCM). Taxpayers must include in gross income for the current year an amount of the gross contract price representing the percent of the contract completed during that year.

The percentage of the contract completed during the year is determined by using the ratio of contract costs incurred for the tax year over the estimated total contract costs. Depending on when you incur contract costs, the PCM can accelerate taxable revenue compared with other available methods, such as the completed contract method, cash, or accrual.

SBTs with home construction contracts or other construction contracts are exempt from using PCM if they:

1. Estimate (at the time the contract is entered into) the contract will be completed within two years of commencement, and
2. Meet the gross receipts limitation for SBTs for the year the contract is entered into.

How do you switch accounting methods?

You may need IRS approval to change accounting methods. Consult a tax professional to identify the most suitable accounting method for your specific circumstance and review the tax implications.

You’ll also need to comply with applicable regulations. Generally, taxpayers wishing to change their accounting method must fill out Form 3115, Change in Accounting Method.

How we can help

Changing accounting methods can bring a slew of benefits, from potential tax advantages and simplified filing processes to better insight into your financial performance. But sifting through the details can be a challenge.

CLA’s tax professionals can help you weigh your options and create flexible strategies to assess cash flow, reduce tax liabilities, and fulfill complex transactions.

Contact us

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