By Christopher Axene,
CPA, principal,
[email protected]
(Dublin office)
EXPENSE – Your company bought and received $2,000
worth of supplies in December (and you immediately
received an invoice for your purchase), but you held off on
paying your bill until January. Under cash basis, you would
recognize the purchase in January when you actually paid for
the supplies. But under accrual basis, the purchase would
have to be recognized in December, since that’s when you
actually received the invoice. Thus, the cash method defers
the deduction to the year in which payment is made.
Now imagine your company, like so many others, has to
carry a significant amount of inventory or that your custom-
ers opt to pay their bills in installments – your whole sys-
tem of accounting can quickly become pretty complicated.
Therefore, in an attempt to err on the side of simplicity, most
companies prefer using the cash basis accounting method.
But, pre-TCJA, only businesses with average gross receipts
less than $10 million ($5 million for C corporations) over the
prior three years were eligible for this option. Thanks to the
tax reform package, that’s no longer the case!
YOU MAY NOW BE ELIGIBLE TO
MAKE THE SWITCH
TCJA effectively raised the gross receipts limit, which
means companies with gross receipts of $25 million or less
over the preceding three years are now allowed to use the
cash basis method of accounting. As for your inventories,
well, they can either be treated as non-incidental materials
and supplies or they will conform to your existing financial
accounting treatment. A tax professional can help guide you
toward your ideal solution.
CA N MA K IN G THE SW ITCH
R E A L LY PAY OFF?
We’ve already identified a number of clients who could
benefit from making the switch from accrual to cash ac-
counting. For example, in working with one client, a small
manufacturer with limited risk, our tax team identified a
significant opportunity. After taking a look at their year-end
reports, receivables and payables and performing a con-
version analysis, we discovered that this particular compa-
ny could receive a one-time tax deferral of $150,000. Our
study also found that there was no need for the company
to pay quarterly estimates for the current tax year.
Our next step will be to conduct our analysis again at the end
of the year to determine if the accounting method change
truly is in the company’s best interest. Then we will move
forward with electing the change by including a completed
Form 3115 with their tax return. The client will also receive a
detailed packet of information, which will include their total
tax deferral, tax code and analysis.
This particular example is not the only one out there either!
Many companies have an opportunity to benefit from this
particular TCJA provision. In fact, we are working with an-
other client who, when it’s all said and done, will likely have
$800,000 more cash in hand at of the end of this year if they
elect to defer their taxes.
WI LL SWI T CHI NG WO RK FO R YO U ?
Making a change to cash accounting could streamline
recordkeeping for lots of small businesses, many of which
might also benefit by deferring the payment of taxes. This
is also a good option for those who have a large project
or investment coming up and could use an influx of cash.
That being said, converting to cash accounting might not be
such a great option for a company that does not carry large
receivable balances at year-end, is planning to buy or sell,
or that has a major change of operations in the works.
To determine if you should consider switching, take a look
at your projected gross receipts and other business activ-
ity – especially if you plan to sell in the next few years. You’ll
also want to consider whether you operate on a calendar or
fiscal year to determine the immediacy of a change.
Also, keep in mind that inflation does apply to the deferral.
And like many parts of the TCJA, we are awaiting additional
IRS guidance.
In the meantime, please note that making the switch from
accrual to cash requires permission from the IRS. If you are
interested in taking on this initiative, please don’t tackle it
alone. Switching to the cash accounting method requires
additional tax strategies and long-term planning tactics.
If you have any questions about the process or want to
consider your options, talk to your tax advisor.
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