This week we take a look at new rules impacting tax accounting methods for small businesses.
An accounting method includes both an overall system of accounting (cash, accrual etc.) and the accounting treatment of individual items. The accounting method used for tax purposes must clearly reflect income and must be consistently applied.
Small businesses have generally been exempt from certain accounting method requirements imposed for tax purposes. Under old law, a wide range of gross receipts tests determined whether a taxpayer qualified as a small business.
A single $25 million gross receipts test now determines whether a taxpayer qualifies as a small business for tax purposes. To pass this test, average annual gross receipts for the preceding 3 tax years must not exceed $25 million. Businesses that meet this gross receipts test have greater flexibility in applying the following accounting methods for tax purposes.
Cash Method of Accounting
In general, the cash method of accounting is the simplest method of accounting. Under the cash method, taxpayers report income in the year in which cash is received and deductions are taken in the year expenses are actually paid, unless a special rule requires the expenses to be taken in a different year to clearly reflect income.
A small business taxpayer is eligible to use the cash method of accounting which can help simplify the overall accounting for the business.
A business that meets the $25 million gross receipts test can use a method of accounting for inventory that either:
UNICAP (Uniform Capitalization) Rules
The UNICAP rules require certain expenses to be capitalized to inventory instead of being immediately expensed.
A small business taxpayer is not required to conform to these rules.
Percentage of Completion Method for Construction Contracts
Taxpayers generally must account for long-term construction contracts using the percentage of completion method of accounting. Under this method, income is recognized based on the percentage of work completed.
Small business taxpayers are not required to use this method of accounting if the construction contract will be completed within two years.
Determining an initial method of accounting and changing an existing method of accounting are decisions that require thoughtful analysis. A thorough understanding of your business is crucial in choosing the most appropriate tax accounting method(s). BMM has the knowledge and experience to help businesses navigate these complexities. Give us a call today.