Accounting Method Changes under the 2017 Tax Cuts and Jobs Act
January 8, 2018
There are a number of key changes to accounting methods that occur under the 2017 Tax Cuts and Jobs Act (“the Act”). Many involve the overall method of accounting for a business, while several affect certain types of businesses. Overall, most businesses should be reviewing the changes, which by in large are favorable, to determine impacts and develop an action plan as soon as possible.
Cash Basis Method of Accounting
The Act will now allow more businesses to utilize this method of accounting. Specifically, C corporations with average gross receipts of under $25 million over the previous 3 tax years can now elect to file on the cash basis for tax purposes in 2018, versus the previous threshold of $5 million. This same threshold will now also apply to partnerships with C corporation partners. Control group rules will continue to apply when testing for average revenues for certain related entities.
The Act will now allow businesses who meet the above-mentioned revenue tests to no longer be subject to the UNICAP rules also known as Internal Revenue Code Section 263A. This onerous section of the Code requires businesses with inventories to apply certain overhead costs to their inventories. As inventory levels rise, so do the costs added to the taxpayer’s balance sheet and a resulting addition to taxable income.
Businesses, with inventories, that satisfy the below $25 million gross receipts test can use the cash method and account for their inventories as non-incidental materials and supplies or use their financial accounting treatment for inventories.
Both of these thresholds used to be $10 million and going forward both will be indexed for inflation.
Long Term Contract Accounting
The same revenue threshold will now apply when defining who a “small contractor” is for purposes of Internal Revenue Code 460 and the long term contract accounting rules. Businesses who fall under the maximum revenue average can start using any other permitted method for contracts entered into during tax years beginning after December 31, 2017. The former threshold was also $10 million.
Deferred Revenue/Advance Payments
The rules here have changed a bit, in that generally speaking, revenue can only be deferred if it is deferred for financial statement purposes. This affects both one year and two year deferral items. It essentially codifies the IRS position taken in Revenue Procedure 2004-34 on the latter issue, meaning advance payments can only be deferred to the year after the year of receipt or sooner, if so reported on your applicable financial statements. Not all financials are applicable financial statements, so one will need to review that definition, which has changed from the definition in the above-cited Revenue Procedure. This deferral change doesn’t apply to long term contract accounting or installment sale reporting.
Research & Development expense accounting
For tax years beginning after December 31, 2021, R&D expenses must be capitalized and amortized over 5 years. For now, businesses may continue to expense such items under Internal Revenue Code 174. The R&D credit is still alive and well under the Act.
So as we turn the calendar in 2018, one of the items that should be on the top of the tax planning list is to determine what impacts the above changes will have for your business. Many of the changes can be applied right now and impact your estimated tax payments for 2018, as well as your general tax planning for the year. Form 3115 is required to elect an accounting method change for existing entities, while new businesses can simply start using an appropriate method under the Tax Act in 2018.
As always, if you have any questions please Contact the SC&H Group Tax Team to develop a game plan.