Using the cash method of accounting, rather than the accrual method, for tax purposes can be very advantageous for your business. Under the cash method, expenses are deductible when paid and income is earned when collected. You have more control over your taxable income for any given year by deciding how much of your expenses to pay before year end, for example.
The recently passed Tax Act provides an opportunity for more businesses to qualify to use the cash method. Starting in 2018, corporations or a flow-through entity with a corporate partner, could be eligible to use the cash method of accounting if the entity’s prior three years of gross receipts average less than $25,000,000. Also, this threshold is now indexed for inflation, so over time the limitation will increase. If you are not reporting on a cash basis for tax purposes but want to be, you may qualify for an automatic change in method of accounting. Obtaining an automatic method change is done by filing a form with your tax return; no additional fees are required to be paid to the IRS. Certain businesses classified as an LLC or partnership can use the cash method of accounting even when their gross receipts exceed $25,000,000.
Not all businesses can use the cash method for tax purposes. If your average gross receipts over the prior three years exceed certain thresholds, other methods may be required. Up until 2018, for example, construction contractors were generally required to use the percentage of completion method for long term contracts if their average revenues exceeded $10,000,000. C-Corporations (or partnerships with C-Corporation partners) were required to use the accrual method if their average revenues exceeded $5,000,000. Businesses with inventories generally had to use the accrual method if their revenues averaged more than $1,000,000.
Please note, contractors are still required to use the percentage of completion method for Alternative Minimum Tax (AMT) purposes, so there could be large AMT adjustments. However, this will not affect C-corporation contractors, since the AMT has been repealed for Corporations.
California has not conformed to many of these changes. This could result in different methods of accounting for federal and state purposes which could be very confusing.
If you think this might be an opportunity for you, please call Erika Shuper at 408.385.3416 to discuss.