Written by: Paula Brewster CPA
Generally, when a method of accounting is selected to report taxable income, approval to change that method of accounting requires IRS consent prior to implementing the change. Adjustments are often needed so that affected items are neither duplicated nor omitted in prior or subsequent years as a result of the change. For some accounting method changes there are automatic procedures for obtaining IRS consent for a change. However, passage of the Tax Cuts and Jobs Act (TCJA) in December, 2017, greatly expanded the number of taxpayers eligible to change accounting methods for its trade or business. Subsequently in May, 2018, the IRS updated its automatic consent procedures and the accounting method changes to which the procedures apply.
The statutory changes to the tax accounting rules of the Code are effective for business years that begin after December 31, 2017, and benefit those businesses earning less than $25 million in gross receipts for a three year tax period, ending with the prior year. Prior to the TCJA, this gross receipts limit was $10 million. Businesses meeting the TCJA gross receipts test are now eligible to use one of the new TCJA-permitted methods of accounting (excluding tax shelters). Use of any of the following provisions of the TCJA by an eligible taxpayer is deemed a change in accounting method, and those wanting to make such a change must use the automatic consent procedures that apply (Rev. Proc. 2018-40, 2018-34 IRB).
- Eligible taxpayers that want to change to the cash method of accounting from the accrual method of accounting may do so as long as they are not otherwise prohibited by statute.
- Taxpayers that meet the gross receipts test are not required to maintain inventories, which will allow small businesses to either treat inventories as non-incidental materials and supplies that are deducted as they are consumed, or account for it using a method that is consistent with the accounting procedures used in their financial statements for the tax year.
- The new rule exempts eligible small businesses from the application of uniform capitalization rules (UNICAP) which requires the capitalization of inventory costs. The rule is effective for tax years that begin after December 31, 2017.
- Eligible construction companies are exempt from the requirement to use the percentage of completion method for long-term contracts, and from capitalizing costs for certain home construction contracts entered into after December 31, 2017 or completed after that date.
As with any decision affecting your business over the long term, weigh the benefits against the risks. It is important to note that consent for an accounting method change is not the same as a determination that the change is permissible, and automatic change procedures cannot be used to change the treatment of the same item more than once in a five-year period.