The Tax Cuts and Jobs Act (TCJA) made many changes to the Internal Revenue Code. While many were widely discussed, businesses should know other provisions that may affect the taxable income computations on federal tax returns.
Gross Receipts Test
More small businesses will be eligible to use the overall cash method of accounting since the passage of the TCJA. C corporations and partnerships with C corporation partners may now use the cash method of accounting if these businesses meet the Sec 448(c) gross receipts test. This test is satisfied if the taxpayer’s annual gross receipts, averaged over the prior three tax years, does not exceed $25 million.
There are several rules for the gross receipts test:
1. Entities treated as a single employer have the gross receipts aggregated.
2. If If a taxpayer has not been in existence for the 3-year period, the test is based on the period it has been in business. If it is less than a year, gross receipts are annualized.
3. “Taxpayer” can include any predecessor of the taxpayer.
The TCJA increased the gross receipts test from $5 million to $25 million beginning in 2017. The amount will be adjusted annually beginning with tax year 2018. For the 2019 tax year the annual gross receipts will increase to $26 million. Small business taxpayers are also exempt from requirements for accounting of inventory, capitalization of certain costs, and can use a percentage-of-completion method for some long-term contracts.
Meeting the gross receipts test allows the taxpayer to use the cash method even if the purchase, production, or sale of merchandise is an income-producing factor. The TCJA only requires these taxpayers to account for inventory as non-incidental materials and supplies. When supplies or materials are consumed the cost is deducted in that tax year.
The TCJA also exempts any producer or reseller that meets the gross receipts test from the Sec. 263A uniform capitalization (UNICAP) rules.
This is a significant change to the accounting rules and can provide an opportunity for business planning.
Form 3115 must be included with the return to take advantage of any of the changes to accounting method. There are procedures that must be followed to obtain the automatic consent to a change in accounting method. The procedures are provided in Rev. Proc. 2018-40. All of the changes discussed here can be made on one Form 3115.
Treasury Circular 230 Disclosure
Unless expressly stated otherwise, any federal tax advice contained in this communication is not intended or written to be used, and cannot be used or relied upon, for the purpose of avoiding penalties under the Internal Revenue Code, or for promoting, marketing, or recommending any transaction or matter addressed herein.