Is it time to take a second look at the cash method for income tax purposes?

By: Dave Herbe, CPA, MAcc- Tax Manager

The new tax law has changed the tax landscape significantly. There are changes to depreciation, tax rates, credits, deductions, you name it. One of the biggest changes that came with the Tax Cuts and Jobs Act (TCJA) was the threshold for small businesses that qualify for the cash method of accounting for income tax purposes. Under the old tax laws, for a small business to qualify for the cash method of accounting their gross receipts over the three previous tax years had to average $5 million or less. However, under the TCJA the threshold is average gross receipts of $25 million or less. Let’s look at an example below to help illustrate:

XYZ Corporation has had gross receipts of $8, $10, & $12 million over the last three calendar years. When they file their 2017 tax return, their average gross receipts for the previous three years totals $10 million. Under the old tax laws they would not be eligible to elect the cash method of accounting for income tax purposes. However, under the new law they would be eligible because their average gross receipts are under $25 million.

This allows small businesses who didn’t previously qualify to now make this election as their accounting method for tax purposes.

There are also some other advantages that come with choosing the cash method over the accrual method when eligible. It allows for more tax planning flexibility, as the business can control if they want to delay invoices to defer income to next year or escalate expenses before the end of the year to increase the deductions taken on the tax return. It also allows for potential cash flow benefits as it allows the business to pay tax on the actual cash it received v what has been earned but not into the bank account yet.  The business can also keep accrual financials for internal record keeping, but with the help of a tax accountant an easy accrual to cash adjustment can be made to convert the financials to a true cash basis. These are just some of the advantages that the cash method offers small businesses.

Although there are many benefits, it may not be the best option for every business that is eligible. There are some limitations besides the gross receipts test that can disallow a certain type of business from being allowed to convert to the cash method. It also might make sense to use the accrual method based on the type of business you are and how income is recognized. Before you switch from accrual to cash be sure to consult with your tax adviser to ensure it makes sense and is done properly.  Holbrook & Manter would be happy to assist you, please contact us today.