Cash Method of Accounting Under the Tax Cuts and Jobs Act of 2017
The Tax Cuts and Jobs Act of 2017 (“TCJA”), signed into law on December 22, 2017, brought significant changes and tax reform, amending the Internal Revenue Code. Significant changes included tax cuts to both corporations and individuals, increase in available asset expensing, availability of 100 percent “bonus” depreciation on qualifying assets, and additional relief for small business taxpayers. The relief for small business taxpayers was aimed to simplify the Internal Revenue Code and restrictions for small taxpayers and lessen the administrative burden associated with certain accounting methods and procedures.
The new amendments to the Internal Revenue Code, effective for tax years beginning in 2018 and ending in 2025, include a significant increase to the availability of the overall cash method of accounting for small business taxpayers. Under the pre-TCJA rules, there were several limitations to utilizing the cash method of accounting, including (but not limited to) gross receipts requirements, limitations due to inventories, and ineligible business due to specific trade or business activities.
Under the pre-TCJA tax rules, certain industries were not able to use the cash method of accounting due to the nature of their business. Specifically, manufacturers, retailers, wholesalers, and other similar businesses that have inventories were extremely limited in their accounting method choices. Due to the presence of inventories, the taxpayers were required to use complex accounting rules pursuant to Internal Revenue Code Sections 471 and 263A, which govern the capitalization of overhead costs and certain selling, general and administrative expenses.
The TCJA amended the Internal Revenue Code to provide much more latitude to the use of the overall cash method of accounting. Under the new rules, taxpayers with average gross receipts (average of the prior three tax years) that do not exceed $25 million are now eligible to use the overall cash method of accounting, where they may have been limited previously.
In addition to the $25 million gross receipts exemption, the TCJA also amended Internal Revenue Code Sections 471 and 263A, which govern the treatment of inventory costs. Under the TCJA rules, the amended Tax Law provides a small business exemption where these complex rules would no longer apply to taxpayers meeting the $25 million gross receipts test. Due to the new exemptions, the TCJA will allow manufacturers, retailers, wholesalers, and other taxpayers who do not exceed the $25 million gross receipts test to use the overall cash method of accounting.