Small Business Taxes: New and Improved Access and Accounting Methods

December 13, 2018 — The IRS has provided procedures that benefit many small business taxpayers by allowing them to obtain automatic consent to change to new accounting methods allowed under the Tax Cuts and Jobs Act (TCJA) in Rev. Proc. 2018-40. These updates may simplify compliance for small businesses and provide for expanded access to a beneficial change of accounting method.

The TCJA increased the availability of the cash method and simplified cost capitalization requirements. Qualifying small businesses may now take advantage of exemptions from requirements for percentage-of-completion method for most long-term contracts and exceptions to the requirements to capitalize costs under 263A and 471 for small business taxpayers satisfying the $25 million gross receipts test. Generally, taxpayers with gross receipts for the 3-tax-year period ending with the prior tax year not in excess of $25 million qualify. The changes apply for tax years beginning after December 31, 2017.

Small business taxpayers wishing to change their accounting method under these new rules must file a Form 3115, Change in Accounting Method. Assuming the general requirements are met, a taxpayer should file using the automatic consent procedures provided in 2018-31, as modified by 2018-40. Generally, no user fee is required and Form 3115 can be filed with the return, rather than requiring advanced consent from the IRS.

IRS procedures typically preclude a taxpayer from changing their overall accounting method if they have made or requested an overall change in accounting method during any of the five taxable years ending with the year of change. However, the new procedures provide that for the taxpayer’s first, second and third tax year beginning after December 31, 2017, this ineligibility rule does not apply.

A taxpayer concurrently filing the automatic change methods #233, 234, and/or 235 may elect to file these changes on a single Form 3115. The new revenue procedures also provide that only a partial Form 3115, Application for Change in Accounting Method, needs to be completed for these changes.

Small Business Taxpayer Changing to Overall Cash Method – Automatic Change #233

Taxpayers meeting the $25 million gross receipts test are allowed to use the cash method regardless of whether they are a C Corporation or a partnership with C Corporation partners and regardless of whether the purchase, production or sale of inventory is an income-producing factor. Tax shelters are prohibited from using the cash method of accounting, regardless of its amount of annual gross receipts.

Automatic Change #233 applies to small business taxpayers that want to change their overall method of accounting from the accrual to cash method for a trade or business. A Section 481(a) adjustment must be made to catch up income and deductions to the new method.

If eligible, taxpayers making this change should use the automatic change procedures provided in Rev. Proc 2018-31, Section 15.18 as added by Rev. Proc 2018-40.

Small Business Taxpayer Exception from Requirement to Capitalize Costs under 263A – Automatic Change #234

Small business taxpayers meeting the $25 million gross receipts test can be excluded from requirements to capitalize additional costs to inventory under 263A. Under prior law, there was a $10 million gross receipts test exception, which only applied to resellers of inventory (i.e. not to producers).

Automatic Change #234 applies to small business taxpayers that capitalize costs under Sec. 263A and want to change to a method that no longer capitalizes costs under Sec. 263A, except for a taxpayer who wishes to no longer capitalize 263A costs to its home construction contracts. A Section 481(a) adjustment must be made to catch up income and deductions to the new method.

If eligible, taxpayers making this change should use the automatic change procedures provided in Rev. Proc 2018-31, Section 15.18 as added by Rev. Proc 2018-40.

Small Business Taxpayer Exception from the requirement to Capitalize Inventory under IRC 471 – Automatic Change #235

Small business taxpayers meeting the $25 million gross receipts test can elect to treat inventories as non-incidental materials and supplies or conform to the taxpayer’s financial accounting treatment of inventories.   A Section 481(a) adjustment must be made to catch up income and deductions to the new method.

If eligible, taxpayers making this change should use the automatic change procedures provided in Rev. Proc 2018-31, Section 22.19 as added by Rev. Proc 2018-40.

Small Business Taxpayer Exemption from the requirement to use the percentage-of-completion method (PCM) for long-term contracts or to capitalize costs under 263A for certain home construction contracts – Automatic Change #236

Small business taxpayers can elect out of the requirement to use PCM for long-term contracts if the contract: (1) is expected, at the time the contract is entered into, to be completed within two years of commencement and (2) is performed by a taxpayer that (for the tax year in which the contract was entered into) meets the $25 million gross receipts test. Under prior law, an exception was provided for construction companies with average annual gross receipts of $10 million or less in the preceding three years.

Accounting change #236 applies to taxpayers that, beginning in the year of change, qualify as a small business taxpayer and want to change their method of accounting for exempt long-term construction contracts from the PCM to another allowable method (e.g. cash, accrual, completed contract method). Accounting change #236 also applies to small business taxpayers who elect to no longer capitalize 263A costs to their home construction contracts. Both contract accounting method changes are applied prospectively, only to long-term construction contracts entered into after December 31, 2017 (i.e. no 481(a) adjustment is required or allowed.) If eligible, taxpayers making this change should use the automatic change procedures provided in Rev. Proc. 2018-31, Section 19.01 as added by Rev. Proc. 2018-40.