Tax Law Expands Cash Basis and Simplified Inventory to More Businesses

Back to Updates (Home)

 

Last December's Tax Cuts and Jobs Act (TCJA) expanded the opportunity for small businesses to use the cash method of accounting. In addition, it exempted more businesses from applying the Internal Revenue Code section 263A Uniform Capitalization rules, known as UNICAP, in calculating their inventory for tax purposes.

 

Background

Accounting methods are the basic rules and guidelines businesses use to keep their financial records and prepare their financial reports. The two main accounting methods are cash basis and accrual basis. The cash basis method of accounting reports revenue when cash is actually received and expense when it is actually paid. This method does not recognize accounts receivable or accounts payable. Under the accrual basis, revenue is recorded when income is earned and expense when a liability is incurred, regardless of when money actually changes hands.

 

UNICAP requires a business to capitalize, as part of inventory, some general business costs that might otherwise be deducted. This applies to goods that are produced (such as by manufacturers) and goods acquired for resale (such as by wholesalers). The complicated UNICAP rules generally result in reporting more income and paying more tax.

 

Before 2018, resellers with inventory were required to apply UNICAP if their average gross receipts over the previous three years exceeded $10 million. Manufacturers always had to use UNICAP regardless of receipts. Businesses with inventory had to use the accrual method of accounting if their average receipts exceeded $1 million ($10 million in certain industries). C corporations (and partnerships with a C corporation as a member) had to use the accrual method if they had average annual gross receipts of more than $5 million.

 

New Tax Law

Starting in 2018, TCJA raises the gross receipts threshold for all these purposes to $25 million (average for the preceding three years). This opens up the cash method and eliminates the need to use UNICAP for many small businesses. Gross receipts of commonly owned businesses must be aggregated to compute the limit, which will also be indexed for inflation in subsequent years. The $25 million exception to the UNICAP rules now applies to producers as well as resellers, so even manufacturers may avoid UNICAP if they meet the new gross receipts test.

 

Use of the cash basis does not mean that these businesses may write off inventory items when they pay for them. Instead, they may use a method of accounting for inventories that either treats them as non-incidental materials and supplies or follows the way their financial statements treat inventory. Either way, inventory on hand at year end must still be capitalized, but as a cash-basis taxpayer, the business will not recognize income on accounts receivable or expenses on accounts payable.

 

If your business is using the accrual method of accounting or applying UNICAP rules to inventory, you may qualify for the new relief enacted in TCJA. Your LMC professional can help determine if you may benefit from changing to the cash method or using a simpler treatment of inventory.

 

Back to Updates (Home)