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Tax reform provides an opportunity for simplification and tax relief for "small" businesses. Under the Act, a small business is defined as a taxpayer with average gross receipts during the previous three tax years of $25,000,000 or less. The $25,000,000 limit will be indexed for years after 2018. So what are qualifying taxpayers eligible for?

  • Cash method of accounting - previously, C corporations with average gross receipts of greater than $5,000,000 had to use the accrual method of accounting. In addition, taxpayers where inventory was a material income producing factor had to use the accrual method of accounting. Under the new rules, qualifying small businesses, regardless of inventory, may use the cash method of accounting.
  • Uniform Capitalization Rules - Section 263A required manufacturers and retailers with average gross receipts under $10,000,000 to capitalize certain direct and indirect costs. Under the new rules, qualifying small businesses, whether a manufacturer or retailer, will be exempt from the Section 263A capitalization rules.
  • Accounting for inventories - With some exception, taxpayers must account for inventories if the production, purchase, or sale of merchandise is an income-producing factor to the taxpayer. Under the new rules, qualifying small businesses, will not be required to account for inventories, but instead will account for their inventories as either: 
    • Non-incidental materials and supplies. Generally the taxpayer is able to deduct the cost of non-incidental materials and supplies in the taxable year in which they are first used or are consumed in the taxpayer's operations.
    • To the method that conforms to the taxpayer's financial accounting treatment of inventories.

Under the new rules, the $10,000,000 threshold above is raised to $25,000,000, thus possibly allowing more small contractors to defer income until the completion of the contract by utilizing the completed contract method of accounting.

  • Long term contract method of accounting - Under the percentage-of-completion method of accounting, income is earned and taxed as costs are incurred during the contract. Unlike percentage-of-completion, under the completed contract method of accounting, income and costs are included in taxable income at the time of completion of the contract. Generally, long term construction and manufacturing contracts must be accounted for under the percentage-of-completion method of accounting. One exception to using the percentage-of-completion method was for small construction contracts. Small construction contracts are those contracts for the construction or improvement for real property if the contract is:
    • Expected to be completed within two years, and
    • Is performed by a taxpayer whose average annual gross receipts for the prior three years do not exceed $10,000,000.
    • Under the new rules, the $10,000,000 threshold above is raised to $25,000,000, thus possibly allowing more small contractors to defer income until the completion of the contract by utilizing the completed contract method of accounting.

Generally these new rules are favorable to taxpayers allowing for simplification and deferral of taxable income. However, adoption of any of these changes is a change in method of accounting for tax purposes and requires a Form 3115 to be filed with your tax return in the year of change. For more information on this topic contact us in one of our many locations.