Tax Reform for Businesses: Cash vs. Accrual Method of Accounting

Many small businesses are rethinking their current method of accounting due to the Tax Cuts and Jobs Act (TCJA). The new tax law increased the gross receipts ceiling for cash basis accounting, causing companies to question whether to use the cash or accrual method going forward.

Previous Law Limitations

Gross receipts were limited to $5 million for small businesses in prior years. If gross receipts were more than $5 million in any tax year, the business was automatically disqualified from using cash basis accounting. Typically, unless the company was very small, meeting the requirements for the cash method of accounting was difficult.

New Law

Tax reform redefined a small business as a corporation or partnership with less than $25 million in gross receipts for the prior three-year period under §448(c). With the update, gross receipts in the three-year period immediately preceding the current tax year are examined. The TCJA also removed limitations placed on taxpayers in certain industries from using the cash method. The increased gross receipts threshold and decrease in tax years under examination creates an opportunity for more businesses to take advantage of the cash method.

Deciding Cash vs. Accrual

The cash method of accounting can create tax savings, as income recognition does not occur until cash is actually or constructively received and a deduction is allowed when funds are used to pay for expenses. In comparison, the accrual method of accounting recognizes revenue when earned, even if cash has not yet been received and accounts for expenses as they are incurred.

Benefits of Cash Method for Small Businesses

Below are a few advantages of using the cash method brought on by tax reform:

  • Easier administration and simplified accounting
  • Tax savings through deferred income recognition
  • Accurate portrayal of cash on hand
  • Improved cash flow

On August 3, 2018, the IRS issued Rev. Proc. 2018-40, which contains automatic method change guidance for adopting the small taxpayer accounting methods newly allowable under the TCJA changes.

Contact an Anders advisor to ensure the best method of accounting is used for your small business. Visit our Tax Reform Resource Center for videos, blog posts and resources on how tax reform will impact you, your family and your business.