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

News Tax Tax Planning and Compliance

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.

Our firm provides this information for general educational guidance only and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Podcasts posted by Anders CPAs + Advisors are not intended to be used and cannot be used by any individual or business, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose. Please note that some content may be generated using artificial intelligence and is intended for educational and informational purposes only. In no way does listening, reading, emailing or interacting on social media with our content establish a professional relationship.

All Insights