IRS Unveils Procedures to Take Advantage of Expanded Universe for Cash Method and Other Simplification Methods (article)

IRS Unveils Procedures to Take Advantage of Expanded Universe for Cash Method and Other Simplification Methods (article)

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The Paperwork Reduction Act of 1980 caught another bruising with the August 3 IRS guidance covering procedures that eligible taxpayers must use to take advantage of the new tax law’s favorable tax accounting method provisions. The new tax law commonly known as the Tax Cuts and Jobs Act (TCJA) allows many more taxpayers to use the cash method of accounting. The TCJA also offers more taxpayers an exemption from the requirement to maintain inventories, to comply with uniform capitalization (UNICAP) rules, and use the percentage completion method (PCM) for long-term contracts. But, the IRS is requiring eligible taxpayers to file an application for change in accounting method to take advantage of these opportunities, which will stoke a tidal wave of these taxpayer submissions.

Man looks through inventories

Background

Legislative history to the TCJA provides that the new law “expands the universe” of taxpayers eligible to use the cash method of accounting and the other simplified methods of accounting mentioned previously. Any taxpayer that meets a $25 million average annual gross receipts test and that is not a tax shelter is eligible for these opportunities for tax years beginning after Dec. 31, 2017. This is a significant change from prior law and IRS guidance, which provided varying (and much lower) gross receipts limitations for different types of taxpayers and different industries. Taxpayers now may take advantage of these opportunities regardless of whether inventories are an income-producing factor and regardless of whether they are C corporations or partnerships with C corporation partners.

Changes to adopt any of these methods generally are made by measuring the cumulative difference between a taxpayer’s present method and proposed method as of the first day of the year of change, and recognizing that difference in taxable income through a section 481(a) adjustment (which generally should be a favorable decrease to taxable income recognized in the tax year of change). However, a change to adopt the exemption from the PCM must be made on a “cut-off” basis, whereby the accounting for existing contracts continues and only new contracts entered after Dec. 31, 2017 may utilize a method other than the PCM.

The Basics for the Cash Method and Other Simplified Methods

Cash method taxpayers generally recognize items of income when actually or constructively received and items of expense when paid. As Congress indicated behind the TCJA provisions, “The cash method is administratively easy and provides the taxpayer flexibility in the timing of income recognition.” As might be obvious, the cash method matches taxable income more closely to a taxpayer’s net cash position and thus provides predictability for associated tax liabilities. More importantly, a cash method taxpayer generally can defer taxation of revenues associated with client business on account until the time cash is collected from those accounts receivable.

Taxpayers eligible for the exemption to maintain inventories may treat merchandise as non-incidental supplies that are generally capitalized until the supplies are used or consumed in the taxpayer’s business (e.g., sold in this case). Such taxpayers may use any reasonable method of determining cost flows associated with the capitalized balance of supplies, where prior guidance provided that LIFO assumptions would not be deemed reasonable for that purpose. Capitalized supplies track closely in concept to maintained inventories for a taxpayer in this case, where the main difference between these methods pertains to simplification in the case of capitalized supplies.

The UNICAP rules provide an often tortuous maze of capitalization requirements for direct and indirect costs associated with a taxpayer’s property acquired or produced for sale. UNICAP rules are derided for their excessive complexity and have been part of the tax law since 1986. Taxpayers exempt from the UNICAP rules enjoy relief from this complexity while being able to expense these direct and indirect costs that otherwise must be capitalized.

Taxpayers exempt from the required use of the PCM for long-term contracts can take advantage of the completed contract method (CCM) to recognize taxable income from such contracts. Long-term contracts are those for the manufacture, construction, building, or installation of property that is not completed within the same tax year during which the contract commences. The CCM allows these taxpayers to defer recognition of gross income (and deductions for allocable costs) until the contract is complete. The PCM otherwise accelerates these items by requiring recognition in an amount equal to the percentage of the contract that is completed during the taxable year.  The CCM is simpler to track, results in a more predictable incidence of taxation, and defers taxable income.

New IRS Guidance to Adopt the Cash Method and Other Simplified Methods

The IRS published Rev. Proc. 2018-40 on August 3 to set forth procedures by which eligible taxpayers may adopt the aforementioned tax accounting method opportunities provided by the TCJA. Although the TCJA changes the law itself in regards to a taxpayer’s eligibility for these accounting methods, the IRS guidance still requires taxpayers to request a change in accounting method by filing Form 3115. This is a departure from procedures employed for a prior law changes pertaining to accounting methods where taxpayers were permitted to simply adopt new accounting methods without filing Form 3115. Although taxpayers must request consent to change an accounting method for any of the aforementioned opportunities, the IRS will grant automatic consent to a taxpayer’s properly submitted request. Among other benefits, these automatic changes benefit from timing requirements in that they are not due until the due date (including extensions) of the tax return for the year of change.

Applications to change an accounting method to adopt the cash method of accounting, to utilize the exemption from the requirement to maintain inventories, or to utilize the exemption from UNICAP requirements may be filed together on a single application. An application to change an accounting method to adopt the CCM (or another alternative method to PCM) must be requested separately. Importantly, all of these accounting method opportunities may be requested under the automatic consent procedures for a taxpayer’s first, second, or third taxable year beginning after Dec. 31, 2017 regardless of whether a taxpayer previously requested an accounting method change for the same item during the past five taxable years.

To assist somewhat with the administrative burden associated with these requests, the IRS provided simplified information reporting requirements on Form 3115. Taxpayers therefore are required to complete only certain sections of Form 3115, but given the “expanded universe” of taxpayers now eligible for these accounting method opportunities, the IRS can expect a mountain of these applications from taxpayers across the country.

A few nuances particular to each accounting method opportunity are noteworthy among the IRS guidance. A taxpayer adopting the cash method of accounting must include in income amounts attributable to open accounts receivable due in more than 120 days, because such accounts receivable are regarded a property and as such are due at the time the receivable is created. This treatment mirrors requirements of former guidance under Rev. Proc. 2001-10 and Rev. Proc. 2002-28. Open accounts receivable that are due in full in 120 days or less are included in income only when actually or constructively received by the taxpayer. Example 14 in Rev. Proc. 2002-28 contains an example of this situation.

Also, a taxpayer adopting the exemption from the requirement to maintain inventories may either treat its inventory as non-incidental supplies, or may conform its inventory accounting to the method reflected in its applicable financial statements or its books and records if it does not have applicable financial statements. Applicable financial statements include (among others) a certified financial statement prepared in accordance with GAAP that is a Form 10-K, an audited financial statement used for credit or owner reporting purposes (or any other nontax purpose), or in any other case is filed by the taxpayer with any other federal agency for non-tax purposes. The IRS guidance does not provide a definition to be used to determine what constitutes a taxpayer’s “books and records,” and requested comment in this area. Furthermore, the IRS stated that the automatic consent granted for the exemption from the requirement to maintain inventories will not constitute a determination that the new method of accounting is permissible. This leaves the door open for the IRS to later assess whether a taxpayer’s cost flow assumptions used to track capitalized non-incidental supplies is permissible, and whether a taxpayer’s capitalization policy for non-incidental supplies is permissible.

More Guidance Coming

The IRS noted in Rev. Proc. 2018-40 that future guidance will be published on the topics covered, so this will not be the last foray into these matters. The topics for future guidance likely relate to areas in which the IRS requested comment, which are: (1) how the gross receipts test should apply to each trade or business of a taxpayer that is not a corporation or a partnership; (2) how “books and records” should be determined for the exemption from the requirement to maintain inventories; and (3) how to interpret the cut-off basis for implementing a change from the PCM for long-term contracts. There are other significant questions raised by the AICPA recently that were not addressed in Rev. Proc. 2018-40. These hopefully will be addressed in future guidance as well.

In the meantime, taxpayers now have guidance on the broad strokes of procedures to use in order to take advantage of the favorable changes in the TCJA for accounting methods. For more information on these procedures and how your business can take advantage of them, please contact your local CBIZ MHM tax professional.


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IRS Unveils Procedures to Take Advantage of Expanded Universe for Cash Method and Other Simplification Methods (article)IRS unveils new accounting method change requirements....2018-08-07T20:37:18-05:00IRS unveils new accounting method change requirements.