Under the Tax Cuts and Jobs Act (TCJA), many more manufacturing businesses are now eligible to use the cash method of accounting for federal tax purposes, or be exempted from the uniform capitalization rules (“UNICAP”) of §263A, which requires businesses to capitalize any indirect costs (purchasing, handling, warehousing costs, etc.) related to inventory. Both offer greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether one of these methods would be advantageous and, if so, consider switching methods.
Previously, the cash method was unavailable to certain businesses, including:
- C corporations — as well as partnerships (or limited liability companies taxed as partnerships) with C corporation partners — whose average annual gross receipts for the previous three tax years exceeded $5 million, and
- Businesses required to account for inventories, whose average annual gross receipts for the previous three tax years exceeded $1 million ($10 million for certain industries).
In addition, companies whose average annual gross receipts exceeded $1 million for the previous three tax years (a $10 million threshold in some circumstances) were required to capitalize indirect costs related to inventory, otherwise known as the UNICAP rules. Generally, capitalizing inventory under UNICAP is less favorable, from a tax perspective, than the company’s financial statement method of accounting for inventory. The UNICAP rules require the deduction for some manufacturing costs to be recognized over a period of time (which inventory is held) whereas most inventory recognition methods for financial statement purposes allow for a deduction in the current year. Additionally, UNICAP is an extra calculation with additional time and effort needed to gather the information and perform the calculation.
The TCJA raised all of these thresholds to $25 million, beginning with the 2018 tax year. In other words, if your average gross receipts for the previous three tax years is $25 million or less, you generally now will be eligible for the cash method, regardless of how your business is structured or whether you have inventories. And, manufacturing companies under the threshold are not required to follow UNICAP rules, which streamlines some of the accounting rules.
Cash method advantages
Tax-planning flexibility: It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility.
Cash flow benefits: Because income is taxed in the year it is received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.
Should you switch?
If you are eligible to switch to the cash method and/or claim an exemption from UNICAP, you need to determine whether it is the right method for you. Usually, if receivables exceed payables, the cash method will allow more income to be deferred than will the accrual method. In most cases, manufacturing companies prefer to use the same method of accounting for inventory for their financial statements and income tax return instead of completing the UNICAP calculation.
The IRS has established procedures for obtaining automatic consent to such a change, beginning with the 2018 tax year, by filing Form 3115 with your tax return. For more information, or if you have questions, contact Shawn Sullivan using the information below.
Senior Vice President
Shawn serves as one of two primary leaders in the firm’s large tax group. He has extensive public and private experience in the fields of tax and accounting and works frequently with clients in the manufacturing, wholesale/retail distribution, real estate development and management, construction, and contractor industries. In addition to enhancing business performance to minimize tax consequences, he has experience in mergers and acquisitions and international tax and business structuring.
A certified public accountant, Shawn is a member of the American Institute of Certified Public Accountants, the Kansas Society of Certified Public Accountants (KSCPA) and chairs the KSCPA Committee on Taxation.