One part of the Tax Cuts and Jobs Act (TCJA) that’s particularly attractive to manufacturers and distributors is the new rule that expands the opportunity for businesses to use the cash method of accounting.
The change raises the gross receipts limit for resellers from a pre-TCJA limit of $10 million or less to the new higher limit of $25 million or less for the immediately preceding three years—a significant increase.
Most manufacturers and distributors are accustomed to the accrual method of accounting, which recognizes revenue on the income statement when earned and expenses when incurred. In contrast, the cash method of accounting recognizes revenue when received and expenses when they are paid.
Both methods offer some tax planning advantages. For example, companies using the cash method can defer income by sending invoices later or shift deductions into the current year by accelerating payment of deductible expenses. Companies using the accrual method can defer income on certain advance payments and deduct yearend bonuses paid within the first two-and-a-half months of the following year.
In terms of timing, switching to the cash method will create a one-time boost of a smaller tax bill in the first year. For companies with increasing sales, the change will seem great in year one but will have little effect after the first year. For companies with volatile or decreasing sales—or whose sales numbers are close to the $25 million limit— the change may not be worthwhile.
The TCJA also included some changes that affect inventory accounting, namely allowing simplified alternatives for inventory accounting if the business meets certain requirements relative to how it treats inventory and allowing companies to avoid the complex uniform capitalization (UNICAP) rules under certain circumstances.
To determine whether a change in accounting methodology is right for your company, talk to your tax advisor.