Under the terms of the new Tax Cuts and Jobs Act, the IRS will provide automatic consent to a small business taxpayer’s application to change to the cash method of accounting.
Eligible small business taxpayers, as defined by the TCJA, are generally those with average annual gross earnings of $25 million or less in the prior three-year period. The automatic consent changes include:
- a switch to the overall cash method of accounting;
- exemption from UNICAP for certain inventory costs, including self-constructed assets;
- certain additional changes to inventory items; and
- a change from the percentage-of-completion method for long-term construction contracts.
In most cases, a taxpayer that wishes to change its accounting method must apply for and secure the prior consent of the IRS. However, for some accounting method changes, IRS provides an automatic procedure for obtaining its consent to the change. The agency issued an updated list of accounting changes to which its automatic change procedures apply in a May 2018 Revenue Procedure.
When a taxpayer changes its accounting method, adjustments are generally required to prevent items from being duplicated or omitted. However, in limited circumstances, a “cut-off” method can be used instead, where only the items arising on or after the beginning of the year of the change are accounted for under the new accounting method.
The above changes generally apply to tax years beginning after Dec. 31, 2017. An exception can be made for a fiscal year business whose 2017 return (i.e. covering 10/1/17–9/30/18) may include exempt long-term contracts entered into after Dec. 31, 2017.
The new methods are subject to reduced filing requirements, in that only a partial Form 3115, Application for Change in Accounting Method, needs to be filed. A taxpayer changing to more than one of the new methods can make these changes concurrently on a single Form 3115, provided that the taxpayer enters the designated automatic accounting method change numbers on the appropriate line of the form.
The new procedure provides that, if a taxpayer is taking into account an adjustment resulting from a prior, but related, change in method of accounting at the time it changes to one of the new methods, the taxpayer may choose to either:
- account for the prior adjustment separately from the adjustment required by a change to one of the new methods; or
- combine or net the two amounts.
In the latter case, the taxpayer must indicate this choice in the statement required on Line 26 of Form 3115.
If you have any questions regarding these rules or any other tax matters, please consult a member or our tax team.