Cash Method or Accrual Method?! And Why You Might Want to Consider a Change in Method of Accounting
One of the key takeaways from the Tax Cuts and Jobs Act passed in December of 2017, which took effect for 2018, was the threshold for requiring taxpayers to follow the accrual method of accounting. The threshold was increased from $5 million of gross receipts to $25 million. Now, businesses that average less than $25 million of gross receipts for the past three tax years can change to the cash method of accounting and are not forced to adopt the accrual method of accounting. The cash method is known to be an easier method to implement, and can potentially provide a way to defer taxes.
The cash method of accounting allows taxpayers to recognize income and deductions when cash is either received or paid. Taxpayers do not have to recognize income until payment is received. Under the accrual method of accounting, taxpayers are required to recognize the income when it was earned rather than when they received the cash for the services or goods.
One large deduction that is available to qualifying small businesses that change from the accrual method of accounting to the cash method of accounting under the new tax laws pertains to inventory. Previously, taxpayers under the accrual method accounted for inventory when they recognized a sale, and could not receive the tax deduction prior. However, the cash method of accounting will allow the taxpayer to take a deduction for inventory when purchased and paid for. If a taxpayer elects to use the cash method of accounting, they can write off any inventory on their books, which can amount to a hefty deduction and therefore tax savings for the year.
Although the cash method of accounting should not be used for every business, it may be something to potentially consider. With the increase in the threshold which requires the accrual method of accounting, there is a substantial increase in the number of taxpayers that can now qualify for the cash method of accounting.
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