Taxes and the Right Accounting Method
A small business taxpayer now under the Tax Cuts and Jobs Act (TCJA) can obtain automatic consent to change its method of accounting. TCJA eased the eligibility rules for using the cash method of accounting, making this simpler cash method available to more businesses. If you have the option to use either accounting method, it pays to consider whether switching methods would be benefit your business.
Cash vs. Accrual – Which is best for you
Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.
In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:
- Expressly prohibited from using the cash method, or
- Expressly required to use the accrual method.
Advantages to the cash method
The cash method offers several advantages, including:
- It’s easier and cheaper to implement and maintain.
- It provides 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. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.
- It benefits cash flow because income is taxed in the year it’s received. Therefore the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.
Advantages of the accrual method
In some cases, the accrual method may offer tax advantages.
- Accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.
- The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).
If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.
Making a change
Keep in mind that cash and accrual are the two primary tax accounting methods, but there are other options. Your businesses may qualify for a different method, such as a hybrid of the cash and accrual methods. Ciuni & Panichi, Inc. tax professionals have been helping businesses plan for the best tax advantages for over 45 years. To learn how we can help your business contact Nick Leacoma, CPA, Tax Department Senior Manager at 216-831-7171, or by email here.
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