On Dec. 10, IRS Commission-er Charles Rossotti met with ACCA and other small-business organizations to announce the new rules. Effective with the 2001 tax year, companies with less than $10 million in gross receipts that provide services and are not classified principally as retailers, manufacturers, or wholesalers, will be able to report income and deduct expenses when payments occur.
“There’s been a controversy for the last several years on the type of accounting small businesses are allowed to use,” said Craig Silvertooth, manager of federal relations for ACCA. This has involved cash vs. accrual accounting.
With the cash method of accounting, he explained, you simply record receipts when they come in. Accrual accounting, which is more complex, has generally been used by businesses that are larger or whose primary activity requires inventory. With the accrual method, you record receipts when you book an order, whether or not the income is actually received, and you have a tax liability for that revenue.
Around 1997, said Silvertooth, “The IRS began targeting smaller businesses, such as hvacr contractors, who may maintain inventory as part of their business even though it’s not part of their principal activity, and — for companies as small as $1 million — tried to force them to use the accrual method of accounting.” For a smaller firm, this method can create a cash strain on the business.
Congress had originally tried to create a safe harbor for businesses of $5 million annually in gross receipts when legislators revised the tax code in 1986. “But the law was written poorly and was not as clear as it could have been,” he stated. “So it gave the IRS leeway.”
In the late 90s, the IRS decided to pursue a variety of small businesses, although their guidelines were unclear, and in 2000, officially issued a guidance setting the limit at $1 million.
The new guidelines provide for simplicity in accounting for small businesses without affecting tax revenues. The new $10 million limit is based on an average of receipts over the previous three years.
This issue has been a legislative priority for ACCA since 97 and the association has been lobbying Congress to require the IRS to make this change.
The IRS estimates that “more than 500,000 businesses [overall] may take advantage of this relief.”
The new changes do not apply to companies that are required to use the accrual method by law, such as corporations or partnerships with general partners that have gross receipts in excess of $5 million.
The IRS’s official notice will be published in Internal Revenue Bulletin 2001-52, dated Dec. 26, 2001. It will also be available through the IRS website at www.irs.gov. Contractors currently using the accrual method who would like to change accounting methods, and qualify under the new guidelines, must file Form 3115, “Application for Change in Accounting Method.”
For more information, contact Silvertooth at 703-824-8841; firstname.lastname@example.org (e-mail).
Publication date: 12/24/2001