Automatic Accounting Method Change Opportunities
September 10, 2021
The tax accounting method is essential to a business’s cash flow. By selecting an optimal accounting method, businesses can improve their cash flow and avoid effectively prepaying taxes. The accounting method determines the timing of recognizing income or deduction for the tax purpose; therefore, an appropriate accounting method is critical.
There are two most common accounting methods: accrued method and cash method. With the accrued method, incomes are recognized when earned and deductions are recognized when expenses are incurred. While with the cash method, income and deductions are recognized when cash is paid or received. There are also other accounting methods of specific items such as inventory valuation or installment sales.
The Tax Cuts and Jobs Act (TCJA) expanded the number of small businesses that are qualified to use the cash method. Taxpayers whose average gross receipt of the prior three years are lower than $25 million are eligible to use the cash method. These small-business taxpayers may also benefit from using other simplified methods of accounting such as exemption of capitalization costs and other areas.
Generally, a taxpayer must obtain IRS consent before changing the accounting method. To apply for advance consent, a company needs to file Form 3115, Application for Change in Accounting Method, and pay a user fee. A taxpayer cannot switch accounting methods until IRS agrees.
However, recently IRS modified the automatic accounting method change procedures. For qualified taxpayers, IRS approves the method change automatically. That to be said, after the taxpayer files the information to IRS, it is granted the changes and doesn’t need to wait for IRS approval. This change simplified the application process of switching to a more favorable accounting method. This automatic change covers certain uniform capitalization (UNICAP) methods, the timing of income recognition, and change from the cash method to an accrual method, etc. However, some other accounting method changes such as cost-offset related inventory methods still need IRS advance consent.