Automatic Changes for Taxpayers Meeting the $25 Million Gross Receipts Test

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Automatic Changes for Taxpayers Meeting the $25 Million Gross Receipts Test

The IRS recently released Revenue Procedure 2018-40.  This release offers procedural guidance for small business taxpayers that meet the $25 million gross receipts test.  According to the new guidance, taxpayers that reach the gross receipts threshold may obtain automatic IRS consent to implement a number of favorable method changes.

Rev. Proc. 2018-40 includes the following:

(1) Changes to the overall cash method;
(2) Exception from the requirement to capitalize costs under Section 263A;
(3) Exception from the requirement to account for inventories under Section 471; and
(4) Exception from the requirement to account for certain long-term contracts under Section 460 or to capitalize Section 263A costs for certain home construction contracts.

Taxpayers making concurrent changes may file a single combined Form 3115 application for several of the method changes (see below for more specifics).

Effective for taxable years beginning after December 31, 2017, these automatic changes are made by attaching Form 3115, Application for Change in Accounting Method, to a timely filed (including extensions) federal income tax return for the year of the change.

An overview of the new automatic accounting method changes is included below:

Small Business Taxpayer Changing to Overall Cash MethodThe average annual gross receipts test that exempts C-corporations and partnerships with C-corporation partners from the requirement to use the overall accrual method of accounting has increased from $5 million to $25 million.  This expands the use of the overall cash method of accounting to a greater number of taxpayers.

Taxpayers are eligible for this method change if –

(1) They meet the $25 million gross receipts test under Section 448(c) and
(2) They are not otherwise prohibited from using the overall cash method (e.g., tax shelter defined in Section 448(d)(3)) or required to use another overall method of accounting.

This change is implemented via a Section 481(a) adjustment.  For the first, second, or third taxable year beginning after December 31, 2017, taxpayers can file this change, even if it previously changed the overall method of accounting within the past five years.

Exception from Requirement to Capitalize Costs under Section 263A – Rev. Proc. 2018-40 increases the average annual gross receipts test, which exempts small resellers from the requirement to capitalize additional Section 263A costs under the uniform capitalization rules (UNICAP), from $10 million to $25 million. It also expands the test to both producers and resellers.

Taxpayers are eligible for this method change if –

(1) They meet the $25 million gross receipts test under Section 448(c) and
(2) They are not otherwise prohibited from using the overall cash method (e.g., tax shelter defined in Section 448(d)(3)) or required to use another overall method of accounting.

This change is also implemented with a Section 481(a) adjustment.  For the first, second, or third taxable year beginning after December 31, 2017, taxpayers can file this change, even if it previously changed the method of accounting for the same item within the past five years.

Exception from Requirement to Account for Inventory under Section 471 – Rev. Proc. 2018-40 increases the average annual gross receipts test, which exempts taxpayers from the requirement to account for inventories, to $25 million. The threshold was previously $1 million under Rev. Proc. 2001-10 or $10 million under Rev. Proc. 2002-28.  This change allows small business taxpayers to simplify their tax accounting for inventoriable costs in order to, in some cases, conform to the financial treatment.

Taxpayers are eligible for this method change if –

(1) They meet the $25 million gross receipts test under Section 448(c) and
(2) They are not otherwise prohibited from using the overall cash method (e.g., tax shelter defined in Section 448(d)(3)) or required to use another overall method of accounting.

Additional details regarding this new exception:

This change applies when a taxpayer chooses to adjust their Section 471 method of accounting for inventory items to one of the following:

(1) Treating inventory as non-incidental materials and supplies under Treas. Reg. Section 1.162-3; or
(2) Conforming to the taxpayer’s method of accounting reflected in its applicable financial statements with respect to the taxable year (or, if the taxpayer does not have applicable financial statements for the taxable year, the books and records prepared in accordance with the taxpayer’s accounting procedures).

Inventory treated as non-incidental materials and supplies is deducted in the taxable year in which it was first used or consumed in the taxpayer’s operations, which is generally when the taxpayer provided the item(s) to the customer.

This change is implemented with a Section 481(a) adjustment.  For the first, second, or third taxable year beginning after December 31, 2017, taxpayers can file this change, even if it previously changed the method of accounting for the same item within the past five years.

Exception from Requirement to Account for Certain Long-Term Contracts under Section 460 or to Capitalize Costs under Section 263A for Certain Home Construction Contracts – Generally, taxpayers must use the percentage-of-completion method to determine the taxable income under a long-term contract. However, exceptions exist for cases in which the contract is (1) a home construction contract or (2) any other construction contract expected to be completed within two years of the contract commencement and performed by a taxpayer whose average annual gross receipts do not exceed $25 million (up from $10 million).

Taxpayers are eligible for this method change if –

(1) They meet the $25 million gross receipts test under Section 448(c);
(2) They are not otherwise prohibited from using the overall cash method (e.g., tax shelter defined in Section 448(d)(3)) or required to use another overall method of accounting; and
(3) They previously adopted the percentage-of-completion method for exempt long-term construction contracts and now want to change to another permissible exempt contract method of accounting, or previously applied Section 263A to home construction contracts.

This change applies to exempt, long-term contracts as described in Section 460(e)(1) that are entered into after December 31, 2017, in taxable years ending after December 31, 2017.  Therefore, this change is made on a cut-off basis (thus, no Section 481(a) adjustment).  For the first, second, or third taxable year beginning after December 31, 2017, taxpayers can file this change, even if it previously changed the method of accounting for the same item within the past five years.

Taxpayers may file a single Form 3115 for the cash method of accounting, exemption from UNICAP, and exemption from Section 471.  The exemption from the percentage-of-completion method must be filed separately.

Please contact your WNDE service provider for more details related to implementation.

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