Editor: Kevin D. Anderson, CPA, J.D.
Inflation adjustments for 2019 and 2020 may increase the number of taxpayers that qualify as a small business and the amount of costs that can be expensed under a Sec. 179 election. The increased dollar limits will allow more taxpayers to take advantage of favorable accounting provisions and potentially accelerate deductions to an earlier year.
Various provisions of the Internal Revenue Code that are tied to specified dollar amounts are adjusted annually for inflation. Provisions of interest in the realm of accounting methods include the increases to the threshold to be considered a small business taxpayer, which determines whether certain entities can use an overall cash method of accounting or be exempt from certain requirements under Secs. 263A, 460, and 471, and whether entities are subject to the Sec. 163(j) business interest expense limitation. Inflation adjustments also apply to the amounts that can be expensed under a Sec. 179 election instead of being capitalized and depreciated. Rev. Proc. 2018-57 states the inflation-adjusted amounts for tax years beginning in 2019, and Rev. Proc. 2019-44 states the inflation-adjusted amounts for tax years beginning in 2020 for these and other Code provisions.
Qualifying as a small business taxpayer
As a general rule, C corporations, partnerships with a C corporation partner, and taxpayers for which inventory is an income-producing factor are required to use the overall accrual method of accounting. The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, provides an exception to this general rule by allowing small business taxpayers to use the cash method of accounting. To qualify as a small business taxpayer, an entity must meet a "gross receipts test" and cannot be considered a tax shelter. The TCJA further provides that the gross receipts test used to determine whether certain taxpayers are required to use an overall accrual method of accounting will be adjusted for inflation for tax years beginning after Dec. 31, 2018.
The inflation adjustment will allow a C corporation or partnership that has a C corporation as a partner to use the overall cash method of accounting for its tax year beginning in 2019 or 2020 if its average annual gross receipts for the three-tax-year period ending before the 2019 or 2020 tax year does not exceed $26 million, an increase of $1 million from 2018. The TCJA also modified Sec. 448 to permit a taxpayer to change to the use of the cash method of accounting if it meets the gross receipts test for the current year, even though it may not have met the test in a prior year and was required to use an accrual method.
In addition to being able to use the cash method, small business taxpayers are also exempt from the requirement to capitalize additional costs under Sec. 263A, the requirement to account for inventoriable costs under Sec. 471, and the requirement to use the percentage-of-completion method for exempt long-term construction contracts under Sec. 460. Costs that are not treated as inventory under Sec. 471 should be accounted for as nonincidental materials and supplies (and deducted when used or consumed), or conform to the taxpayer's method of accounting in its applicable financial statement, or, if the taxpayer does not have any applicable financial statement for a tax year, conform to the taxpayer's books and records prepared in accordance with the taxpayer's accounting procedures.
Importantly, Sec. 448(c)(2) contains an aggregation rule that, if triggered, requires the gross receipts of certain controlled corporations, partnerships, and proprietorships, and of affiliated service groups to be aggregated in applying the gross receipts test. A taxpayer using an accrual method of accounting that meets this test and wishes to use the overall cash method may be able to file an automatic accounting method change under Rev. Proc. 2019-43 to make this change. Similarly, a taxpayer currently capitalizing costs under Secs. 263A and 471 and/or using the percentage-of-completion method under Sec. 460 may be able to file an automatic method change to no longer use these methods. Changes under Secs. 263A and 471 can be combined with a change to the overall cash method and filed on the same Form 3115, Application for Change in Accounting Method. A taxpayer currently using an overall cash method and/or currently exempt from Secs. 263A, 460, and 471 is advised to continue monitoring that it continues to qualify for the small business threshold in subsequent years and, if it no longer qualifies, change to a proper method by filing a Form 3115.
On a related matter, the TCJA also modified Sec. 447 to apply the gross receipts test to corporations engaged in farming. Specifically, a C corporation or partnership that has a C corporation as a partner that is engaged in the trade or business of farming and that meets the gross receipts test may use the overall cash method of accounting instead of an accrual method. C corporations with average annual gross receipts for the three-tax-year period ending before the 2019 or 2020 tax year that do not exceed $26 million may use the cash method.
The same aggregation rules under Sec. 448(c)(2) also apply here to require that the gross receipts of certain controlled corporations, partnerships, and proprietorships, and of affiliated service groups be aggregated in applying the gross receipts test. A farming corporation using an accrual method of accounting that meets the test and that wishes to use the overall cash method may be able to file an automatic accounting method change under Rev. Proc. 2019-43 to make the change.
The increased amount for this gross receipts test will also affect the limitation on the business interest deduction under Sec. 163(j). Now, for tax years beginning in 2019 or 2020, if a taxpayer meets the $26 million gross receipts test, it will be exempt from the business interest limitation for that year because it qualifies as a small business.
Taxpayers that were close to the $25 million threshold when performing the gross receipts test for the 2018 tax year or that have had a significant increase or decrease in gross receipts may want to revisit the gross receipts test for 2019 or 2020 to see how the increased gross receipts amount affects them.
Increase in the amount of depreciable business assets a taxpayer may elect to expense
A taxpayer that desires to expense certain qualified depreciable business assets under Sec. 179 instead of depreciating them also benefits from an inflation adjustment for tax years beginning in 2019 and 2020. The limitation and phaseout for the election to expense certain depreciable business assets under Sec. 179 had been increased for inflation for a number of years; the TCJA added an inflation adjustment to the limitation for the cost of certain sport utility vehicles (SUVs) for tax years beginning after Dec. 31, 2018.
For tax years beginning in 2019, the aggregate maximum cost of Sec. 179 property that a taxpayer may elect to expense is $1,020,000, a $20,000 increase from 2018. This limitation is reduced by the amount by which the cost of Sec. 179 property placed in service during the tax year beginning in 2019 exceeds $2,550,000, an increase of $50,000 from 2018. Further, for qualifying SUVs, the costs that may be taken into account for tax years beginning in 2019 have been increased by $500 to $25,500.
For tax years beginning in 2020, the aggregate maximum cost of Sec. 179 property that a taxpayer may elect to expense is $1,040,000. This limitation is reduced by the amount by which the cost of Sec. 179 property placed in service during the tax year beginning in 2020 exceeds $2,590,000. Further, for qualifying SUVs the costs that may be taken into account for tax years beginning in 2020 is $25,900.
An in-depth discussion of Sec. 179 is outside the scope of this item, but note that the TCJA expanded the types of property that may be expensed under Sec. 179, including certain Sec. 1250 improvements to existing buildings that are nonresidential real property. Specifically, qualified improvement property and qualifying roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems that are structural components of buildings are treated as qualified real property eligible for the election.
In addition, TCJA changes to Sec. 168(k) increased the special allowance for certain property (bonus depreciation) to 100% for qualified property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. In part, qualified property is property with a recovery period of 20 years or less, computer software, a qualified film or television production, or a qualified live theatrical production. Bonus depreciation was also expanded to apply to used property.
A taxpayer interested in expensing as much of its depreciable property as possible should consider taking bonus depreciation for its shorter-lived property if it uses the modified accelerated cost recovery system (property required to be depreciated under the alternative depreciation system will not qualify for bonus depreciation) and making the Sec. 179 election for more expensive, longer-lived property.
This is an updated version of an article originally posted in BDO News and Insights.
Kevin D. Anderson, CPA, J.D., is a managing director, National Tax Office, with BDO USA LLP in Washington, D.C.
For additional information about these items, contact Mr. Anderson at 202-644-5413 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.