Proposed regulations (REG-132766-18) issued Thursday update various tax accounting regulations to adopt the simplified tax accounting rules for small businesses enacted by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.
For tax years beginning in 2019 and 2020, these simplified tax accounting rules apply for taxpayers with inflation-adjusted average annual gross receipts of $26 million or less (known as the gross receipts test). Taxpayers classified as tax shelters are prohibited from using the simplified rules even if they meet the gross receipts test.
A taxpayer is considered to meet the gross receipts test and be permitted to use the cash method of accounting if average annual gross receipts for the three-tax-year period ending immediately before the current tax year are $25 million (adjusted for inflation to $26 million for 2019 and 2020) or less.
The TCJA also exempted small business taxpayers from the Sec. 263A uniform capitalization rules and added an exception to the requirement to use an inventory method if their inventory is treated as nonincidental materials and supplies, or in accordance with the applicable financial statement (AFS). If they do not have an AFS, taxpayers can use their books and records. The proposed regulations implement these statutory changes and provide clarifying guidance on the definition of an AFS, and the types and amounts of costs reflected in an AFS that can be recovered under Sec. 471(c) and when those costs can be taken into account.
One example of a clarifying definition is found in Prop. Regs. Sec. 1.471-1(b)(4)(i), which explains that inventory treated as Sec. 471(c) nonincidental materials and supplies is not eligible for the Regs. Sec. 1.263(a)-1(f) de minimis safe-harbor election because extending the election to encompass Sec. 471(c) materials and supplies is outside the intended scope of the election and runs counter to Sec. 471(c), which treats these materials and supplies as inventory property.
Prop. Regs. Sec. 1.471-1(b)(4)(ii) permits taxpayers to determine the amount of their Sec. 471(c) materials and supplies by using either a specific identification method, a first-in, first-out (FIFO) method, or an average cost method, provided that taxpayers use the method consistently. Taxpayers are not permitted to identify their inventory using a last-in, first-out (LIFO) method or value Sec. 471(c) materials and supplies using a lower-of-cost-or-market (LCM) method because the IRS says that would defeat the goal of simplification by requiring complex accounting.
In addition, the proposed regulations provide guidance for small businesses with long-term construction contracts and the requirements for exemption from the percentage-of-completion method and the uniform capitalization rules. For taxpayers with income from long-term contracts reported under the percentage-of-completion method, guidance is provided for applying the lookback method after repeal of the corporate alternative minimum tax and enactment of the base-erosion and anti-abuse tax (BEAT).
The IRS is also requesting comments on how Sec. 460 (or other special methods of accounting) should apply to a contract with income that is accounted for in part under Sec. 460 (or other special method) and in part under Sec. 451.
The IRS is requesting comments on all issues by 45 days after the rules are published in the Federal Register. The regulations are generally proposed to be effective for tax years ending after they are adopted as final. However, for tax years beginning after Dec. 31, 2017, and before the date the final regulations are published, a taxpayer may rely on these proposed regulations, provided that the taxpayer follows all the applicable rules contained in the proposed regulations for each Code provision that the taxpayer chooses to apply.
— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a Tax Adviser senior editor.