The Tax Cuts and Jobs Act (TCJA) is the most substantial overhaul of the U.S. tax code in more than three decades. It has implications for every small business.
In response to the TCJA (Tax Cuts and Jobs Acts), TD-9942 is the final regulation issued in late 2020. It updates the different tax accounting regulations with the goal of simplifying tax accounting rules for qualified small businesses.
Here’s what you need to know about the new Tax Cuts and Jobs Act (TCJA) updates. Save time, money, and headaches for your e-commerce small business.
Let’s dive in!
Who is qualified as a small business?
For the tax year beginning in 2020 and 2021, these simplified tax accounting rules apply to small businesses (except for tax shelters – see below). Small businesses whose average annual gross receipts of the three tax year periods ending immediately before the current year is $26 million or less (gross receipts test).
A tax shelter is a partnership or any other entity (other than a C corporation) that has at least 35% of its losses allocable to limited partners or limited entrepreneurs.
Businesses, especially those that carry inventory such as e-Commerce businesses, with gross receipts of over $5 million are required to use the accrual method of accounting.
The gross receipts test is also used to determine whether certain taxpayers are required to use the Sec 263A rule (capitalization of certain cost to inventory), and Sec 471 rule, which treats certain nonincidental materials and supplies as inventory.
After TCJA and the final regulations
After Tax Cuts and Jobs Act (TCJA) and the final regularions, qualified small businesses can:
- Use the cash method of accounting instead of the accrual method of accounting (Sec. 448(c));
- Not capitalize additional uniform capitalization (UNICAP) costs to inventory (Sec. 263A(i));
- Treat inventories as nonincidental materials and supplies or use an inventory method that conforms to their financial accounting treatment of inventories (Sec. 471(c))
Why is this important?
Can now use the cash method vs. accrual for accounting
Traditionally, businesses are required to use the accrual method of accounting for tax returns. This is because the gross receipts test threshold is only up to $5 million for most e-commerce businesses. What happens with the accrual method is that the business ends up recognizing revenue before the cash has been received, or they need to defer expenses even when expenses are paid.
In general, the cash method of accounting follows the cash, you recognize income when cash is received, and take deductions when expenses are paid.
Provides limited relief for partnerships that have fluctuating income and losses
For businesses that are considered as “a tax shelter” due to a current year loss, the cash method and the simplified accounting methods do not apply to them. And as such their overall accounting method has to be changed in the year that they are considered a “tax shelter.”
That is problematic as partnerships don’t know if they are considered “tax shelters” until the end of the current year. The final regulations provide an annual election for taxpayers to elect in the loss year to use the allocated taxable income or loss of the immediately preceding tax year to determine whether the taxpayer is a tax shelter for the current tax year.
This allows taxpayers to be better prepared and plan for the current loss year. And since this is an annual election, the partnership can be out of the “tax shelter” status the next year when it becomes profitable again.
This provides limited relief for partnerships that have fluctuating income and loss in the threshold years. Which is a good thing.
Expands pool of qualified small businesses
Before the recent law updates, Sec 263A required capitalization of additional UNICAP costs such as purchasing, handling and storage for businesses that failed the $10 million small reseller exemption.
Instead of deducting certain cost items immediately, costs would be added as part of the inventory. This would further defer expenses for tax deductions.
With the Tax Cuts and Jobs Act (TCJA) and the final regulations, it expands the pool of qualified small businesses that are exempt from this regulation by increasing the gross receipts test threshold amount.
Small taxpayers, including e-commerce, don’t need to follow the rules of Sec. 471
Prior to the law change, Sec. 471(a) required inventories to be taken by a taxpayer when, in the opinion of the Treasury secretary, taking an inventory is necessary to determine the income of the taxpayer.
Regs. Sec. 1.471-1 requires the taking of an inventory at the beginning and end of each tax year in which the production, purchase, or sale of merchandise is an income-producing factor.
The Tax Cuts and Jobs Act (TCJA) provided that small taxpayers do not need to follow the rules of Sec. 471 for valuing or identifying inventories and allowed two options. One, follow the book inventory method. Or two, treat inventory as nonincidental materials and supplies.
Simplifies the inventory adjustment process
This simplifies the inventory adjustment process. Taxpayers can now choose to treat the inventory as nonincidental materials and supplies (NIMS), which are treated as used or consumed when provided to the consumers.
Taxpayers who opt to use the NIMS method are only required to include direct material cost or cost of property required for resale. This means that taxpayers will have the flexibility to deduct direct labor costs or indirect costs in the current year.
Eliminates the five-year restriction on the automatic method, saving time and money
The final regulations eliminate the five-year restriction on the automatic method (i.e. don’t require IRS prior approval). This allows flexibility for taxpayers who need to change from one accounting method to the other.
Since the ruling is automatic, the taxpayers will not need to obtain IRS written ruling before applying the change.
This eliminates a lot of unnecessary costs and waiting time.
All in all, the TCJA (Tax Cuts and Jobs Acts) and TD 9942 come with many benefits. These benefits apply to both general and e-commerce businesses. Understanding the tax updates and regulations could help your business save time and money.
If you’re looking for Tax experts and CPAs, we can help. Contact us today to learn more.