Manufacturers Now See Simpler Reporting Requirements
One of the main goals of tax reform is to encourage reinvestment in U.S. domestic production. This is through several relief provisions in the Act, which both simplify tax accounting methods and open up more tax benefits.
While we recently posted an article on tax reform for manufacturing, here we're looking more closely at reporting requirements.
What’s Your Method of Accounting?
A change from the accrual method to the cash method (cash receipts and disbursements) can make the reporting requirements easier for many small to midsize manufacturing and distribution businesses.
Traditionally, sole proprietorships and individuals favored the cash method, and under the Act, manufacturers can often see benefits from it, too.
Generally, most manufacturers are using an accrual method at this time, wherein:
- items of income are accrued once all events have occurred that fix the right to receive that income, and
- the expected amount of income can be determined reasonably accurately.
On the other hand, those manufacturers who use the cash method:
- generally recognize items of expense when paid, and items of income when actively or constructively received,
- might value the flexibility of this method in terms of how income recognition is timed, and
- may like the relative ease of administration and straightforwardness of this method. This could be especially good for small manufacturers with limited capacity in their accounting departments.
In a pre-tax reform world, C corporations, partnerships with a C corporation as a partner, and tax-exempt trusts or corporations with unrelated business income were usually not permitted to utilize the cash method.
That generally included manufacturing and distribution businesses as well because they are required to keep inventory records. Why? They're important for determining the cost of goods sold in a taxable year.
Starting in 2018, more businesses can utilize the cash method. In particular, it includes businesses where average annual gross receipts for the prior three years are less than $25 million.
Also, this applies regardless of whether the production, purchase, or sale of goods is an income-producing factor.
Other Good News
If you're a small manufacturing business—i.e. your average gross receipts are less than $25 million—you don't have to account for inventories anymore.
- treating inventories as non-incidental materials and supplies, or
- conforming to their financial accounting treatment of inventories.
You might be exempt—ask yourself these two questions; are you using the cash method, and does your business treat inventories as non-incidental materials and supplies? If so, there's a good chance.
The role of 263(a) in our tax code is to address uniform capitalization rules. They require certain costs that are normally expensed to be capitalized as part of the inventory for tax purposes.
They apply to both real or tangible personal property produced by the taxpayer, and real or personal property acquired by the taxpayer for the purpose of resale.
In short, changing to the cash method of accounting and changing the way you account for inventories have the potential to yield sizeable benefits over time, and manufacturers and distributors could start realizing benefits right away. They can also be powerful tax deferral tools over time.
Do you have questions that you’d like to share with someone experienced in comprehensive tax planning? Start a conversation with Redpath CPAs today!