A number of entrepreneurs will find good news in a recently issued IRS procedure allowing certain businesses with gross receipts of up to $10 million to use the cash method of accounting for income and expenses rather than the accrual method.
When companies use the cash method, income is taxable when received, and expenses are deductible when paid. With the accrual method, transactions are taxable or deductible when incurred.
While the proposed change is welcomed by a number of entrepreneurs, it will not apply as broadly as some might think, says Dennis J. Tepe, CPA and tax partner with accounting firm Jackson, Rolfes, Spurgeon & Co. in Dayton, Ohio. For example, manufacturers, wholesalers, retailers, miners, and certain publishers and sound recorders aren't allowed to use the cash method of accounting, according to the IRS, unless they are principally a service business or perform certain kinds of custom manufacturing.
Even so, the IRS is providing needed guidance for any service business that has a small percentage of inventory items as part of its revenues--such as a computer trainer/consultant who also sells software applications. In the past, it was unclear whether these firms were required to use the accrual method. Now, as long as the service part is more than 50 percent of the business, the cash method can be used, says Tepe.
"This change amounts to a home run for small business," says Sen. Christopher "Kit" Bond [R-MO], the ranking Republican on the Senate Committee on Small Business and Entrepreneurship.
In addition, Sen. Bond says the new procedure will result in significant tax simplification for more than half a million small firms. Last year, he introduced legislation calling on the IRS to increase the safe harbor for companies to use cash accounting beyond the current $1 million level. But in 2001 the agency made the change without passage of legislation.
Great Falls, Virginia, writer Joan Szabo has reported on tax issues for more than 15 years.