Inflation Adjustments Impact Qualified Small Businesses

November 2019

Summary

Various provisions of the Internal Revenue Code that are tied to specified dollar amounts provide that those dollar amounts are to be increased for inflation. Provisions of interest in the accounting methods realm 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 Sections 263A, 460 and 471, and whether entities are subject to the Section 163(j) business interest expense limitation. Also, there are inflation adjustments to the amounts that can be expensed under a Section 179 election instead of being capitalized and depreciated. Rev. Proc. 2018-57, 2018-49 I.R.B. 827, states the inflation-adjusted amounts for taxable years beginning in 2019 for these, and other, Internal Revenue Code provisions.
 

Qualification as small business taxpayer

The law known as the Tax Cuts and Jobs Act, P.L. 115-97, amended Section 448(c) to provide 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 taxable years beginning after December 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 taxable year beginning in 2019 if its average annual gross receipts for the three taxable year period ending before the 2019 taxable year does not exceed $26,000,000, an increase of $1 million from 2018. In addition to being able to use the cash method, small business taxpayers are also exempt from the requirement to capitalize additional costs under Section 263A, the requirement to account for inventoriable costs under Section 471, and the requirement to use percentage-of-completion for long term contracts under Section 460.

Remember that Section 448(c)(2) requires that the gross receipts of certain controlled corporations, partnerships and proprietorships, and of affiliated service groups will need to be aggregated in applying this test. See “The Not-So-Simple Aggregation Rules For Tax Reform’s Simplifying Conventions,” August 2019. 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 to make such a change. Similarly, a taxpayer currently capitalizing costs under Sections 263A and Section 471 and/or using the percentage-of-completion method under Section 460 may be able to file an automatic method change to no longer use these methods; some of these method changes can be combined with a change to the overall cash method. A taxpayer currently using an overall cash method and/or currently exempt from Sections 263A, 471 and 460 should confirm that it continues to qualify for exemption, or that it needs to change to a proper method if it no longer qualifies.

The increased amount for this gross receipts test will also affect the limitation on the business interest deduction under Section 163(j). Now, for taxable years beginning in 2019, if a taxpayer meets the $26 million gross receipts test, it will be exempt from the business interest limitation for 2019 because it qualifies as a small business.
 

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 Section 179 instead of depreciating them also benefits from an inflation adjustment for taxable years beginning in 2019. The limitation and phaseout for the election to expense certain depreciable business assets under Section 179 had been increased for inflation for a number of years; the Tax Cuts and Jobs Act added an inflation adjustment limitation for the cost of any sport utility vehicle for taxable years beginning after December 31, 2018.

For taxable years beginning in 2019, the aggregate cost that a taxpayer may elect to deduct is $1,020,000, a $20,000 increase from 2018. This limitation is reduced by the amount by which the cost of Section 179 property placed in service during the taxable year beginning in 2019 exceeds $2,550,000, an increase of $50,000 from 2018. Further, for sport utility vehicles the costs that may be taken into account for taxable years beginning in 2019 have been increased $500 to $25,500.

We expect that before the end of 2019, the Internal Revenue Service will issue a revenue procedure that will provide the inflation adjusted amounts for taxable years beginning in 2020.

If you have any questions, please contact a member of the Accounting Methods group. The Accounting Methods group within BDO USA’s National Tax Office has extensive experience assisting taxpayers of all industries and sizes with their accounting method issues and filing accounting method change requests with the IRS.
 

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