Timing of Profits Spurs Debate on Accounting in IRS Code: Taxes

For companies concerned about changes to the U.S. tax code, the issue may not be how much money they make but when they make it.

Two approaches to corporate accounting are squaring off in Congress’s plans to change the Internal Revenue Code, and the outcome may have a big impact on some types of businesses, Bloomberg BNA reported.

Farms and professional services businesses such as engineering and accounting firms are pushing for greater use of the cash method of accounting, which counts income when it is actually received and expenses when they are actually paid. Accrual accounting, by contrast, counts income when an order is made and an expense when goods are received.

Congress is weighing the biggest changes to the tax code since 1986, looking to cut rates, eliminate deductions and simplify the rules. Lobbyists have been pushing to save breaks for everything from retirement savings to credit unions, and representatives from industries from engineering to steel have been weighing in.

The House Ways and Means Committee proposed new rules in March for when businesses can use cash accounting. After a plan to expand its use and impose new limits on which companies can use this method, the committee signaled more adjustments may be on the way when a bill is introduced in coming weeks.

The annual cost of cash accounting for corporations, in terms of revenue lost to the government, is less than $50 million per year, the congressional Joint Committee on Taxation said in an annual report in 2012. The cost on the individual side of the tax code is between $1 billion and $1.5 billion annually from 2012 to 2017, the group estimated.

Camp’s Approach

Ways and Means Committee Chairman Dave Camp touted his March proposal as a simpler, more common-sense approach that would ease the cost of compliance for small businesses. His proposal would allow all sole proprietorships, as well as firms with less than $10 million in gross receipts, to use cash accounting, which the committee said would expand and simplify cash accounting for small businesses.

The proposal may force larger engineering firms to switch from cash accounting to the accrual method, which might require debt financing to cover the difference between expenses and income, the American Council of Engineering Companies said in written comments to the committee in May. In some cases, firms may have to pay taxes on income not yet received.

“The resulting cash flow challenges that would result from a switch to accrual accounting would create additional negative consequences, including workforce downsizing among some firms, delayed expansion plans, and decreased shareholder distributions,” the engineering group said.

Engineering Impact

Engineering firms tend to hold large numbers of accounts receivable and work in progress, for which they have not yet been paid, the group said. Although they must pay employees every two weeks, they also often wait as long as 120 days to receive payment for jobs completed, the organization told the Ways and Means Committee.

Cash accounting can help companies pay taxes after receiving payment for completed work, the group said.

The American Institute of CPAs said the proposal would impose accrual accounting on some partnerships, S corporations, farms and personal services corporations -- most of which have been allowed to use cash accounting regardless of gross receipts as long as they don’t hold inventory.

The American Farm Bureau Federation is concerned about the issue as well, the organization’s tax lobbyist, Patricia Wolff, told Bloomberg BNA. Larger farms that have used cash accounting would be forced into the accrual method, Wolff said.

Family Farms

Corporate family farms -- those in which at least 50 percent is controlled by one, or sometimes two or three, families -- are allowed to use the cash method unless their gross receipts reach $25 million per year, Wolff said. In addition, partnerships that include a corporation as one partner can’t use cash accounting, she said.

Most farmers like to use cash accounting because it simplifies recordkeeping and can reduce taxes by coordinating income and expenses, Wolff said.

Although the proposal from Camp, a Michigan Republican, affected mainly bigger farms, Wolff said, the effect on them may be significant. The “blank slate” approach Camp and Senate Finance Committee Chairman Max Baucus, a Montana Democrat, have taken toward tax expenditures has farms of all sizes concerned about implications for cash accounting, she said.

The blank slate means the chairmen will approach the tax rewrite by wiping the code clean of all tax expenditures, then adding some back based on their merits.

“We recommend the continuation of unrestricted cash accounting for farmers and ranchers who pay taxes as individuals and caution against reducing the number of corporate farms eligible to use it,” Wolff said.

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