A new restriction on the cash method of accounting may loom for individuals and businesses with more than $10 million in annual gross receipts. This measure comes from Dave Camp, R-Mich., chairman of the U.S. House of Representatives’ Ways and Means Committee.
Many International Warehouse Logistics Association (IWLA) members stand to experience a significant change: This tax reform focuses on turning small-business accounting practices from cash-based to accrual methods.
Cash vs. Accrual
Small-to medium-sized businesses typically operate under the cash method of accounting. Revenues and expenses are recorded in real-time—the moment the funds enter/leave a bank account. This method is beneficial to a smaller operation because it allows for better oversight.
On the other hand, an accrual accounting system is more likely practiced in larger public corporations, because it accumulates revenue and expenses on an annual basis and allows publicly traded companies to make projections.
“Timing of the accrual system is what matters: Pre-paid versus post-payments of things such as rent, deposits, and projected expenses can have a positive or negative impact on a company’s revenues,” says Donna Rebeck, IWLA’s contracted CFO Consultant. “Because taxes are based on the net revenue, converting from cash to accrual may require businesses to pay taxes to the Internal Revenue Service on money that you haven’t yet received.”
The impact for smaller warehouses whose services are dedicated to one customer could be severe. If you have to move all of the revenue to another year, even with a long-term deal and contracts, you can end up with negative cash. The next step in these situations typically involves borrowing with interest to cover cash flow, stretching already thin small-business margins.
According to Rebeck, depending on the circumstance, the proposed tax reform could run a small business dry during the first year, as some may not be able to cover the taxes from projected revenues.
If a small business works under long-term contracts, the risk of not receiving payments increases. “In some cases a client evades payments or breaks a contract. Then you’re paying taxes on revenues you never received,” Rebeck says.
There would another impact with this change: adjustment of long-term contracts. “Many businesses base long-term expenses on long-term revenue, so this would need readjustment to align tax planning to match projections.
“For example, some businesses that are locked into five-year contracts will lock themselves into five-year agreements for fuel. Instead, they will be required to change contracts to match projections to revenues,” says Rebeck.
What’s the point of all this?
On the cash basis, the government believes, businesses have more opportunities to evade taxes by hiding revenues or bartering services.
“They are trying to collect taxes on revenue whether it’s paid or not. There may be situations that [the IRS is] not collecting and it should. The agency would rather have the money than not have it,” Rebeck says.
Rebeck thinks this is just one aspect of tax reforms affecting U.S. businesses. The IRS wants to collect as much it can from goods and services performed. IWLA encourages members to monitor proposed changes through active involvement in the association’s advocacy efforts. IWLA’s participation in BI-PAC helps us watch, preempt and effect change. Learn more by visiting the IWLA Legislative Action Center.