It is tax time. Boo!
This year, however, there may be a silver lining. The Tax Cuts and Jobs Act … you know, the “New Tax Law” or “TCJA” … has a provision that may help suppliers better match their taxable income with cash collected. If your company has average annual gross receipts over the 3-year period ending with the prior taxable year of less than $25 million, you may be eligible to use the cash-basis method of accounting.
Before we get started, this article is for owners of DME companies frustrated by cash flow and dreading the call from their accountant about 2018 taxes due. I am going to cover the topic at a very high level. Instead of inundating readers with the complexity of the tax law, the purpose of this article is to draw attention to a provision that may or may not benefit your situation. I have no idea if it will, and as such, you should discuss all tax issues with your tax accountant in detail before acting.
A Brief Lesson on Methods of Accounting
Taxpayers have choices when it comes to how they account for revenues and expenses. Two popular methods are the accrual method and the cash method. There are others, but these are the two with which most are familiar.
The accrual method reports revenue when it is earned and deducts expenses when incurred, not when cash is received or paid. Under the accrual method, accounts receivable represent revenues earned but not yet collected, and accounts payable represent expenses for which a company is liable but has not yet paid.
The cash method, on the other hand, is pretty straight forward. Taxpayers report revenue when cash is received and deduct expenses when they are paid. No accounts receivable or payable are necessary because there are no timing differences between the reporting of revenue and expenses and the receipt or payment of cash.
So you may ask, dear reader …
Why on Earth Would DME Suppliers Choose the Accrual Method When the Collectability of AR is so … Iffy?
Taxpayers may choose any method they prefer so long as it accurately reflects income. The Internal Revenue Service has specific rules, however, to clarify what does and does not accurately reflect income.
Basically, the IRS rules and regulations require taxpayers to use the accrual method when inventory is a significant income-producing factor. A pure service business, like a medical billing company, can often use the cash-basis method. Most DME suppliers cannot, however, because they deal in products and have inventory.
There are exceptions. Under the old rules (and I continue to oversimplify here), the following were exempt from requirements to use the accrual method:
- Companies with average gross receipts less than $1 million for each prior tax year ending on or after December 31, 1998 (average gross receipts calculation specified by Rev Proc 2001-10).
- C Corporations and partnerships with C Corporations as partners, so long as average gross receipts were less than $5 million.
Additionally, Rev Proc 2002-28 provided another exception to the accrual method for companies with average gross receipts less than $10 million. 2002-28, however, excluded certain types of companies, namely those that have inventory.
Because durable medical equipment inventory is a significant income-producing factor and few DME suppliers met any of the exceptions, many could not use the cash-basis method of accounting under the old rules.
Tax Cuts and Jobs Act
Under the old rules, DME suppliers with average gross receipts greater than $1 million were likely saddled with the accrual method. The New Tax Law ups the limit to average annual gross receipts less than $25 million regardless of whether inventory is a significant income-producing factor. Hooray, New Tax Law!
Though the Tax Cuts and Jobs Act opens up the cash method to more businesses, it is not a pure cash method. The New Tax Law requires companies meeting the exception to account for inventory as nonincidental materials and supplies. As such, taxpayers cannot deduct inventory costs until the latter of the:
- Date the inventoriable equipment is provided to customers.
- Date the taxpayer pays for the inventory.
Vendor leases and other financing arrangements may make it difficult to determine the date the taxpayer pays for the inventory. Your accountant will help you make the determination based on your actual financing arrangements.
[Since you are already thinking about the future, join Andrea Stark and Jeff Baird for the 2019 Look Ahead for DME Suppliers on February 28, 2019, at 1:00 PM (ET).]
Changing Methods From Accrual to Cash
For companies eligible to convert to the cash-basis method under the new rules, the change falls under the automatic change request provisions. That means that you do not need to pay a big filing fee and wait for a decision from the IRS.
Informed taxpayers should file Form 3115, Application for Change in Accounting Method by the tax return due date, including extensions, for the tax year in which the change applies. For example, DME suppliers taxed as partnerships (Form 1065) wishing to make changes to their accounting method for the 2018 tax year have until March 15, 2019, (September 15, 2019, if extended).
Talk to your tax preparer to discuss your specific situation. If you have any questions, give us a shout.
Form 3115, Application for Change in Accounting Method
Treasury Regulation Sec. 1.446-1(c)(2)(i)
IRC Sec. 448(c)
IRC Sec. 471(c)(1)
IRC Sec. 471(c)(3)
IRS Revenue Procedure 2001-10
IRS Revenue Procedure 2002-28
IRS Revenue Procedures 2015-13
IRS Revenue Procedure 2018-40
Treasury Regulation Sec. 1.162-3