Among the many significant tax law changes in the Tax Cuts and Jobs Act (TCJA), some of the most far-reaching revisions involved raising the gross receipts tests for various small-business exemptions. Contractors that qualify for these exemptions should make sure they are taking full advantage of the newer, more favorable provisions.
Cash vs. Accrual
Before 2018, pass-through entities such as S corporations and partnerships were required to use the accrual method of accounting for tax purposes once their annual gross receipts exceeded $10 million in any given year. For C corporations the ceiling was $5 million.
The new law raised that threshold significantly, redefining a small business as a corporation or partnership with less than $25 million in average gross receipts for the prior three years. The increased threshold created opportunities for more contractors to take advantage of the cash method of accounting for tax purposes.
Under cash method accounting, businesses do not recognize income until money is received, not when they send the invoice. That means federal income taxes can be deferred until the money is in hand. This deferral can be particularly beneficial in the construction industry, where the lag between billing and payment can be quite long.
Accounting for Long-Term Contracts
The TCJA made the same changes in revenue thresholds for determining how contractors must account for long-term contracts. Previously, contractors with gross receipts greater than $10 million ($5 million for C corporations) were required to use the percentage-of-completion method for federal tax purposes, recognizing revenue in increments over the course of a project as they completed various milestones.
Under the new rules, contractors with average annual gross receipts under $25 million can choose from other methods, including the completed contract method. Like the switch to cash basis accounting, this change allows more contractors to defer revenue recognition for tax purposes.
Many contractors will still want to use the accrual and percentage-of-completion methods for business management and financial reporting, and some states’ income tax rules will vary from the federal code. Nevertheless, making the switch to these more favorable methods for federal income tax purposes is a relatively simple step that can deliver significant cash flow benefits to contractors with revenues below the $25 million threshold.