5 Takeaways from IRS Small Business Accounting Method Regulations Update
The IRS has issued final regulations to implement the changes to the accounting method rules made by the Tax Cuts and Jobs Act (TCJA). The intersection where these changes and the Michigan Marijuana Tax Act Meet should be of particular importance to operators and practitioners alike. Here’s why:
The new changes affect Sections 263A and 471- Section 263A (Uniform Capitalization or Unicap) requires the taxpayer producing or acquiring tangible property for resale to capitalize certain direct and indirect costs to the basis of the property. Cannabis operators seeking to minimize their taxable income should carve out a tax strategy that maximizes the cost of goods sold through inventory capitalization. Section 471 provides taxpayers with inventories, an accounting method that classifies most of their expenditures as inventorial costs – thus avoiding Section 280E. Before the enactment, taxpayers adhering strictly to Section 471’s wording were required to maintain two separate cost accounting systems - one for financial statement purposes and another purposed for tax. The new rules aim to simplify this recordkeeping.
Cash v. Accrual – The new regulations guide whether taxpayers are to employ the accrual accounting method or whether the much simpler cash method is applicable. Under the accrual accounting method, a business records transactions regardless of the economic substance (e.g., recognizing income on its income statement before it collects the cash). The cash method of accounting calls for companies to record revenue and spending after funds have been exchanged. The new regulation removes the requirement that companies follow the principles of accrual accounting – eliminating the need for omnibus financial statements and the obligation to pay tax on uncollected revenue.
Expanded the Field – Whereas the old rules restricted the use of Section 471’s alternative tax accounting concepts to firms with gross revenues under $1M, the new rules now offer expanded protections for firms with gross revenues under $25M. The expansion of the considered class is of particular importance to Michigan Cannabis operators who can easily eclipse sales of $1M per month.
AFS – TCJA amended both Section 263A and Section 471 so that a small business taxpayer now holds an exemption permitting them to account for their inventory using accounting method reflected on their applicable financial statement. Michigan Marijuana operators should find favorable this provision in light of the annual AFS requirement.
Applicable Dates - The final regulations are applicable for tax years beginning on or after the day the final regulations are published in the Federal Register. The taxpayer may apply the final regulations for a tax year between December 31, 2017, and the final regulations are published in the Federal Register, provided that if the taxpayer applies any aspect of the final regulations under a particular Code provision. For example, a taxpayer that wants to be exempt from capitalizing costs under the new Code Sec. 263A or exempt from the general inventory rules of Cod Sec. 471(a) must both apply Reg §1.448-2 to determine whether it is eligible for the exemption.
While businesses can still defer revenue, 280(e) still applies to leave deductions off the table for plant-touching companies. Even holding companies that multiple operating licenses will fail to qualify for Sec 471 once revenues surpass $25M. Companies must retain representation and counsel to advise them on expanding tax terrain the challenges inevitable to the cannabis industry.