Many taxpayers do not realize they have a choice when it comes to how they report revenue and expenses on their annual tax filings.
Recent changes to the tax code allow more businesses the opportunity to change how they report revenue. For some businesses, this could mean large one-time deductions, which can be very helpful for companies who are strapped for cash.
Generally, there are two ways to report income and expenses: Cash and Accrual
Here’s what you need to know about each reporting method:
Very simply, cash basis taxpayers report income when money is received, and they report expenses when money goes out. It’s the most straightforward method of accounting out there and is used by the majority of companies.
Taxpayers using the accrual basis method of accounting report income and expenses as they accrue. For example, once money is earned or an invoice is sent to a client, the company recognizes that amount as revenue – even before the cash is received.
On the flip side, invoices received for expenses are recognized as expenses even before those invoices are paid.
These two examples represent accounts receivable and accounts payable, respectively.
What is the Benefit of Each Method?
The answer depends on your business. Many small businesses would be better served using the cash method simply because it’s easier and may help reduce taxes. It also allows for a simple look at a company’s cash position without having to consider receivables and payables.
Larger businesses (or those who are required to carry inventory on their books) are typically better off using the accrual method of accounting.
Accrual accounting allows companies to get a more realistic idea of income and expenses during a certain time period and generally allows for a more accurate picture of how a company is performing. Most public companies file taxes on an accrual basis.
Why Don’t all Small Businesses Report on a Cash Basis
Before the Tax Cuts and Jobs Act (TCJA) of 2017, many small businesses were actually required to file taxes using the accrual method. The TCJA dramatically increased the number of companies exempt from this requirement. It also laid out a process for companies to make an automatic change to their accounting method under the new rules.
Should You Change Your Accounting Method?
For companies that are now eligible to switch to the cash method, the conversion could offer a large one-time tax deduction. This is heavily dependent on accounts receivable and accounts payable on the books, and how much has racked up through the years.
Want to learn more about which accounting method is right for you? Contact Cunningham and Associates today to learn more about how you can maximize your deductions. Call us at (508) 797-5003 to see how much you can save.