Manufacturing Monitor, Part I: New Cash Basis Options

*This is the first in a series of articles addressing the impact of the TCJA on the Manufacturing industry.

TCJA: A Recap

The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. Many of these new or altered provisions directly affect manufacturers, and in this and subsequent articles of a series of articles, Monitoring Manufacturing: Effects of the New Tax Code, I’ll address those likely to have the most impact on our industry.

Pros & Cons of Cash Basis Accounting

One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting. Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred.

The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

Who is eligible?

The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of inventory for tax purposes. Combining these opportunities could yield considerable benefits.

The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. It is likely that many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK CPAs & Consultants' Manufacturing team at (330) 758-8613.

About the Author(s)

Jim is a Principal of HBK CPAs & Consultants and the National Director of HBK Manufacturing Solutions, a group of specialists focused on manufacturing clients and their unique needs.

After joining the firm in 1988, Jim has spent his career working in a variety of industries, including manufacturing and distribution. As the National Director of HBK Manufacturing Solutions, Jim advises manufacturing clients on issues including tax planning, finance, succession planning, mergers and acquisitions, and ESOP transitions. In addition, he shares his knowledge and experiences with manufacturing specialists throughout the firm as well as local and regional organizations and trade associations focused on the manufacturing industry. To recognize his accomplishments, Jim was named Business Professional of the Year in August 2019 by the Youngstown Warren Regional Chamber of Commerce.

In addition to his HBK role, Jim is Chairman of the Board of the Youngstown Business Incubator, an internationally recognized incubator focused on programs including the use of additive manufacturing and advanced manufacturing technologies in the Mahoning Valley and Northeast Ohio.

Jim’s accomplishments include:

  • Evaluating and implementing strategies including the LIFO (last-in, first-out) inventory accounting method, cash basis accounting method, research & development tax credits, Interest Charge Domestic International Sales Corporations (IC-DISC), and cost segregation studies with manufacturing clients in a variety of sub-industries.
  • Supporting clients with cash flow projections and financial statement projections, including companies with annual revenues in excess of $100 million dollars.
  • Assisting a company in securing an asset-based line of credit with a financial institution for $30 million dollars.
  • Helping companies analyze state income and sales tax filings requirements in order to minimize liability and maximize compliance.
  • Aiding a manufacturing client in obtaining state tax credits based on their investment in expanding their manufacturing capabilities.
  • Representing clients before the Internal Revenue Service and state and local taxing authorities.
  • Developing a training program for the HBK Manufacturing Solutions team, to improve internal capabilities and overall manufacturing expertise.
  • Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.