In a letter sent to the Senate Finance Committee last week, a coalition of six business organizations, including the American Institute of CPAs (AICPA), emphasized their opposition to a proposal that would force many of the groups’ members to use the accrual method of accounting instead of the cash method of accounting for tax purposes.
Under the cash method of accounting, the business records transactions only when cash changes hands, while the accrual method requires the business to record transactions when they occur, even if no cash changes hands.
The proposal was made last November by Senate Finance Committee Chairman Max Baucus (D-MT), who is not seeking re-election and will likely become the next US ambassador to China. As part of his quest for comprehensive tax reform, Baucus released a series of drafts that covered a restructuring of the international tax system, tax administration and fraud-prevention techniques, and cost-recovery deductions.
Under Baucus' tax accounting proposal, businesses with average annual gross receipts for a three-year taxable period of $10 million or less could elect to adopt either the cash method or the accrual method of accounting, “regardless of whether inventory is a material income-producing factor in the business,” according to the senator.
However, businesses – including farmers and personal business corporations – that do not meet the three-year gross receipts threshold would be required to adopt the accrual method.
The AICPA had already sent one letter to Baucus and Senate Finance Committee Ranking Member Orrin Hatch (R-UT) expressing their opposition to the proposed limitations on the use of the cash method. In a letter sent to both senators on January 17, the AICPA and five other groups – the American Council of Engineering Companies, American Dental Association, American Institute of Architects, American Farm Bureau Federation, and the S Corporation Association – wrote that a change from the cash basis method “would result in those who own and operate these businesses to pay tax before cash is received.”
“They would be required to recognize revenue in advance of actually getting paid,” the letter stated. “Because the expenses of such organizations would essentially remain the same, this requirement would result in higher net-taxable income for federal tax purposes.”
In addition, the six organizations wrote that switching from the cash method to the accrual method will lead to significant cash-flow problems for the affected companies.
“For example, among professional services firms, the primary cost is labor, and businesses must regularly pay their employees even if they are not paid by their clients for several months,” the letter stated. “The use of cash accounting helps to mitigate this challenge by allowing the business’ owners to make tax payments after receiving payment for their services.”
Under Baucus’ proposal, the gross receipts test would increase from $5 million to $10 million for all businesses to continue using the cash basis method – for which the groups wrote “is a welcome change.”
“Farms and businesses operating in the personal service sector – which include accounting firms, law firms, medical and dental practices, architecture firms, engineering firms, and others – should be allowed to continue to use the cash basis method for paying federal taxes,” the letter stated. “We strongly oppose requiring these personal service entities to use the accrual method and lowering the current $25 million threshold for farms.”
While the six business organizations lauded the two senators’ work on tax reform and simplifying the tax code, they concluded their letter by saying converting from the cash method to the accrual method of accounting “would not be simpler and may actually create a significant burden on these professional services sector businesses and farms.”